THE DOCUMENT COMPANY
XEROX
Anne M. Mulcahy
Chairman and Chief Executive Officer
Fellow Shareholders:
Enclosed is our Annual Report for 2001. As you know, it was delayed in
order to give us time to comply with the terms of a settlement we reached with
the Securities and Exchange Commission in April. As part of the settlement we
agreed to restate our results for the years 1997 to 2000 and to adjust our 2001
results. That process has now been completed -- essentially ending a painful
chapter in our history and giving us a solid foundation on which to report our
progress to you now and in the future.
While our accounting issues with the SEC have been attracting all the
headlines, we have been quietly and aggressively restoring our operations to
good health. As of this writing, we have approximately $1.8 billion cash on
hand. We have successfully renegotiated our "revolver" -- our line of credit
with our banks. We have taken actions to take more than $1.2 billion out of our
cost base over a 20-month period. We have shed non-core assets to raise $2.4
billion in cash and increase our focus on the core business. And we have entered
into a series of agreements -- primarily with GE Capital -- to outsource the
financing of our customer receivables.
Even as we cut costs and pruned operations, we have been steadfastly
investing in our future. This year marks one of the biggest product introduction
years in our history led by the DocuColor iGen3 Digital Production Press -- our
third generation digital color press that promises to revolutionize the industry
and drive the new business of printing. A fleet of other new products, solutions
and services -- trumpeted by aggressive marketing and communication plans -- are
all aimed at putting Xerox back on a growth trajectory. And we are focusing all
our resources and attention on three key markets --- production, the office and
services. All three build from our core strengths, proven track record and
customer needs. And all three will give us ample opportunity for profitable
growth.
We have been tested to be sure, but with a new management team in place
we are prepared to take on the challenges of the future with a renewed sense of
purpose and optimism.
You put a lot of faith in us. I take that very seriously. And I insist
that all our people do as well. We have too much opportunity in front of us to
fail. And we're eager to give you a good return on your trust. Our objective
this year is to restore our financial strength and to continue to position Xerox
for future growth.
Our best days are still ahead of us. Thank you for the confidence you
have placed in us. Our collective task at Xerox is to continue to earn that
confidence and to give you a good return on your investment.
/s/ ANNE M. MULCAHY
Anne M. Mulcahy
Chairman and Chief Executive Officer
Xerox Corporation
800 Long Ridge Road [LOGO]
Stamford, Connecticut 06904 XEROX
Telephone 203.968.3553 Worldwide Partner
1
INDEX TO FINANCIAL SECTION
Report of Management
FINANCIAL REVIEW
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Introduction
Restatement of Prior Year Financial Statements
Settlement with the Securities and Exchange Commission
Application of Critical Accounting Policies
Financial Overview
Summary of Total Company Results
Revenues by Type
Gross Margin
Research and Development
Selling, Administrative and General Expenses
Restructuring Programs
Other Expenses, Net
Gain on Affiliate's Sale of Stock
Income Taxes and Equity in Net Income of Unconsolidated Affiliates
Manufacturing Outsourcing
Divestitures
Acquisition of the Color Printing and Imaging Division of Tektronix,
Inc.
Business Performance by Segment
New Accounting Standards
Capital Resources and Liquidity
Liquidity, Financial Flexibility and Funding Plans
Actions Taken to Address Liquidity Issues
Cash and Debt Positions
Plans to Strengthen Liquidity and Financial Flexibility Beyond 2002
Contractual Cash Obligations and Other Commercial Commitments and
Contingencies
Other Funding Arrangements
Cash Management
Financial Risk Management
Forward-Looking Cautionary Statements
AUDITED FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Common Shareholders' Equity
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
2. Restatement
3. Restructuring Programs
4. Acquisitions
5. Divestitures
6. Receivables, Net
7. Inventories and Equipment on Operating Leases, Net
8. Land, Buildings and Equipment, Net
9. Investments in Affiliates, at Equity
10. Segment Reporting
11. Discontinued Operations
12. Debt
2
13. Financial Instruments
14. Employee Benefit Plans
15. Income and Other Taxes
16. Litigation and Regulatory Matters
17. Preferred Securities
18. Common Stock
19. Earnings Per Share
20. Subsequent Events
OTHER DATA
Quarterly Results of Operations
Five Years in Review
3
REPORT OF MANAGEMENT
Xerox Corporation management is responsible for the integrity and objectivity of
the financial data presented in this annual report. The consolidated financial
statements were prepared in conformity with generally accepted accounting
principles in the United States of America and include amounts based on
management's best estimates and judgments.
The Company maintains an internal control structure designed to provide
reasonable assurance that assets are safeguarded against loss or unauthorized
use and that financial records are adequate and can be relied upon to produce
financial statements in accordance with generally accepted accounting
principles. This structure includes the hiring and training of qualified people,
written accounting and control policies and procedures, clearly drawn lines of
accountability and delegations of authority. In a business ethics policy that is
communicated annually to all employees, the Company has established its intent
to adhere to the highest standards of ethical conduct in all of its business
activities.
The Company monitors its internal control structure with direct management
reviews and a comprehensive program of internal audits. In addition,
PricewaterhouseCoopers LLP, independent accountants, have audited the 2001, 2000
and 1999 consolidated financial statements and have reviewed the internal
control structure to the extent they considered necessary to support their
report, which follows.
The Audit Committee of the Board of Directors, which is composed solely of
outside directors, meets regularly with the independent accountants, the
internal auditors and representatives of management to review audits, financial
reporting and internal control matters, as well as the nature and extent of the
audit effort. The Audit Committee also recommends the engagement of independent
accountants. The independent accountants and internal auditors have free access
to the Audit Committee.
/s/ Anne M. Mulcahy /s/ Lawrence A. Zimmerman /s/ Gary R. Kabureck
Anne M. Mulcahy Lawrence A. Zimmerman Gary R. Kabureck
Chairman and Chief Senior Vice President and Assistant Controller and
Executive Officer Chief Financial Officer Chief Accounting Officer
4
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Introduction. In this Management's Discussion and Analysis of Results of
Operations and Financial Condition (MD&A) we begin by describing the matters
considered by management to be important to an understanding of the results of
our operations and our capital resources and liquidity as of and for the three
years ended December 31, 2001. This section begins with a discussion of our
recent settlement with the Securities and Exchange Commission (SEC) regarding
accounting issues that had been under investigation since June 2000. The
discussion includes the financial effects of the related restatement.
Immediately following, is a new disclosure for most companies this year. It is
an analysis of the critical accounting policies which affect the recognition and
measurement of our transactions and the balances in our consolidated financial
statements. In this section, we review the critical accounting judgments and
estimates which we believe are most important to an understanding of the MD&A
and the Consolidated Financial Statements. We then analyze the results of our
operations for the last three years including the trends in the overall business
and our operating segments including our Turnaround Program and important
transactions and events such as asset sales. This section concludes with a
summary of recent accounting pronouncements which will have an impact on our
financial accounting practices. Thereafter, we discuss our cash flows and
liquidity, capital markets events and transactions, debt ratings, our new credit
facility, derivatives, our transition to vendor financing, special purpose
entities, contractual commitments and related issues. The MD&A concludes with
important forward-looking cautionary statements.
Restatement of Prior Years Financial Statements. We have determined that certain
of our accounting practices misapplied U.S. generally accepted accounting
principles (GAAP). Accordingly, we have restated our financial statements for
the four years ended December 31, 2000 and revised our previously announced 2001
results included in our earnings release dated January 28, 2002. Throughout this
MD&A, the term "previously reported" will be used to refer to our previously
filed 1997-2000 Financial Statements as well as our previously announced 2001
results. The restatement adjustments relate almost exclusively to the timing of
revenue and expense recognition. We reversed cumulative net revenue of $1.9
billion that was recognized in prior years, of which $1.3 billion is reflected
in the years 1997 to 2001. This revenue adjustment is comprised of a reduction
in equipment sales revenue, previously recognized from 1997 through 2001, of
$6.4 billion offset by $5.1 billion of service, rental, document outsourcing and
financing revenue now recognized from 1997 through 2001. The remaining net
amount of revenue reversed, of $600 million, represents the cumulative net
revenue impacts of reversing equipment sales transactions that were previously
recorded in periods prior to 1997. Based on the cumulative impacts of the
revenue adjustments for all periods prior to December 31, 2001, including
pre-1997 impacts, we anticipate the recognition of $1.9 billion in revenues over
the next several years through 2006. This represents sales-type lease revenue
that had previously been recorded, that is expected to be earned over time as a
component of our rental, service and finance revenue. In addition to the
aforementioned revenue timing adjustments, and as more fully discussed below, we
permanently reduced reported revenue by $269 million, for the five-year period
ended December 31, 2001, as a result of the deconsolidation of our South African
affiliate. Revenues from 1997 through 2001 as originally reported were $92.6
billion compared to $91.0 billion after the restatement. Substantially all
non-revenue items included in the restatement have reversed within the five-year
period ended December 31, 2001; our liquidity is not impacted since the
restatement items reflect timing differences. As of December 31, 2001 our
restated Common Shareholders' Equity is $1.8 billion versus $3.1 billion as
originally included in our January 28, 2002 earnings release.
Settlement with the Securities and Exchange Commission. On April 11, 2002, we
reached a settlement with the SEC relating to matters that had been under
investigation by the SEC since June 2000. We believe the settlement is in the
best interests of our shareholders, customers, employees and other stakeholders
because it resolves these matters - eliminating the distraction and risk
associated with potential SEC litigation - thereby enabling us to focus on
continuing to improve our operations and restore the Company's financial health.
In addition, as a result of the settlement with the SEC, we are undertaking a
review of our material internal accounting controls and accounting policies to
determine whether any additional changes are required in order to provide
additional reasonable assurance that the types of accounting errors that
occurred are not likely to reoccur.
The restatement reflects adjustments which are corrections of errors made in the
application of GAAP and includes (i) adjustments related to the application of
the provisions of Statement of Financial Accounting Standards No. 13 "Accounting
for Leases" (SFAS No. 13) and (ii) adjustments that arose as a result of other
errors in the application of GAAP. In making these restatements we have
conducted an extensive review of all significant transactions, accounting
policies and procedures and disclosures for the period 1997 through 2001. The
principal adjustments are discussed below.
5
Application of SFAS No. 13:
Revenue allocations in bundled arrangements: We sell most of our products and
services under bundled lease arrangements which contain multiple deliverable
elements. These multiple element arrangements typically include separate
equipment, service, supplies and financing components for which a customer pays
a single fixed negotiated price on a monthly basis, as well as a variable amount
for page volumes in excess of stated minimums. The restatement primarily
reflects adjustments related to the allocation of revenue and the resultant
timing of revenue recognition for sales-type leases under these bundled lease
arrangements.
The methodology we used in prior years for allocating revenue to our sales-type
leases involved first, estimating the fair market value of the service and
financing components of the leases. Specifically, with respect to the financing
component, we estimated the overall interest rate to be applied to transactions
to be the rate we targeted to achieve a fair return on equity for our financing
operations. This is effectively a discounted cash flow valuation methodology. In
estimating this interest rate we considered a number of factors including our
cost of funds, debt levels, return on equity, debt to equity ratios, income
generated subsequent to the initial lease term, tax rates, and the financing
business overhead costs. We made service revenue allocations based, primarily,
on an analysis of our service gross margins. After deducting service and finance
values from the minimum payments due under the lease, the equipment value was
derived. These allocation procedures resulted in adjustments to values initially
reflected in our accounting systems, such that values attributed to the service
and financing components were generally decreased and the values assigned to the
equipment components were generally increased.
The SEC staff advised us of its view that our previous methodology, as described
above, did not comply with the requirements of SFAS No. 13. SFAS No. 13 requires
us to use the discount rate which causes the aggregate present value of the
minimum lease payments, excluding executory and service income, and any
unguaranteed residual value, to equal the fair value of the equipment. However,
our revenue allocation processes with respect to the principal (i.e., equipment)
and interest components of our leases did not begin with the estimated fair
value of the equipment, and did not treat unearned finance income as the derived
value.
We have determined that the previous allocation methodology was not in
accordance with SFAS No. 13, therefore, we have utilized a different methodology
to account for our sales-type leases involving multiple element arrangements.
This methodology begins by determining the fair value of the service component,
as well as other executory costs and any profit thereon, and second, by
determining the fair value of the equipment based on a comparison of the
equipment values in our accounting system to a range of cash selling prices. The
resultant implicit interest rate is then compared to fair market value rates to
assess the reasonableness of the overall allocations to the multiple elements.
We conducted an extensive analysis of available verifiable objective evidence of
fair value (VOE) based on cash sales prices and compared these prices to the
range of equipment values recorded in our lease accounting systems. With the
exception of Latin America, where operating lease accounting is applied as
discussed below, the range of cash selling prices supports the reasonableness of
the range of equipment lease prices as originally recorded, at inception of the
lease, in our accounting systems. In applying our new methodology described
above, we have therefore concluded that the revenue amounts allocated by our
accounting systems to the equipment component of a multiple element arrangement
represents a reasonable estimate of the fair value of the equipment. As a
consequence, $2.4 billion of previously recorded equipment sale revenue during
the five years ended December 31, 2001 has been reversed and we have recognized
additional service revenue and finance income of $1.7 billion, which represents
the impact of reversing amounts previously recorded as equipment sales-type
leases and recognizing such amounts over the lease term. The net cumulative
reduction in revenue, as a result of this change, was $641 million for the
five-year period ended December 31, 2001. In total approximately $840 million of
revenue previously recognized has been reversed and will be recognized in future
years, estimated as follows: $410 million - 2002, $260 million - 2003 and $170
million - thereafter.
Transactions not qualifying as sales-type leases: We re-evaluated the
application of SFAS No. 13 for leases originally accounted for as sales-type
leases in our Latin American operations, and we determined that these leases
should have been recorded as operating leases. This determination was made after
we conducted an in-depth review of the historical effective lease terms compared
to the contractual terms of our lease agreements. Since, historically, and
during all periods presented, a majority of leases were terminated significantly
prior to the expiration of the contractual lease term, we concluded that such
leases did not qualify as sales-type leases under certain provisions of SFAS No.
13. Specifically, because we generally do not collect the receivable from the
initial transaction upon termination of the contract or during the subsequent
lease term, the recoverability of the lease investment was not predictable at
the inception of the original lease term. The accounting for these transactions
as sales-type leases is further complicated due to our very high market shares
in many of these countries, which makes it difficult to establish a reasonable
basis for estimating the fair value of the equipment component of our leases due
to a lack of available VOE. In addition historical and continuing economic and
political instability in many of these countries also raises concerns about
reasonable assurance of collectibility. As a consequence, $2.8 billion of
previously
6
recorded equipment sale revenue during the five years ended December 31, 2001
has been reversed and we have recognized additional rental revenue of $2.2
billion, which represents the impact of changing the classification of
previously recorded sales-type leases to operating leases. The net cumulative
reduction in revenue, as a result of this change, was $633 million for the
five-year period ended December 31, 2001. In total, approximately $800 million
of revenue previously recognized has been reversed and will be recognized in
future years, estimated as follows: $240 million - 2002, $240 million - 2003 and
$320 million - thereafter.
During the course of the restatement process, we concluded that the estimated
economic life used for classifying leases for the majority of our products
should have been five years versus the three to four years we previously
utilized. This resulted from an in-depth review of our lease portfolios, for all
periods presented, which indicated that the most frequent term of our lease
contracts was 60 months. We believe that this has been and is representative of
the period during which the equipment is expected to be economically usable,
with normal repairs and maintenance, for the purpose for which it was intended
at the inception of the lease. As a consequence, many shorter duration leases
did not meet the criteria of SFAS No. 13 to be accounted for as sales-type
leases. Additionally, other lease arrangements were found to not meet other
requirements of SFAS No. 13 for treatment as sales-type leases. As a
consequence, $588 million of equipment revenue recorded during the five years
ended December 31, 2001 has been reversed and we have recognized additional
rental revenue of $387 million, which represents the impact of changing the
classification of previously recorded sales-type leases to operating leases. The
net cumulative reduction in revenue, as a result of this change, was $201
million for the five-year period ended December 31, 2001. In total approximately
$140 million of revenue previously recognized has been reversed and will be
recognized in future years, estimated as follows: $70 million - 2002, $40
million - 2003 and $30 million - thereafter.
Accounting for the sale of equipment subject to operating leases: We have
historically sold pools of equipment subject to operating leases to third party
finance companies (the counterparties) or through structured financings with
third parties and recorded the transaction as a sale at the time the equipment
is accepted by the counterparties. These transactions increased equipment sale
revenue, primarily in Latin America, in 2000 and 1999 by $148 million and $400
million, respectively. Upon additional review of the terms and conditions of
these contracts, it was determined that the form of the transactions at
inception included retained ownership risk provisions or other contingencies
that precluded these transactions from meeting the criteria for sale treatment
under the provisions of SFAS No. 13. The form of the transaction
notwithstanding, these risk of loss or contingency provisions have resulted in
only minor impacts on our operating results during the five years ended December
31, 2001. These transactions have however been restated and recorded as
operating leases in our consolidated financial statements. As a consequence $569
million of equipment revenue recorded during the five years ended December 31,
2001 has been reversed and we have recognized additional rental revenue of $670
million, which represents the impact of changing the previously recorded
transactions to operating leases. The net cumulative increase in revenue as a
result of this change was $101 million for the five-year period ended December
31, 2001. In total approximately $110 million of revenue previously recognized
has been reversed and will be recognized in future years, estimated as follows:
$80 million - 2002 and $30 million - 2003. Additionally, for transactions in
which cash proceeds were received up-front we have recorded these proceeds as
secured borrowings. The remaining balance of these borrowings aggregated $55
million at December 31, 2001.
In summary and in connection with the restatement of reported results of
operations regarding accounting for leases, our policy is to now measure the
reasonableness of estimates of fair values of leased equipment by comparison to
VOE from cash sales of the same or similar equipment or on the basis of other
objective evidence of fair value. Going forward, due to a change in business
model, we expect equipment sales in Latin America will either be for cash or
will be financed by third party financial institutions. In connection with
negotiations underway with third parties, we anticipate substantially exiting
our financing business. Our business processes and the terms of our third party
financing contracts may result in our customer transactions being initially
recorded as leases in our financial statements prior to being sold to the
financing companies. The accounting effect may require us to account for
transactions with third party finance companies as sales of the underlying
leases, and to recognize gains or losses on the sales of such leases as they are
sold.
Other adjustments:
In addition to the aforementioned revenue related adjustments, other errors in
the application of GAAP were identified. These include the following:
Sales of receivables transactions: During 2001 and 1999, we sold approximately
$2.0 billion of U.S. finance receivables originating from sales-type leases
($1.4 billion in 1999 and $600 million in 2001). These transactions were
originally accounted for as sales of receivables. These sales were made to
special purpose entities (SPEs), which qualified for non-consolidation in
accordance with then existing accounting requirements. As a result of the
changes in the estimated economic life of our equipment to five years, certain
leases transferred in these transactions did not meet the sales-type lease
requirements and were accounted for as operating leases. This change in lease
classification affected a number of the leases
7
that were sold into the aforementioned SPEs resulting in these entities now
holding operating leases as assets. This change disqualified the SPEs from
non-consolidation and effectively required us to record the proceeds received on
these sales as secured borrowings. This increased our debt by $490 million, $418
million and $950 million as of December 31, 2001, 2000 and 1999, respectively.
These transactions are also discussed in Note 6 to the Consolidated Financial
Statements. This change has no effect on our liquidity or amounts due to the
SPEs from the Company.
During 1999, we sold $288 million of accounts receivables to financial
institutions. Upon additional review of the terms and conditions of these
transactions, we determined that $57 million (including $14 million which was
restated in connection with the prior restatement of our financial statements)
did not qualify for sale treatment as a result of our agreeing to reacquire the
receivables in 2000. Accordingly, we have restated our previously reported
results for these transactions and they are now reported in our Consolidated
Financial Statements as short-term borrowings. This change increased Accounts
receivable, net and debt by $57 million as of December 31, 1999; the
transactions were settled in early 2000. No similar transactions have occurred
since 1999.
South Africa deconsolidation: We determined that we inappropriately consolidated
our South African affiliate since 1998 as the minority joint venture partner has
substantive participating rights. Accordingly, we have deconsolidated all
assets, liabilities, revenues and expenses. We now account for this investment
on the equity method of accounting. The cumulative reduction in revenues through
December 31, 2001 was $269 million and there was no impact on net income or
Common Shareholder's Equity.
Purchase accounting reserves: In connection with the 1998 acquisition of XL
Connect Solutions, Inc. (XLConnect), we recorded liabilities aggregating $65
million for contingencies identified at the date of the acquisition. During 2000
and 1999, we determined that certain of these contingent liabilities were no
longer required, and $29 million of the liabilities were either reversed into
income or we charged certain costs related to ongoing activities of the acquired
business against these liabilities. Upon additional review we determined that
approximately $51 million of these contingent liabilities did not meet the
criteria to initially be recorded as acquisition liabilities. Accordingly, we
have adjusted the goodwill and liabilities at the date of acquisition and
corrected the 2000 and 1999 income statement impacts.
Restructuring reserves: During 2000 and 1998, we recorded restructuring charges
associated with our decisions to exit certain activities of the business. Upon
additional review we determined that certain adjustments made to the original
charges were not in accordance with GAAP. The adjustments to increase pre-tax
loss in 2001 of $87 million and decrease pre-tax loss in 2000 of $65 million
consist primarily of corrections to the timing of the release of reserves
originally recorded under the March 2000 restructuring program. We should have
reversed the applicable reserves in late 2000 when the information was available
that our original plan had changed indicating that such reserves were no longer
necessary. Previously, the reversal was recorded in early 2001. Similarly, the
adjustment of $12 million to decrease 1999 pre-tax income relates primarily to
the inappropriate release of restructuring reserves which should have been
recorded in 1998 based on information available at the time. The adjustments to
reduce the 1998 restructuring provisions of $138 million related to charges
which did not meet the criteria to be recorded as part of the initial
restructuring reserves. Such charges did not qualify as exit costs or
appropriate separation costs in accordance with the accounting guidance
governing restructuring actions. In total, these adjustments increased pre-tax
income by $104 million for the five year period ended December 31, 2001.
Tax refunds: In 1995, we received a final favorable court decision that entitled
us to refunds of certain tax amounts paid in the U.S., plus accrued interest on
the tax. The court established the legal precedent upon which the refunds were
to be based. We recorded the income associated with the tax refunds and the
related interest from 1995 through 1999. We determined that the benefit should
have been recorded in periods prior to 1997. These adjustments decreased pre-tax
income by $153 million for the five year period ended December 31, 2001.
Other adjustments: In addition to the above items and in connection with our
review of prior year's financial records we determined that other accounting
errors were made with respect to the accounting for certain non-recurring
transactions, the timing of recording and reversing certain liabilities and the
timing of recording certain asset write-offs. We have restated our 2000 and 1999
Consolidated Financial Statements, and revised our previously announced 2001
results for such items. These adjustments decreased pre-tax income by $290
million for the five year period ended December 31, 2001.
The following table presents the effects of the aforementioned adjustments on
total revenue:
Increase (decrease) to total revenue:
(in millions)
Year ended December 31,
-----------------------
8
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Revenue, previously reported $ 16,502 $ 18,701 $ 19,567 $ 19,593 $ 18,225
Application of SFAS No. 13:
Revenue allocations in bundled arrangements 65 (78) (257) (284) (87)
Latin America - operating lease accounting 187 (58) 57 (358) (461)
Other transactions not qualifying as sales-type leases 73 57 (60) (119) (152)
Sales of equipment subject to operating leases 197 124 (243) 67 (44)
-------- -------- -------- -------- --------
Subtotal 522 45 (503) (694) (744)
Other revenue restatement adjustments:
Sales of receivables transactions 42 61 (6) -- --
South Africa deconsolidation (66) (72) (71) (60) --
Other revenue items, net 8 16 8 (62) (24)
-------- -------- -------- -------- --------
Subtotal (16) 5 (69) (122) (24)
Increase (decrease) in total revenue 506 50 (572) (816) (768)
-------- -------- -------- -------- --------
Revenues, restated $ 17,008 $ 18,751 $ 18,995 $ 18,777 $ 17,457
======== ======== ======== ======== ========
The following table presents the effects of the aforementioned adjustments on
sales revenue:
Increase (decrease) to sales revenue:
(In millions)
Year ended December 31,
-----------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Revenue allocations in bundled arrangements $ (440) $ (541) $ (650) $ (508) $ (233)
Latin America - operating lease accounting (125) (459) (300) (902) (1,007)
Other transactions not qualifying as sales type leases (31) (74) (160) (162) (161)
Sales of equipment subject to operating leases 33 (111) (342) (20) (129)
South Africa deconsolidation (27) (31) (30) (25) -
Other revenue items, net 5 (4) 8 (55) (22)
-------- -------- -------- -------- --------
Decrease in sales revenue $ (585) $(1,220) $(1,474) $ (1,672) $ (1,552)
======== ======== ======== ======== ========
In total, approximately $1.9 billion of revenue recognized in years 2001 and
prior has been reversed and is estimated to be recognized as follows: $800
million - 2002, $570 million - 2003 and $530 million - thereafter.
The following table presents the effects of the aforementioned adjustments on
pre-tax income (loss): Increase (decrease) to pre-tax income (loss):
(in millions)
Year ended December 31,
-----------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Pre-tax (loss) income, previously reported $(137) $(384) $1,908 $579 $2,005
Revenue restatement adjustments:
Revenue allocations in bundled arrangements 68 (74) (252) (281) (87)
Latin America - operating lease accounting 335 80 39 (238) (354)
Other transactions not qualifying as sales-type leases 54 12 (50) (74) (100)
Sales of equipment subject to operating leases 91 11 (162) 19 (35)
Sales of receivables transactions 12 18 (32) - -
South Africa deconsolidation (10) (11) (8) (6) -
Other revenue items, net 10 12 22 (31) (21)
-------- -------- -------- -------- --------
Subtotal 560 48 (443) (611) (597)
Other restatement adjustments:
9
Purchase accounting reserves (2) (7) (20) - -
Restructuring reserves (87) 65 (12) 138 -
Tax refunds - - (14) (97) (42)
Other, net 31 (89) (131) (22) (79)
-------- -------- -------- -------- --------
Subtotal (58) (31) (177) 19 (121)
Increase (decrease) to pre-tax income (loss) 502 17 (620) (592) (718)
-------- -------- -------- ------- --------
Pre-tax income (loss), restated $ 365 $ (367) $ 1,288 $ (13) $ 1,287
======== ======== ======== ======= ========
The impact of these adjustments on certain key ratios is as follows:
Year ended December 31,
-----------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Sales Gross Margin:
- Previously reported 32.9% 37.5% 43.1% 43.8% 44.5%
- Adjusted and restated 30.5% 31.2% 37.2% 40.5% 39.5%
Service, Outsourcing and Rentals Gross Margin:
- Previously reported 39.4% 37.6% 42.8% 44.4% 47.4%
- Adjusted and restated 42.2% 41.1% 44.7% 46.6% 48.4%
Finance Gross Margin:
- Previously reported 34.6% 34.5% 49.4% 50.1% 48.8%
- Adjusted and restated 59.5% 57.1% 63.0% 58.2% 58.6%
Total Gross Margin:
- Previously reported 36.0% 37.4% 43.3% 44.4% 46.9%
- As adjusted and restated 38.2% 37.4% 42.3% 44.3% 44.8%
Selling, Administrative and General Expenses as a percentage of
revenue:
- Previously reported 29.1% 30.2% 27.0% 27.3% 28.7%
- As adjusted and restated 27.8% 29.4% 27.4% 28.3% 29.8%
These adjustments resulted in the cumulative net reduction of Common
Shareholders' Equity of $1.3 billion as of December 31, 2001. The following
table presents the impact of the restatement adjustments on Common Shareholders'
Equity as of January 1, 1997:
(in millions)
Increase (decrease) in Common Shareholders' Equity:
Common Shareholders' Equity balance -
January 1, 1997, previously reported $ 4,352
-------
Revenue allocations in bundled arrangements (223)
Latin America - operating lease accounting (1,326)
Other transactions not qualifying as sales-type leases 8
Sales of equipment subject to operating leases (49)
Other items, net 285
Income tax impacts of above adjustments 436
-------
Decrease in Common Shareholders' Equity (869)
-------
Common Shareholders' Equity balance -
January 1, 1997, restated $3,483
=======
10
The comparative impacts of changes to the amounts previously reported in our
2000 and 1999 financial statements are included in Note 2 to the consolidated
financial statements. The following tables present the impact of the adjustments
on our previously reported 2001 results on a condensed basis:
Previously As
Reported Adjusted
-------- --------
Year ended December 31, 2001
----------------------------
(in millions, except per share data)
Statement of operations:
Total Revenues $16,502 $17,008
Sales 8,028 7,443
Service, outsourcing, financing and rentals 8,474 9,565
Total Costs and Expenses 16,639 16,643
Net Loss (293) (71)
Diluted Loss per Share $ (0.43) $ (0.12)
Balance Sheet:
Accounts receivable and finance receivables, net $ 6,557 $ 5,818
Inventories 1,345 1,364
Deferred taxes and other current assets 1,451 1,428
Total Current Assets 13,344 12,600
Finance receivables due after one year, net 6,336 5,756
Equipment on operating leases, net 521 804
Land, buildings and equipment, net 1,992 1,999
Other long-term assets 4,365 5,085
Goodwill, net 1,475 1,445
Total Assets 28,033 27,689
Short-term debt and current portion of long-term debt 9,737 6,637
Other current liabilities 3,671 3,623
Total Current Liabilities 13,408 10,260
Long-term debt 6,484 10,128
Other long-term liabilities 2,752 3,251
Total Liabilities 22,644 23,639
Common Shareholders' Equity 3,148 1,820
Total Liabilities and Equity $28,033 $27,689
Application of Critical Accounting Policies. In preparing our financial
statements and accounting for the underlying transactions and balances, we apply
our accounting policies as disclosed in our Notes to Consolidated Financial
Statements. We consider the policies discussed below as critical to an
understanding of our financial statements because their application places the
most significant demands on management's judgment, with financial reporting
results relying on estimation about the effect of matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs. The impact and any associated risks related to
these policies on our business operations is discussed throughout this
Management's Discussion and Analysis where such policies affect our reported and
expected financial results. For a detailed discussion on the application of
these and other accounting policies, see Note 1 to the consolidated financial
statements. Senior management has discussed the development and selection of the
critical accounting estimates and the related disclosure included herein with
the Audit Committee of the Board of Directors. Preparation of this Annual Report
on Form 10-K requires us to make estimates and assumptions that affect the
reported amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our financial statements, and the reported amounts of
revenue and expenses during the reporting period. Actual results may differ from
those estimates.
Revenue Recognition for Sales-Type Leases Under Bundled Arrangements: We sell
most of our products and services under bundled contract arrangements, which
contain multiple deliverable elements. These arrangements typically include
equipment, service and supplies, and financing components for which the customer
pays a single negotiated price for all elements. These arrangements typically
also include a variable service component for page volumes in excess of stated
minimums. When separate prices are listed in multiple element customer
contracts, they may not be representative of the fair values of those elements
because the prices of the different components of the arrangement may be
modified in customer negotiations, although the aggregate consideration may
remain the same. Therefore, revenues under these arrangements are allocated
based upon estimated fair values of each element. Our revenue allocation
methodology first begins by determining the fair value of the service component,
as well as other executory costs and any profit thereon and second, by
determining
11
the fair value of the equipment based on comparison of the equipment values in
our accounting systems to a range of cash selling prices. The resultant implicit
interest rate is then compared to fair market value rates to assess the
reasonableness of the overall allocations to the multiple elements.
Determination of Appropriate Revenue Recognition for Sales-Type Leases: Our
accounting for leases involves specific determination under SFAS No. 13 which
often involve complex provisions and significant judgments. The general criteria
for SFAS No. 13, at least one of which is required to be met in order to account
for a lease as a sales-type lease versus as an operating lease, are (a) whether
ownership transfers by the end of the lease term, (b) whether there is a bargain
purchase option at the end of the lease term which is exercisable by the lessee,
(c) whether the lease term is equal to or greater than at least 75 percent of
the economic life of the equipment and (d) whether the present value of the
minimum lease payments, as defined, are equal to or greater than 90 percent of
the fair market value of the equipment. Criteria (a) and (b) are relatively
minor considerations for qualifying our leases as sales, as we usually do not
employ such contract terms. Under our current product portfolio and business
strategies, generally a non-cancelable lease of 45 months or more qualifies
under the economic life criteria as a sale. Certain of our lease contracts are
customized for larger customers which result in complex terms and conditions and
require significant judgment in applying the above criteria. In addition to
these criteria, there are also other important criteria that are required to be
assessed, including whether collectibility of the lease payments is reasonably
predictable and whether there are important uncertainties related to costs that
we have yet to incur with respect to the lease. In management's opinion, our
sales-type lease portfolios contain only normal credit and collection risks and
have no important uncertainties with respect to future costs.
The critical elements of SFAS No. 13 that we analyze with respect to our lease
accounting are the determination of economic life and the fair value of
equipment, including our estimates of residual values. Accounting for sales-type
lease transactions requires management to make estimates with respect to
economic lives and expected residual value of the equipment in accordance with
specific criteria as set forth in generally accepted accounting principles.
Those estimates are based upon historical experience with economic lives of all
of our equipment products. We consider the most objective measure of historical
experience for purposes of estimating the economic life to be the original
contract term since most equipment is returned by lessees at or near the end of
the contracted term. The most frequent contractual lease term for our principal
products is five years and only a small percentage of our leases are for
original terms longer than five years. Accordingly, we have estimated the
economic life of most of our products to be five years. We believe that this is
representative of the period during which the equipment is expected to be
economically usable, with normal repairs and maintenance, for the purpose for
which it was intended at the inception of the lease. When we originally reported
our 1999 and 2000 results, we had utilized an economic life for our principal
products of three to four years. The increase to five years had the effect of
reducing equipment sale revenue by $37 million, $66 million and $115 million for
the years ended December 31, 2001, 2000 and 1999, respectively. Residual values
are established at lease inception using estimates of fair value at the end of
the lease term. Our residual values are established with due consideration to
forecasted supply and demand for our various products, product retirement and
future product launch plans, end of lease customer behavior, remanufacturing
strategies, used equipment markets (to the extent they exist for the particular
product), competition and technological changes. Since we are the developer,
servicer and frequently the manufacturer of our products, we do not believe we
have any significant risks to recovery of our recognized residual values.
Accounts and Finance Receivables Allowance for Doubtful Accounts and Credit
Losses: We perform ongoing credit evaluations of our customers and adjust credit
limits based upon customer payment history and current creditworthiness, as
determined by our review of our customers' current credit information. We
continuously monitor collections and payments from our customers and maintain a
provision for estimated credit losses based upon our historical experience and
any specific customer collection issues that we have identified. While such
credit losses have historically been within our expectations and the provisions
established, we cannot guarantee that we will continue to experience the same
credit loss rates that we have in the past. Measurement of such losses requires
consideration of historical loss experience, including the need to adjust for
current conditions, and judgments about the probable effects of relevant
observable data, including present economic conditions such as delinquency rates
and financial health of specific customers. In addition to provisions related to
the credit worthiness of our customers, we also record provisions for customer
accommodations, among other things. We recorded $506 million, $613 million and
$450 million in provisions to the Consolidated Statements of Operations for
doubtful accounts for both our accounts and finance receivables for the three
years ended December 31, 2001, 2000 and 1999, respectively.
Historically about half of the provision relates to our finance receivables
portfolio. This provision is inherently more difficult to estimate than the
provision for trade accounts receivable because the underlying lease portfolio
has an average maturity, at any time, of approximately four years and contains
both past due billed amounts, as well as unbilled amounts. Estimated credit
quality of any given customer, class of customer or geographic location can
significantly change during the
12
life of the portfolio. We consider all available information in our quarterly
assessments of the adequacy of the reserves for uncollectible accounts.
Securitization and Transfers of Financial Assets: From time to time, we engage
in securitization activities in connection with our accounts and finance
receivables. We enter into these transactions for the purposes of generating
cash from these assets through sales or secured borrowings. In several of the
countries where we have completed lease transaction funding arrangements with
third party finance companies we have effectively transferred substantially all
of the related collection risk to these financiers. Gains and losses from
securitizations, accounted for as sales, are recognized in the Consolidated
Statements of Operations when we surrender control of the transferred financial
assets. The gain or loss on the sale of financial assets depends in part on the
previous carrying amount of the assets involved in the transfer, allocated
between the assets sold and the retained interests based upon their respective
fair values at the date of sale.
As part of the transactions accounted for as sales, the receivables are
typically sold to a special purpose entity that meets the applicable accounting
standards for non-consolidation. When special purpose entities are involved
neither we, nor any of our employees has any involvement in the management of
such entity. When we sell receivables, we may retain servicing rights,
beneficial interests, and in some cases, a cash reserve account, all of which
are retained interests in the securitized receivables. The retained interest is
initially recorded at carrying value, which approximates fair value in our
Consolidated Balance Sheets. Subsequently, decreases in the value of such
interests, if any, are recognized in our Consolidated Statements of Operations.
The securitization gain or loss involves our best estimates of key assumptions,
consisting of receivable amounts, anticipated credit losses, and discount rates
commensurate with the risks involved. The use of different estimates or
assumptions could produce different financial results. For those transactions
accounted for as secured borrowings, we have made the determination that the
criteria for surrender of control were not met, or that the receivables were
sold into a special purpose entity that did not meet the requirements for
deconsolidation.
These transactions are often complex, involve highly structured contracts
between us and the buyer or transferee and involve strict accounting rules
application. The key distinction in the application of the accounting rules to
the structured contracts and similar transactions (sale versus a secured
borrowing) is the inclusion or exclusion of the related receivables and or
associated obligations that would or would not be included in our Consolidated
Balance Sheet, as well as any gain or loss that would result from a sale
transaction. In order for a transaction to qualify as a sale, several accounting
requirements must be met including the surrender of control over the receivables
and the existence of a bankruptcy remote contract structure. Transactions not
meeting these requirements must be accounted for as secured borrowings. See Note
6 to the consolidated financial statements for a discussion of our
securitization transactions.
Provisions for Excess and Obsolete Inventory Losses and Residual Value Losses:
We value our inventory at the lower of average cost or net realizable values. We
regularly review inventory quantities on hand and record a provision for excess
and obsolete inventory based primarily on our estimated forecast of product
demand and production requirements for the next twelve months. Several factors
may influence the realizability of our inventories, including our decisions to
exit a product line (e.g., SOHO), technological change and new product
development. These factors could result in an increase in the amount of obsolete
inventory quantities on hand. Additionally, our estimates of future product
demand may prove to be inaccurate, in which case we may have understated or
overstated the provision required for excess and obsolete inventory. In the
future, if we determine that our inventory was overvalued, we would be required
to recognize such costs in Cost of sales at the time of such determination.
Likewise, if we determine that our inventory is undervalued, we may have
overstated Cost of sales in previous periods and would be required to recognize
such additional operating income at the time of sale. Therefore, although we
make every effort to ensure the accuracy of our forecasts of future product
demand, including the impact of planned future product launches, any significant
unanticipated changes in demand or technological developments could have a
significant impact on the value of our inventory and our reported operating
results. We recorded $242 million, $235 million and $144 million in inventory
write-down charges for the three years ended December 31, 2001, 2000 and 1999,
respectively. These amounts include $42 million and $84 million in 2001 and
2000, respectively, associated with our restructuring programs. At this time,
management does not believe that anticipated product launches will have a
material effect on the recovery of our existing net inventory balances.
We have a similar accounting policy relating to unguaranteed residual values
associated with equipment on lease, which totaled $414 million and $508 million
in our Consolidated Balance Sheet at December 31, 2001 and 2000 respectively. We
review residual values regularly and, when appropriate, adjust them based on
estimates of forecasted demand including the impacts of future product launches.
Impairment charges are recorded when available information indicates that the
decline in recorded value is other than temporary and we would not therefore be
able to fully recover the recorded values. We recorded $14 million, $17 million
and $4 million in residual value impairment for the years ended December 31,
2001, 2000 and 1999, respectively.
13
Estimates Used Relating to Restructuring and Asset Impairments: Over the last
several years we have engaged in significant restructuring actions, which have
required us to develop formalized plans as they relate to exit activities. These
plans have required us to utilize significant estimates related to salvage
values of assets that were made redundant or obsolete. In addition, we have had
to record estimated expenses for severance and other employee separation costs,
lease cancellation and other exit costs. Given the significance of, and the
timing of the execution of such actions, this process is complex and involves
periodic reassessments of estimates made at the time the original decisions were
made. The accounting for restructuring costs and asset impairments requires us
to record provisions and charges when we have a formal and committed plan. Our
policies, as supported by current authoritative guidance, require us to
continually evaluate the adequacy of the remaining liabilities under our
restructuring initiatives. As management continues to evaluate the business,
there may be supplemental charges for new plan initiatives as well as changes in
estimates to amounts previously recorded as payments are made or actions are
completed.
Discontinued Operations: In the fourth quarter of 1995, we announced our planned
disengagement from our insurance operations. From 1995 to 1998 all our insurance
operations were sold. As part of the sales of these insurance operations, we
were required to continue to provide aggregate excess of loss reinsurance
coverage (the Reinsurance Agreements) to two former insurance entities through
Ridge Reinsurance Limited (Ridge Re), a wholly owned subsidiary. The coverage
limits for these two remaining Reinsurance Agreements total $578 million, which
is exclusive of $234 million in coverage that Ridge Re reinsured in 1998. We
have guaranteed that Ridge Re will meet all its financial obligations under the
two remaining Reinsurance Agreements. As of December 31, 2001, Ridge Re has $684
million of cash and investments held in restricted trusts as collateral for
their potential liability under these reinsurance obligations. Our remaining net
investment in Ridge Re was $348 million, net of our expected liability of $336
million, at December 31, 2001. Based on Ridge Re's current projections of
investment portfolio returns and reinsurance obligation payments, all of which
are based on actuarial estimates, we expect to fully recover our remaining net
investment of $348 million. Our ongoing evaluation of the insurance liabilities,
and estimates thereof, could result in a significant change in our estimate of
recoverability of this net investment. The expected liability is a discounted
value, consistent with accounting standards applicable to insurance companies. A
material change in the timing of the estimated payments could materially affect
the liability recognized but not to an amount greater than our coverage limit as
described above.
Pension and Postretirement Benefit Plan Assumptions: We sponsor pension plans in
various forms covering substantially all employees who meet eligibility
requirements. Postretirement benefit plans primarily only cover U.S. employees
for retirement medical costs. Several statistical and other factors that attempt
to anticipate future events are used in calculating the expense and liability
related to the plans. These factors include assumptions we make about, among
others, the discount rate, expected return on plan assets, rate of increase of
health care costs and rate of future compensation increases. In addition, our
actuarial consultants also use subjective factors such as withdrawal and
mortality rates to estimate these factors. The actuarial assumptions we use may
differ materially from actual results due to changing market and economic
conditions, higher or lower withdrawal rates or longer or shorter life spans of
participants. These differences may result in a significant impact to the amount
of pension or postretirement benefits expenses we have recorded or may record.
Assuming a constant employee base, the most important estimate associated with
our post retirement plan is the assumed health care cost trend rate. A
one-percentage-point increase in this estimate would increase the expense by
approximately $5 million. A similar analysis for the expense associated with our
pension plans is more difficult due to the variety of assumptions, plan types
and regulatory requirements for these plans around the world. However, by way of
example, for the U.S. plans, which represent approximately 70 percent of the
consolidated projected benefit obligation at December 31, 2001, a 0.25 percent
change in the discount rate would change the annual pension expense by
approximately $6 million.
Income Taxes and Tax Valuation Allowances: We record the estimated future tax
effects of temporary differences between the tax bases of assets and liabilities
and amounts reported in our Consolidated Balance Sheets, as well as operating
loss and tax credit carryforwards. We follow very specific and detailed
guidelines in each tax jurisdiction regarding the recoverability of any tax
assets recorded on the balance sheet and provide necessary valuation allowances
as required. We regularly review our deferred tax assets for recoverability
based on historical taxable income, projected future taxable income, the
expected timing of the reversals of existing temporary differences and tax
planning strategies. If we continue to operate at a loss in certain
jurisdictions or are unable to generate sufficient future taxable income, or if
there is a material change in the actual effective tax rates or time period
within which the underlying temporary differences become taxable or deductible,
we could be required to increase the valuation allowance against all or a
significant portion of our deferred tax assets resulting in a substantial
increase in our effective tax rate and a material adverse impact on our
operating results. Valuation allowance provisions were $247 million, $12
million, and $92 million for the years ended December 31, 2001, 2000 and 1999,
respectively.
Goodwill and Other Acquired Intangible Assets: We have made acquisitions in the
past that included the recognition of a significant amount of goodwill and other
intangible assets. Under generally accepted accounting principles in effect
through December 31, 2001, these assets were amortized over their estimated
useful lives and were tested periodically to determine if
14
they were recoverable from estimated future pre-tax cash flows on an
undiscounted basis over their useful lives. Effective in 2002, goodwill will no
longer be amortized but will be subject to an annual (or under certain
circumstances more frequent) impairment test based on its estimated fair value.
Other intangible assets that meet certain criteria will continue to be amortized
over their useful lives and will also be subject to an impairment test based on
estimated fair value. Estimated fair value is typically less than values based
on undiscounted operating earnings because fair value estimates include a
discount factor in valuing future cash flows. There are many assumptions and
estimates underlying the determination of an impairment loss.
Legal Contingencies: We are a defendant in numerous litigation and regulatory
matters including those involving securities law, patent law, environmental law,
employment law and ERISA, as discussed in Note 16 to the consolidated financial
statements. As required by SFAS No. 5, we determine whether an estimated loss
from a loss contingency should be accrued by assessing whether a loss is deemed
probable and can be reasonably estimated. We analyze our litigation and
regulatory matters based on available information to assess potential liability.
We develop our views on estimated losses in consultation with outside counsel
handling our defense in these matters which involves an analysis of potential
results, assuming a combination of litigation and settlement strategies. Should
these matters result in an adverse judgment or be settled for significant
amounts, they could have a material adverse effect on our results of operations,
cash flows and financial position in the period or periods in which such
judgment or settlement occurs.
Other Significant Accounting Policies: Other significant accounting policies,
not involving the same level of uncertainties as those discussed above, are
nevertheless important to an understanding of the financial statements. See Note
1 to the consolidated financial statements, Summary of Significant Accounting
Policies, which discusses accounting policies that must be selected by
management when there are acceptable alternatives.
Other accounts affected by management estimates.
The following table summarizes other significant areas which require management
estimates:
Year ended December 31
----------------------
(in millions) 2001 2000 1999
---- ---- ----
Restated Restated
Amortization of goodwill and intangible assets .................... $ 94 $ 86 $ 50
Depreciation of equipment on operating leases ..................... 657 626 560
Depreciation of land, buildings and equipment ..................... 402 417 416
Amortization of capitalized software .............................. 179 115 64
Pension benefits - net periodic benefit cost ...................... 99 44 102
Other benefits - net periodic benefit cost ........................ 130 109 107
15
Financial Overview
As previously discussed we have restated our prior year's financial statements
and our previously released 2001 results. All dollar and per share amounts, and
financial ratios have been revised, as appropriate, to reflect these
restatements. In 2001 we reduced our net loss to $71 million or $(0.12) per
share from a net loss of $273 million, or $(0.48) per share in 2000. In 2001 we
executed aggressive plans to exit certain businesses, outsource some internal
functions and substantially reduce our cost base in order to restore our
financial strength and significantly improve our core operations while
effectively positioning ourselves to exploit future opportunities in the
production, office and services markets. These actions resulted in strong 2001
fourth quarter performance including the highest gross margin in the past two
years; lower year over year selling, administrative and general expenses;
reduction of inventory to historically low levels; improved cash and reduced net
debt. We believe the combination of actions already implemented, continuing cost
reduction activities and our focus on more profitable revenue positions us for
continued improvement and builds a solid foundation for future growth.
The 2001 net loss of $71 million included $507 million of after-tax charges
($715 million pre-tax) for restructuring and asset impairments associated with
our Turnaround Program, aimed at creating a leaner, faster and more flexible
enterprise, and our disengagement from our worldwide Small Office/Home Office
(SOHO) business. 2001 results also included a $304 million after-tax gain ($773
million pre-tax) from the sale of half of our interest in Fuji Xerox, a $40
million after-tax gain related to the early retirement of debt, and $21 million
of after-tax gains associated with unhedged foreign currency. Unhedged foreign
currency exposures are the result of net unhedged positions largely caused by
our restricted access to the derivatives markets since the fourth quarter 2000.
This limitation has increased our risk to financial volatility associated with
currency gains and losses. Further discussion of the restructuring charges and
sale of half our interest in Fuji Xerox is included below and in Notes 3 and 5,
respectively, to the consolidated financial statements.
The $273 million net loss in 2000 was substantially worse than 1999 net income
of $844 million. The 2000 net loss was largely attributable to $339 million of
after-tax charges ($475 million pre-tax) for restructuring and asset impairments
and our $37 million share of a Fuji Xerox restructuring charge, partially offset
by after-tax gains of $119 million ($200 million pre-tax) from the sale of our
China operations and $69 million of unhedged foreign currency after-tax gains.
Results of Operations
(in millions except per share amounts) For the Year Ended
2001 2000 1999
---- ---- ----
Restated Restated
Revenue $ 17,008 $ 18,751 $ 18,995
Net (loss) income $ (71) $ (273) $ 844
Diluted (loss) earnings per share $ (0.12) $ (0.48) $ 1.17
16
In 1999, we faced several business challenges, which adversely impacted our
performance beginning in the second half of that year and continued into 2001.
Many of the business challenges were company specific and included increased
sales force turnover, open sales territories and lower sales productivity
resulting from the realignment of our sales force from a geographic to an
industry structure. Further disruption and incremental costs were associated
with the consolidation of our U.S. customer administration centers and changes
in our European infrastructure. In addition, there were significant competitive
and industry changes, and adverse economic conditions affecting our operations
toward the latter part of 2000. These challenges were exacerbated by significant
technology and acquisition spending negatively impacting our cash availability,
credit rating downgrades, limited access to capital markets and marketplace
concerns regarding our liquidity.
To counter these challenges, we implemented actions beginning in mid-2000 to
stabilize our sales force and minimize further disruption to our operations. In
October 2000, we announced a Turnaround Program designed to help ensure adequate
liquidity, re-establish profitability and build a solid foundation for future
growth. The Turnaround Program encompassed four major components: (i) asset
sales of $2 to $4 billion; (ii) accelerated cost reductions designed to reduce
costs by at least $1 billion annually; (iii) the transition of equipment
financing to third party vendors and (iv) a focus on our core business of
providing document processing systems, solutions and services to our customers.
By the end of 2001, we had made significant progress executing this program and
achieving these goals.
By year-end 2001, we had completed asset sales of $2.3 billion, comprised of the
March 2001 sale of half our ownership interest in Fuji Xerox Co., Ltd. (Fuji
Xerox) to Fuji Photo Film Co., Ltd. (FujiFilm) for $1,283 million, the December
2000 sale of our China Operations to Fuji Xerox for $550 million, the April 2001
sale of our Nordic leasing businesses to Resonia AB for approximately $370
million, and in the fourth quarter 2001 the first in a series of asset sales to
transfer our office product manufacturing operations to Flextronics for
approximately $118 million. We believe the asset sale component of our
Turnaround Program has been largely completed.
We also intensified cost reductions to improve our competitiveness. During 2001,
we implemented work force resizing and cost reduction actions that we believe
will result in approximately $1.1 billion in annualized savings. These savings
are expected to result from reducing layers of management, consolidating
operations where prudent, reducing administrative and general spending,
capturing service productivity savings from our digital products and tightly
managing discretionary spending. We are reducing costs in our Office segment by
moving to lower cost indirect sales and service channels and by outsourcing our
office products manufacturing. Our worldwide employment declined by
approximately 13,600 to 78,900 at December 31, 2001. In our ongoing efforts to
reduce our cost base, we will continue to implement restructuring actions and
incur substantial restructuring charges throughout 2002; although less than the
amounts recorded in 2001.
Our transition to third party financing will significantly improve our liquidity
while ensuring equipment financing is still provided to our customers. In 2001,
we entered into framework agreements with General Electric Capital Corporation
(GE Capital) for them to manage our customer administrative functions and become
the primary equipment financing provider for Xerox customers in the U.S.,
Canada, France and Germany. On May 1, 2002, Xerox Capital Services LLC (XCS),
our U.S. venture with GE Capital Vendor Financial Services, became operational.
XCS manages our customer administration and leasing activities in the U.S.,
including financing administration, credit approval, order processing, billing
and collections. We are currently in the process of completing the negotiation
of definitive agreements with GE Capital for the implementation of the Canadian
joint venture which is expected in the second half of 2002. These agreements are
subject to the completion of due diligence on GE's part as well as the
fulfillment of various regulatory requirements.
Ongoing funding for new leases by GE Capital and its affiliates in both the U.S.
and Canada is expected to be in place later this year upon development and
completion of systems and process modifications. In Europe, a number of
initiatives are under way and have been implemented. In Germany, we received a
$77 million loan in May 2002 secured by certain finance receivables, as we
continue to complete our vendor financing transition this year. In France we are
completing due diligence, fulfilling regulatory requirements, consulting with
local works councils and expect to complete the agreement with GE Capital in the
third quarter 2002. We have fully transitioned our leasing businesses in the
Nordic countries, the Netherlands and Italy. Our Nordic leasing business was
sold to Resonia AB in April 2001. In the first quarter 2002, we formed a joint
venture with De Lage Landen International BV (DLL) in which they provide funding
and manage equipment financing for our customers in the Netherlands. In April
2002, we sold our equipment financing operations in Italy for approximately $207
million in cash plus the assumption of $20 million of debt. We have made
significant progress in our Developing Markets Operations (DMO), beginning in
April 2002, with Banco Itau S.A. in Brazil and collectively with the Capita
Corporation de Mexico S.A. de C.V., Organizacion Auxiliar Del Credito and
Arrendadora Capita Corporation, S.A. de C.V. in Mexico becoming the primary
equipment financing providers in their respective countries. By the end of 2002,
we expect that approximately two-thirds of all new financed lease originations
will be funded by third parties, through a combination of structures including
direct financing, finance receivable securitizations and ongoing secured
borrowings.
17
In addition to the vendor financing agreements, in 2001 and through the first
half of 2002, we borrowed approximately $3.1 billion in the U.S., Canada and
U.K. from GE Capital through the securitization of certain existing lease
contracts. We and GE Capital are parties to a loan agreement dated November 2001
which provides for a series of secured loans in the U.S. up to an aggregate of
$2.6 billion. Through June 2002, approximately $1.9 billion of loans have been
funded under this GE Capital agreement including a $499 million loan which
closed on May 12, 2002.
In line with our strategy to focus on our core business, we announced the
disengagement from our worldwide SOHO business in June 2001. By the end of the
year, we had sold the remaining equipment inventory and in the fourth quarter
achieved profitability in this business through the sale of supplies to our
current base of SOHO customers. We expect this profitable supplies revenue
stream to decline over time as the equipment is eventually replaced.
Summary of Total Company Results
To understand the trends in our business, we believe that it is helpful to
adjust revenue and expense (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 adjustment as "pre-currency."
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. We generally do not hedge the translation effect of revenues
denominated in currencies where the local currency is the functional currency.
When compared with the average of the major European and Canadian currencies on
a revenue-weighted basis, the U.S. dollar in 2001 was approximately 3 percent
stronger than in 2000. The U.S. dollar was approximately 10 percent stronger in
2000 than in 1999. As a result, foreign currency translation unfavorably
impacted revenue growth by approximately one percentage point in 2001 and 3
percentage points in 2000.
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. In 2001, currency devaluations
in Brazil continued to impact our results, as the Brazilian Real devalued 22
percent against the U.S. dollar. The devaluation was 2 percent in 2000 and 35
percent in 1999.
Total revenues of $17.0 billion in 2001 declined 9 percent (8 percent
pre-currency) from 2000. Approximately 25 percent of the decline reflected the
loss in revenues resulting from the 2000 sale of our China operations and our
exit from the SOHO business in the second half of 2001. The remaining revenue
decline occurred in all operating segments, but was most pronounced in the
Developing Markets segment, which declined by $330 million or 14 percent from
2000 and the Production segment which declined by $433 million or 7 percent from
2000. Revenues in all geographies were impacted by marketplace competition,
further weakening of the worldwide economy and our reduced participation in
aggressively priced bids and tenders as we focus on improved profitability. We
expect total revenues to decline in 2002, reflecting the effects of our exit
from the SOHO business, lower equipment population in all geographies,
competitive pressures and the weak economic environment, partially offset by the
benefit of new product launches in the second half 2002. We expect finance
income will decline over time as we transition equipment financing to third
parties.
In 2000, revenues of $18.8 billion declined one percent (grew 2 percent
pre-currency) from 1999. 2000 revenues declined 5 percent (one percent
pre-currency) excluding the beneficial impact of the January 1, 2000 acquisition
of the Tektronix, Inc. Color Printing and Imaging Division (CPID). CPID is
discussed in Note 4 to the consolidated financial statements. Revenues in 2000
were impacted by a combination of the previously mentioned company specific
issues, increased competitive environment and some weaker European and Latin
American economies toward the latter part of the year.
Revenues by Type. Revenues and year-over-year changes by type of revenues were
as follows:
Revenues % Change
--------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Restated Restated
($ in billions)
Equipment Sales ............................................... $ 4.3 $ 5.3 $ 5.7 (18)% (9)%
Post Sale and Other Revenue ................................... 11.6 12.3 12.1 (6) 2
Financing Income .............................................. 1.1 1.2 1.2 (3) (1)
----- ----- ----- ----- ----
Total Revenues ............................................ $17.0 $18.8 $19.0 (9)% (1)%
===== ===== ===== ===== ====
Note 1: Post sale and other revenue include service, document outsourcing,
rentals, supplies and paper, which represent the revenue streams that follow
equipment placement, as well as other revenue not associated with equipment
placements, such as royalties.
18
Note 2: Revenue from document outsourcing arrangements of $3.7, $3.8 and $3.2
billion in 2001, 2000 and 1999, respectively, are included in all revenue
categories.
Note 3: Total Sales revenue in the Consolidated Statement of Operations includes
equipment sales noted above as well as $3.1, $3.5 and $3.3 billion of supplies
and paper and other revenue for 2001, 2000 and 1999, respectively.
2001 equipment sales declined 18 percent (17 percent pre-currency) from 2000.
Over one third of the decline was due to our exit from the SOHO business and the
sale of our China operations. Equipment sales in North America and Europe
declined 5 percent and 21 percent respectively from 2000, reflecting increased
marketplace competition, continued economic weakness and pricing pressures in
many major market segments. In Europe equipment sales also declined due to our
decision to reduce participation in aggressively priced bids and tenders as we
reorient our focus from market share to profitable revenue.
2000 equipment sales declined 9 percent (5 percent pre-currency) from 1999 due
to the combination of company specific business challenges, including sales
force disruption and turnover, increased competition and some weaker economies.
Excluding the beneficial impact of the CPID acquisition, 2000 equipment sales
declined 12 percent (9 percent pre-currency).
2001 post sale and other revenue declined 6 percent (5 percent pre-currency) or
5 percent (4 percent pre-currency) excluding the impact of the 2000 sale of our
China operations. Post sale and other revenue grew 2 percent (5 percent
pre-currency) in 2000 including the beneficial impact of the CPID acquisition.
Post sale and other revenues have been adversely affected by reduced equipment
populations and lower page print volumes.
Financing income declined 3 percent (2 percent pre-currency) in 2001 reflecting
lower equipment sales and the initial effects of our transition to third party
finance providers. Financing income declined one percent (grew 2 percent
pre-currency) in 2000. Financing income is determined by the discount rate that
is implicit in the lease agreements with our customers, after determination of
the fair value of the services and equipment included in a bundled lease
agreement with multiple deliverable elements. Refer to a discussion of our
leasing policies above in the Application of Critical Accounting Policies
section for more information. Financing income will generally be dependent on
the amount of new equipment leases that we enter. We expect finance income will
decline over time as we transition equipment financing to third parties.
Total document outsourcing revenues of $3.7 billion declined 2 percent (one
percent pre-currency) in 2001 and grew 19 percent in 2000. The backlog of future
estimated document outsourcing revenues was approximately $7.6 billion at the
end of 2001, a reduction of 7 percent from the end of 2000 and in line with
trends experienced elsewhere in our business. Our backlog is determined as the
estimated post-sale services and financing to be provided under committed
contracts as of a point in time.
Gross Margin
The trend in gross margin was as follows:
2001 2000 1999
---- ---- ----
Total Gross Margin/(1)/ ............................................... 38.2% 37.4% 42.3%
Gross Margin by revenue stream:
Sales/(2)/ ............................................................ 30.5 31.2 37.2
Service, Outsourcing/(2)/, and Rentals ................................ 42.2 41.1 44.7
Finance Income ........................................................ 59.5 57.1 63.0
/(1)/ Includes inventory charges of $42 million and $84 million associated with
2001 and 2000 restructuring actions. These changes impacted 2001 and 2000
total gross margin by 0.2 points and 0.4 points, respectively and sales
gross margin by 0.6 points and 1.0 point, respectively.
/(2)/ The equipment sales gross margin for document outsourcing is included in
the sales gross margin.
The 2001 gross margin of 38.2 percent increased by 0.8 percentage points from
2000, as improved manufacturing and service productivity more than offset
unfavorable mix and competitive price pressures, particularly in the production
monochrome business. Gross margin improved during 2001 from 34.7 percent in the
first quarter to 40.8 percent in the fourth quarter reflecting the benefits of
our cost base restructuring and exit from the SOHO business. We expect the 2002
gross margin will approximate 40 percent, reflecting the beneficial impacts of
continuing cost base restructuring, and our SOHO exit, partially offset by
competitive price pressures.
2000 gross margin of 37.4 percent was 4.9 percentage points below 1999.
Approximately half the decline was the result of production monochrome weakness
reflecting initial competitive product entry during a time when our sales force
was weakened as we realigned from a geographic to an industry structure. Higher
revenue growth in the lower margin document outsourcing business and SOHO inkjet
investments to build equipment population also contributed to the decline.
Finally, gross margin was also adversely impacted by competitive price pressure,
unfavorable transaction currency and temporary
19
pricing actions implemented to reduce inventory on certain products in the
latter part of the year. Manufacturing and other productivity improvements only
partially offset the above items.
Finance margins reflect interest expense related to our financing operations
based on our overall cost of funds, applied against the level of debt required
to support the Company's financed receivables.
Research and Development. 2001 Research and development (R&D) spending of $997
million declined 6 percent from 2000 primarily due to the SOHO disengagement.
2001 R&D spending represented approximately 6 percent of total revenues as we
continued to invest in technological development, particularly color, to
maintain our position in the rapidly changing document processing market.
Including CPID, R&D expense grew 4 percent in 2000 reflecting increased program
spending primarily for solid ink, solutions and the DocuColor iGen3, a
next-generation digital printing press technology which is scheduled to launch
in the second half 2002. We believe our R&D remains technologically competitive
and is strategically coordinated with Fuji Xerox, which invested $548 million in
R&D in 2001, for a combined total of $1,545 million. We are planning to launch
five new platforms this year, compared with two per year during the last several
years. We expect 2002 R&D spending will represent approximately 5 to 6 percent
of revenue, a level that we believe is adequate to remain technologically
competitive.
Selling, Administrative and General Expenses.
Selling, administrative and general (SAG) expenses as a percent of revenue were
as follows:
2001 2000 1999
---- ---- ----
SAG % Revenue ..................................... 27.8% 29.4% 27.4%
SAG declined $790 million or 14 percent (13 percent pre-currency) in 2001 to
$4,728 million reflecting significantly lower labor costs and other benefits
derived from our Turnaround Program, temporarily lower advertising and marketing
communications spending and reduced SOHO spending, partially offset by increased
professional costs related to litigation, SEC issues and related matters. In
2001, SAG represented 27.8 percent of revenue, a 1.6 percentage point
improvement from 2000. We expect a mid-single digit decline in 2002 SAG spending
as we continue to implement cost cutting actions.
In 2000, SAG increased $314 million or 6 percent (9 percent pre-currency) to
$5,518 million. Excluding the CPID acquisition, SAG grew 3 percent (6 percent
pre-currency) reflecting increased sales force payscale and incentive
compensation, significant transition costs associated with implementation of the
European shared services organization, continued effects of the U.S. customer
administration issues and significant marketing, advertising and promotional
investments for our SOHO inkjet printer initiative.
Bad debt expense, which is included in SAG, was $438 million, $473 million and
$386 million in 2001, 2000 and 1999, respectively. Reduced 2001 provisions
reflect lower equipment sales partially offset by some reserve increases due to
the weakened worldwide economy. Provisions increased in 2000 due to continued
resolution of aged billing and receivables issues in the U.S. and Europe
resulting from the consolidation of our customer administration centers and
infrastructure changes and unsettled business and economic conditions in many
Latin American countries. Bad debt provisions as a percent of total revenue were
2.6 percent, 2.5 percent, and 2.0 percent for 2001, 2000 and 1999, respectively.
The agreements with GE Capital in the U.S. and Canada include new approaches to
managing most of our customer administrative functions. On May 1, 2002, XCS, our
U.S. venture with GE Capital Vendor Financial Services, became operational. XCS
manages our customer administration and leasing activities, including financing
administration, credit approval, order processing, billing and collections. We
will consolidate the operations of XCS in our financial statements and include
the XCS headcount with our employee statistics. We are completing the
negotiation of definitive agreements with GE Capital for the implementation of
the Canadian joint venture which is expected in the second half of 2002. Over
time we expect these arrangements will facilitate reduced back office and
infrastructure expenses and improve collection discipline. We expect this will
improve sales force productivity and customer satisfaction through improved
billing practices as well as reduce bad debt expense.
Restructuring Programs. Since early 2000, we have been restructuring our cost
base. We have implemented a series of plans to resize our workforce and reduce
our cost structure through three restructuring initiatives: the October 2000
Turnaround Program, the June 2001 SOHO disengagement and the March 2000
restructuring action. The execution of these actions and payment of obligations
continued through December 31, 2001, with each initiative in various stages of
completion. In total, we recorded restructuring provisions of $715 million in
2001 and $475 million in 2000, including $205 million and $64 million of asset
impairment charges in 2001 and 2000, respectively. As management continues to
evaluate the business, there may be supplemental charges for new plan
initiatives as well as changes in estimates to amounts previously recorded as
payments are made or actions are completed. We expect to complete the
initiatives associated with
20
the programs in 2002 and will have new initiatives going forward under the
Turnaround Program. The restructuring programs are discussed below and in Note 3
to the consolidated financial statements.
Turnaround Program: In October 2000, we announced our Turnaround Program and
recorded a restructuring provision of $105 million in connection with finalized
initiatives. This charge included estimated costs of $71 million for severance
associated with the worldwide resizing of our work force and $34 million
associated with the disposition of a non-core business. Over half of these
charges related to our Production segment with the remainder related to our
Office, DMO and Other segments. In 2001, we provided an incremental $403
million, net of reversals, for initiatives for which we had a formal and
committed plan. This provision included $339 million for severance and other
employee separation costs associated with the resizing of our work force
worldwide, $36 million for lease cancellation and other exit costs and $28
million for asset impairments. The aggregate severance and other employee
separation costs in 2001 and 2000 of $410 million were for the elimination of
approximately 7,800 positions worldwide. The majority of these charges related
to our Production and Office segments. The Turnaround Program restructuring
reserve balance at December 31, 2001 was $223 million.
SOHO Disengagement: In June 2001, we announced our disengagement from our
worldwide SOHO business. In connection with exiting this business, during 2001
we recorded a net charge of $239 million. The charge included provisions for the
elimination of approximately 1,200 positions worldwide, the closing of
facilities and the write-down of certain assets to net realizable value. The
charge consisted of $164 million of asset impairments, $49 million for lease
cancellation and other exit costs and $26 million in severance and related
costs. During the fourth quarter 2001, we sold our remaining inventory of
personal inkjet and xerographic printers, copiers, facsimile machines and
multi-function devices which were distributed primarily through retail channels
to small offices, home offices and personal users (consumers). We will continue
to provide current SOHO customers with service, support and supplies, including
the manufacturing of such supplies, during a phase-down period to meet customer
commitments, which will result in a declining revenue base over the next few
years. The SOHO disengagement restructuring reserve balance at December 31, 2001
was $23 million.
March 2000 and 1998 Restructurings: In March 2000, we recorded a provision of
$489 million as part of a worldwide restructuring program including asset
impairments of $30 million. During 2001 and 2000, we recorded net changes in
estimates for both the March 2000 and the 1998 restructuring programs which
reduced restructuring expense by $25 million and $125 million, respectively. As
of December 31, 2001, these programs had been substantially completed.
As a direct result of the various restructuring actions, we determined that
certain products were not likely to be sold in their product life cycle. For
this reason, in 2001 we recorded a $42 million charge to write-down excess and
obsolete inventory, $34 million of which resulted from the disengagement from
our SOHO operations. In 2000, we recorded a charge of $84 million primarily as a
result of the consolidation of distribution centers and warehouses and the exit
from certain product lines. These charges are included in Cost of sales in the
Consolidated Statement of Operations.
Worldwide employment declined by approximately 13,600 in 2001 to approximately
78,900, largely as a result of our restructuring programs and the transfer of
approximately 2,500 employees to Flextronics as part of our office manufacturing
outsourcing. Worldwide employment was approximately 92,500 and 94,600 at
December 31, 2000 and 1999, respectively.
Other Expenses, Net. Other expenses, net for the three years ended December 31,
2001 were as follows:
2001 2000 1999
---- ---- ----
Restated Restated
(in millions)
Non-financing interest expense ............................................. $ 446 $ 592 $ 407
Currency gains, net ........................................................ (29) (103) (7)
Amortization of goodwill and intangibles ................................... 94 86 50
Business divestiture and asset sale (gains) losses ......................... 10 (67) (78)
Interest income ............................................................ (101) (77) (20)
Year 2000 costs ............................................................ -- 2 47
All other, net ............................................................. 108
------ ------ ------
Total .................................................................. $ 473 $ 524 $ 507
====== ====== ======
In 2001, non-financing interest expense was $146 million lower than 2000,
reflecting lower interest rates and lower debt levels. Non-financing interest
expense in 2001 included net gains of $32 million from the mark-to-market of our
remaining interest rate swaps required to be recorded as a result of applying
SFAS No. 133. Differences between the contract terms of our interest rate swaps
and the underlying related debt restricts hedge accounting treatment in
accordance with SFAS No. 133, which requires us to record the mark-to-market
valuation of these derivatives directly to earnings. Non-financing interest
expense was $185 million higher in 2000 than in 1999 as a result of the CPID
acquisition, which resulted in incremental borrowings of $852 million, generally
higher debt levels and increased interest rates.
21
Net currency (gains) losses result from the re-measurement of unhedged foreign
currency-denominated assets and liabilities. In 2001, exchange gains on yen debt
of $107 million more than offset losses on euro loans of $36 million, a $17
million exchange loss resulting from the peso devaluation in Argentina and other
currency exchange losses of $25 million. In 2000, large gains on both the yen
and euro loans in the fourth quarter contributed to the $103 million gain. These
currency exposures are the result of net unhedged positions largely caused by
our restricted access to the derivatives markets since the fourth quarter 2000.
Due to the inherent volatility in the interest rate and foreign currency
markets, we are unable to predict the amount of the above noted re-measurement
and mark-to-market gains or losses in future periods. Such gains or losses could
be material to the financial statements in any reporting period.
Goodwill and other intangible asset amortization relates primarily to our
acquisitions of the remaining minority interest in Xerox Limited in 1995 and
1997, XL Connect in 1998 and CPID in 2000. Effective January 1, 2002 and in
connection with the adoption of SFAS No. 142, we will no longer record
amortization of goodwill. However, in lieu of amortization, goodwill will be
tested at least annually for impairment using a fair value methodology.
Intangible assets will continue to be amortized. Further discussion is provided
in Note 1 to the consolidated financial statements.
(Gains) losses on business divestitures and asset sales include the sales of our
Nordic leasing business in 2001, the North American paper business and a 25
percent interest in ContentGuard in 2000, and various Xerox Technology
Enterprise businesses in 1999, as well as miscellaneous land, buildings and
equipment in all years. Further discussion of our divestitures follows and is
also contained in Note 5 to the consolidated financial statements.
Interest income is derived primarily from our significant invested cash balances
since the latter part of 2000 and from tax audit refunds. 2001 interest income
was $24 million higher than 2000 due to higher investment interest resulting
from a full year of invested cash balances in 2001, partially offset by lower
interest from tax audit refunds. The increases in our invested cash balances
reflect our decision, beginning in the second half of 2000, to accumulate cash
to maintain financial flexibility rather than continue our historical practice
of paying down debt with available cash.
All other, net includes many additional items, none of which are individually
significant.
Gain on Affiliate's Sale of Stock. In 2001 and 2000, gain on affiliate's sale of
stock of $4 million and $21 million, respectively, reflects our proportionate
share of the increase in equity of ScanSoft Inc. (NASDAQ: SSFT) resulting from
ScanSoft's issuance of stock in connection with acquisitions. The 2000 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 one of the
acquisitions, which is included in equity in net income of unconsolidated
affiliates. ScanSoft, an equity affiliate, is a developer of digital imaging
software that enables users to leverage the power of their scanners, digital
cameras, and other electronic devices.
Income Taxes and Equity in Net Income of Unconsolidated Affiliates. The
effective tax rates were 132.9 percent in 2001, 19.1 percent in 2000 and 34.6
percent in 1999. The difference between the 2001 effective tax rate of 132.9
percent and the U.S. federal statutory income tax rate of 35 percent relates
primarily to the recognition of deferred tax asset valuation allowances
resulting from our recoverability assessments, the taxes incurred in connection
with the sale of our partial interest in Fuji Xerox and continued losses in low
tax jurisdictions. The gain for tax purposes on the sale of Fuji Xerox was
disproportionate to the gain for book purposes as a result of a lower tax basis
in the investment. Other items favorably impacting the tax rate included a tax
audit resolution of approximately $140 million and additional tax benefits
arising from prior period restructuring provisions. On a loss basis, the
difference between the 2000 effective tax rate of 19.1 percent and the U.S.
federal statutory income tax rate of 35 percent relates primarily to continued
losses in low tax jurisdictions, the recognition of deferred tax asset valuation
allowances resulting from our recoverability assessments and additional tax
benefits arising from the favorable resolution of tax audits of approximately
$125 million. The 1999 effective tax rate benefited from increases in foreign
tax credits as well as a shift in the mix of our worldwide profits, partially
offset by the recognition of deferred tax asset valuation allowances. Please
refer to Note 15 to the consolidated financial statements for further
information. Our effective tax rate will change year to year based on
nonrecurring events (such as new Turnaround Program initiatives) as well as
recurring factors including the geographical mix of income before taxes. In the
normal course of business, we expect that our 2002 effective tax rate will be in
the low to mid 40 percent range.
Equity in net income of unconsolidated affiliates is principally related to our
25 percent share of Fuji Xerox income. Equity income was $53 million in 2001,
$66 million in 2000 and $48 million in 1999. The 2001 reduction primarily
reflects our reduced ownership in Fuji Xerox. The 2000 improvement reflected
improved Fuji Xerox operating results and the absence in 2000 of a prior year
$21 million unfavorable tax adjustment relating to an increase in Fuji Xerox tax
rates. These favorable items were partially offset by our $37 million share of a
2000 Fuji Xerox restructuring charge and reductions in income from several
smaller equity investments.
22
Manufacturing Outsourcing. In October 2001, we announced a manufacturing
agreement with Flextronics, a global electronics manufacturing services company.
The agreement provides for a five-year supply contract for Flextronics to
manufacture certain office equipment and components; the purchase of inventory,
property and equipment at a premium over book value; and the assumption of
certain liabilities. The premium will be amortized over the life of the
five-year supply contract, as we will continue to benefit from the property
transferred to Flextronics. Inventory purchased from us by Flextronics remains
on our balance sheet until it is sold to an end user with a corresponding
liability recognized for the proceeds received. This inventory and the
corresponding liability was approximately $27 million at December 31, 2001. In
total, the agreement with Flextronics represents approximately 50 percent of our
overall worldwide manufacturing operations. In the 2001 fourth quarter, we
completed the sales of our plants in Toronto, Canada; Aguascalientes, Mexico and
Penang, Malaysia to Flextronics for approximately $118 million, plus the
assumption of certain liabilities. The sale is subject to certain closing
adjustments. Approximately 2,500 Xerox employees in these operations transferred
to Flextronics upon closing. In January 2002, we completed the sale our office
manufacturing operations in Venray, the Netherlands and Resende, Brazil for $29
million plus the assumption of certain liabilities. Approximately 1,600 Xerox
employees in these operations transferred to Flextronics upon closing. By the
end of the third quarter 2002, we anticipate all production at our printed
circuit board factories in El Segundo, California and Mitcheldean, England and
our customer replaceable unit plant in Utica, New York will be fully transferred
to Flextronics' facilities which will complete the plans that we announced in
October. Included in the 2001 Turnaround Program are restructuring charges of
$24 million related to the closing of these facilities.
Divestitures. In December 2001, we sold Delphax Systems and Delphax Systems,
Inc. (Delphax) to Check Technology Corporation for $14 million in cash, subject
to purchase price adjustments. Delphax designs, manufactures and supplies
high-speed electron beam imaging digital printing systems and related parts,
supplies and maintenance services. There was no gain or loss recorded related to
this sale.
In April 2001, we sold our leasing businesses in the four Nordic countries to
Resonia Leasing AB (Resonia) for proceeds of approximately $370 million, which
approximated book value. The assets sold included the leasing portfolios in the
respective countries, title to the underlying equipment included in the lease
portfolios and the transfer of certain employees and systems used in the
operations of the businesses. Under terms of the agreement, Resonia will provide
on-going exclusive equipment financing to Xerox customers in those countries.
In March 2001, we sold half our ownership interest in Fuji Xerox to FujiFilm for
$1,283 million in cash. The sale resulted in a pre-tax gain of $773 million.
Income taxes of approximately $350 million related to this transaction were paid
in the first quarter 2002. 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 Fuji Xerox and us
continue, ensuring that the two companies retain uninterrupted access to each
other's portfolio of patents, technology and products. With its business scope
focused on document processing activities, Fuji Xerox will continue to provide
office products to us and collaborate with us on research and development. We
maintain our agreement with Fuji Xerox to provide them production publishing and
solid ink technology.
In December 2000, we completed the sale of our China operations to Fuji Xerox
for $550 million cash and the assumption of $118 million of debt for which we
recorded a $200 million pre-tax gain. Revenues from our China operations were
$262 million in 2000.
In June 2000, we entered into an agreement to sell our U.S. and Canadian
commodity paper product line and customer list, for $40 million. We also entered
into an exclusive license agreement for the Xerox brand name. Additionally, we
earn commissions on Xerox originated sales of commodity paper as an agent for
Georgia Pacific.
In April 2000, we sold a 25 percent ownership interest in our wholly owned
subsidiary, ContentGuard, to Microsoft, Inc. for $50 million and recognized a
gain of $23 million. An additional gain of $27 million was deferred pending the
achievement of certain performance criteria. In May 2002, we paid Microsoft $25
million as the performance criteria had not been achieved. In connection with
the sale, ContentGuard also received $40 million from Microsoft for a
non-exclusive license of its patents and other intellectual property and a $25
million advance against future royalty income from Microsoft on sales of
products incorporating ContentGuard's technology. The license payment is being
amortized over the ten year life of the license agreement and the royalty
advance will be recognized in income as earned.
Acquisition of the Color Printing and Imaging Division of Tektronix, Inc. In
January 2000, we acquired the Color Printing and Imaging Division of Tektronix,
Inc. (CPID) for $925 million in cash including $73 million paid by Fuji Xerox
for the Asia/Pacific operations of CPID. CPID manufactures and sells color
printers, ink and related products and supplies. The acquisition accelerated us
to the number two market position in office color printing, improved our
reseller and dealer
23
distribution network and provided us with scalable solid ink technology. The
acquisition also enabled significant product development and expense synergies
with our monochrome printer organization.
Business Performance by Segment. In 2001, we realigned our reportable segments
to be consistent with how we manage the business and to reflect the markets we
serve. Our business segments are as follows: Production, Office, DMO, SOHO, and
Other. The table below summarizes our business performance by segment for the
three-year period ended December 31, 2001. Revenues and associated percentage
changes, along with operating profits and margins by segment are included.
Segment operating profit (loss) excludes certain non-segment items, such as
restructuring and gains on sales from businesses, as further described in Note
10 to the consolidated financial statements.
Business Segment Performance
% Change
--------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Restated Restated
($ in millions)
Total Revenue
Production ................................................ $ 5,899 $ 6,332 $ 6,933 (7)% (9)%
Office .................................................... 6,926 7,060 6,853 (2) 3
DMO ....................................................... 2,027 2,619 2,450 (23) 7
SOHO ...................................................... 407 599 575 (32) 4
Other ..................................................... 1,749 2,141 2,184 (18) (2)
-------- --------- --------- ------ -------
Total ..................................................... $ 17,008 $ 18,751 $ 18,995 (9)% (1)%
======== ========= =========
Memo: Color/(1)/ .............................................. $ 2,762 $ 2,612 $ 1,619 6 % 61 %
Segment Operating Profit (Loss)/(2)/
Production ................................................ $ 454 $ 463 $ 1,236
Office .................................................... 341 (180) 49
DMO ....................................................... (157) (93) 48
SOHO ...................................................... (197) (293) (188)
Other ..................................................... (39) 225 203
-------- --------- ---------
Total ..................................................... $ 402 $ 122 $ 1,348
======== ========= =========
Operating Margin
Production ................................................ 7.7% 7.3% 17.8%
Office .................................................... 4.9 (2.5) 0.7
DMO ....................................................... (7.7) (3.6) 2.0
SOHO ...................................................... (48.4) (48.9) (32.7)
-------- --------- ---------
(2.2) 10.5 9.3
Total ..................................................... 2.4% 0.7% 7.1%
======== ========= =========
/(1)/ Color revenue is included in all segments except Other.
/(2)/ Segment operating profit (loss) includes allocation of certain corporate
expenses such as research, finance, business strategy, marketing, legal, and
human resources. The "Other" segment includes certain expenses which have not
been allocated to the businesses such as non-financing interest expense.
Production: Production revenues include production publishing, 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. Revenues declined 7 percent (6
percent pre-currency) in 2001 and 9 percent (6 percent pre-currency) in 2000.
The monochrome production revenue decline reflected competitive product
introductions, movement to distributed printing and electronic substitutes, and
weakness in the worldwide economy. Revenue from our DocuTech production
publishing family, which had been continually refreshed and expanded since its
1990 launch, declined in both 2001 and 2000 reflecting the 1999 introduction of
a competitive product. While Xerox remained the market leader, our production
publishing market share declined in 2000, but improved significantly in the U.S.
in 2001. In production printing, Xerox maintained its strong market leadership
in both 2001 and 2000, however, revenue decreased reflecting declines in the
transaction printing market.
2001 production color revenues grew 2 percent from 2000 including continued
strong DocuColor 2000 series growth, partially offset by declines in older
products reflecting introduction of competitive offerings and the effects of the
weakened economy in the second half of the year. The DocuColor 2000 series,
launched in 2000, at speeds of 45 and 60 pages per minute established an
industry standard by producing near-offset quality, full color prints including
customized one-to-one printing at a variable cost of less than 10 cents per
page. Production color revenues grew significantly in 2000 largely due to the
very successful launch of the DocuColor 2000 series. Production revenues
represented 35 percent of 2001 revenues compared with 34 percent in 2000.
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2001 Production operating profit continued to decline, but significantly less
than the rate of decline experienced in 2000. Lower 2001 revenue combined with
reduced monochrome gross margin reflecting competitive pressures were only
partially offset by a substantial improvement in SAG expenses generated by our
Turnaround Program. 2000 operating profit was significantly below 1999 due to
lower revenue and gross margin, reflecting increased competition. Expenses
increased due to the earlier sales realignment and administrative transition and
higher DocuColor iGen3 R&D investments.
Office: Office revenues include our family of Document Centre digital
multifunction products, color laser, solid ink and monochrome laser desktop
printers, digital and light-lens copiers under 90 pages per minute, and
facsimile products sold through direct and indirect sales channels in North
America and Europe. 2001 revenues declined 2 percent (one percent pre-currency)
from 2000 as strong office color revenue growth was not sufficient to offset
monochrome declines. Color revenue growth was driven by the Document Centre
Color Series 50 and strong color printer equipment sales including the Phaser
860 solid ink and Phaser 7700 laser printers which use single pass color
technology. 2001 monochrome revenues declined as growth in digital multifunction
was more than offset by declines in light lens as the market continues to
transition to digital technology. This decline was exacerbated further by our
reduced participation in very aggressively priced competitive customer bids and
tenders in Europe, as we reorient our focus from market share to profitable
revenue. These declines were only slightly offset by the very successful North
American launch of the Document Centre 490 in September 2001. In 2001, digital
multifunction equipment sales represented approximately 91 percent of our
monochrome copier equipment sales compared with 82 percent in 2000.
2000 revenues increased 3 percent from 1999 including the January 2000
acquisition of CPID. Excluding CPID, revenues declined 6 percent. Office
revenues represented 41 percent of 2001 revenues compared with 38 percent in
2000.
Operating profit in the Office segment increased significantly in 2001
reflecting lower SAG spending, benefiting from our Turnaround Program and
improved gross margins. Gross margin improvement includes the benefit of our
reduced participation in very aggressively priced European bids and tenders,
significantly improved document outsourcing margins, improving Document Centre
margins facilitated by favorable mix due to the Document Centre 480 and 490
launches, improved manufacturing and service productivity, and favorable
currency. 2000 operating profit was significantly lower than 1999 reflecting
lower gross margins, higher R&D spending associated with the CPID acquisition
and increased SAG expenses due to the sales realignment, administrative
transition and CPID spending.
DMO: DMO includes operations in Latin America, the Middle East, India, Eurasia,
Russia and Africa. DMO included our China operation, which generated revenues of
$262 million in 2000, prior to the December 2000 sale. In Latin America most
equipment transactions are recorded as operating leases. 2001 DMO revenue
declined 23 percent from 2000, with approximately 45 percent of the decline due
to the sale of our China operation. The balance of the decline was due to lower
equipment populations, implementation of a new business model that places
greater emphasis on liquidity and profitable revenue rather than market share as
well as general economic weakness in many of the countries. Revenues in Brazil,
which represented approximately 5 percent of our total revenues in 2001,
declined 18 percent from 2000 primarily as a result of an average 22 percent
currency devaluation of the Brazilian Real and implementation of the new
business model. In 2001, DMO incurred a $157 million loss reflecting lower
revenue and gross margins only partially offset by initial cost restructuring
benefits. In addition, results were adversely impacted by higher aggregate
exchange losses including the Argentinean devaluation.
2000 revenues grew 7 percent reflecting growth in Brazil and most countries
outside Latin America. Revenues in Brazil grew 5 percent as an improved economic
environment was partially offset by increased competitive activity and lower
prices during the latter half of the year as the operation focused on reducing
inventory. DMO incurred an $93 million loss in 2000 compared to a profit of $48
in 1999 reflecting lower margins and an increase in SAG expenses, including
higher bad debt provisions.
SOHO: We announced our disengagement from our worldwide SOHO business in June
2001 and sold our remaining equipment inventory by the end of the year. SOHO
revenues now consist primarily of profitable consumables for the inkjet printers
and personal copiers previously sold through indirect channels in North America
and Europe. SOHO revenues represented 2 percent of 2001 revenues compared with 3
percent in 2000, and declined 32 percent in 2001 from 2000. Despite a gross
margin decline, significant SAG and R&D reductions following our June 2001
disengagement resulted in substantially lower operating losses in 2001 and a
return to profitability in the fourth quarter. We expect profits to continue in
2002 as we sell high-margin consumables for the existing equipment population.
We also expect SOHO revenues and profits to decline over time as the existing
equipment population is replaced.
Other: Other includes revenues and costs associated with paper sales, Xerox
Engineering Systems (XES), Xerox Connect, Xerox Technology Enterprises (XTE),
our investment in Fuji Xerox, consulting and other services. Other also includes
corporate items such as non-financing interest expense and other non-allocated
central costs.
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2001 revenue declined 18 percent from 2000 and operating losses increased
principally reflecting lower paper, XES, Xerox Connect, and XTE revenues, and
lower income related to our reduced investment in Fuji Xerox, partially offset
by lower net non-financing interest expense. The 2001 operating loss also
reflects the additional ESOP funding necessitated by the elimination of the ESOP
dividend; higher professional fees related to litigation, SEC issues and related
matters; employee retention compensation; and lower pension settlement gains.
2000 results benefited from gains on the sales of our North American paper
business, a 25 percent interest in ContentGuard, and a gain on our ScanSoft
affiliate's sale of stock.
New Accounting Standards. Effective January 1, 2001, we adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133), which requires companies to recognize
all derivatives as assets or liabilities measured at their fair value regardless
of the purpose or intent of holding them. Gains or losses resulting from changes
in the fair value of derivatives are 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. Changes in fair value for derivatives not designated as hedging
instruments and for the ineffective portions of hedges are recognized in
earnings of the current period. The adoption of SFAS No. 133 resulted in a net
cumulative after-tax loss of $2 million in the first quarter Consolidated
Statement of Operations and a net cumulative after-tax loss of $19 million 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 million increase in assets and a $424 million increase in
liabilities.
In 2001, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 141, "Business Combinations" (SFAS No. 141).
SFAS No. 141 requires the use of the purchase method of accounting for business
combinations and prohibits the use of the pooling of interests method. We have
not historically engaged in transactions that qualify for the use of the pooling
of interests method and therefore, this aspect of the new standard will not have
an impact on our financial results. SFAS No. 141 also changes the definition of
intangible assets acquired in a purchase business combination, providing
specific criteria for the initial recognition and measurement of intangible
assets apart from goodwill. As a result, the purchase price allocation of future
business combinations may be different than the allocation that would have
resulted under the previous rules. SFAS No. 141 also requires that upon adoption
of Statement of Financial Accounting Standards No. 142 "Goodwill and Other
Intangible Assets" (SFAS No. 142), we reclassify the carrying amounts of certain
intangible assets into or out of goodwill, based on certain criteria (see the
discussion of the impacts of the adoption of SFAS No. 142 below). All business
acquisitions initiated after June 30, 2001 must apply provisions of this
standard.
SFAS No. 142, also issued in 2001, addresses financial accounting and reporting
for acquired goodwill and other intangible assets subsequent to their initial
recognition. This statement recognizes that goodwill has an indefinite useful
life and will no longer be subject to periodic amortization. However, goodwill
will be tested at least annually for impairment, using a fair value methodology,
in lieu of amortization. The provisions of this standard also require that
amortization of goodwill related to equity method investments be discontinued,
and that these goodwill amounts continue to be evaluated for impairment in
accordance with Accounting Principles Board Opinion No. 18, "The Equity Method
of Accounting for Investments in Common Stock." We are in the process of
assessing the impacts of SFAS No. 142 which includes making determinations as to
what our reporting units will be and what amounts of goodwill, intangible assets
and other assets and liabilities should be allocated to those reporting units.
We adopted the provisions of SFAS No. 142 in our first quarter ended March 31,
2002. In connection with the adoption of SFAS No. 142, we reclassified
approximately $60 million of previously identified intangible assets to
goodwill. We will no longer record approximately $60 million of annual
amortization expenses relating to our existing goodwill, as adjusted, for the
reclassifications previously mentioned. Additionally, approximately $5 million
of annual amortization expense of goodwill related to equity method investments
will no longer be recorded. SFAS No. 142 also requires we perform annual and
transitional impairment tests on goodwill using a two-step approach. The first
step is to identify a potential impairment and the second step is to measure the
amount of any impairment loss. We have six months from the date of adoption of
the standard to complete step one of the transitional impairment test and, if
required, until the end of fiscal 2002 to complete step two of the transitional
impairment test. Any impairment loss that results from the transitional goodwill
impairment tests will be reflected as a cumulative effect of a change in
accounting principle in the first quarter of 2002. We continue to assess the
impacts of the impairment testing provisions of SFAS No. 142. We anticipate
completion of the first step of the impairment test in connection with our
second quarter of 2002.
In 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." The Statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
associated asset retirement costs. We are required to implement this standard on
January 1, 2003. We do not expect this Statement will have a material effect on
our financial position or results of operations.
In 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The Statement primarily supercedes FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
26
Long-Lived Assets to be Disposed of." The Statement retains the previously
existing accounting requirements related to the recognition and measurement of
the impairment of long-lived assets to be held and used, while expanding the
measurement requirements of long-lived assets to be disposed of by sale to
include discontinued operations. It also expands on the previously existing
reporting requirements for discontinued operations to include a component of an
entity that either has been disposed of or is classified as held for sale. We
implemented this standard on January 1, 2002, and do not expect this Statement
will have a material effect on our financial position or results of operations.
In 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13 and Technical Corrections." The
Statement rescinds SFAS No. 4 which required all gains and losses from
extinguishment of debt to be aggregated and, when material, classified as an
extraordinary item net of related income tax effect. SFAS No. 145 also amends
Statement 13 to require that certain lease modifications having economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. We are required to implement this standard for
transactions occurring after May 15, 2002 and do not expect this Statement will
have a material effect on our financial position or results of operations. We
will implement the provisions related to the rescission of SFAS No. 4 in the
second quarter of 2002.
Capital Resources and Liquidity
Liquidity, Financial Flexibility and Funding Plans:
Historically, our primary sources of funding have been cash flows from
operations, borrowings under our commercial paper and term funding programs, and
securitizations of accounts and finance receivables. We used these funds to
finance customers' purchases of our equipment and for working capital
requirements, capital expenditures and business acquisitions. Our operations and
liquidity began to be negatively impacted in 2000 by Company-specific business
challenges, which have been previously discussed. These challenges were
exacerbated by significant competitive and industry changes, adverse economic
conditions, and significant technology and acquisition spending. Together, these
challenges and conditions negatively impacted our cash availability and created
marketplace concerns regarding our liquidity, which led to credit rating
downgrades and restricted our access to capital markets.
In addition to the limited access to capital markets which resulted from our
credit rating downgrades, we have been unable to access the public capital
markets. This is because, as a result of the ongoing SEC investigation since
June 2000 and the accounting issues raised by the SEC, the SEC Staff advised us
that we could not make any public registered securities offerings. This
additional constraint had the effect of limiting our means of raising funds to
those of unregistered capital markets offerings and private lending or equity
sources. Our credit ratings became even more important, since credit rating
agencies often include access to other capital sources in their rating criteria.
During 2000, 2001, and 2002, these rating downgrades, together with the recently
concluded review by the SEC, adversely affected our liquidity and financial
flexibility, as follows:
. Since October 2000, uncommitted bank lines of credit and the unsecured
public capital markets have been largely unavailable to us.
. On December 1, 2000, Moody's reduced its rating of our senior debt to
below investment grade, significantly constraining our ability to enter
into new foreign-currency and interest rate derivative agreements, and
requiring us to immediately repurchase certain of our then-outstanding
derivative agreements for $108 million.
. In the fourth quarter 2000, as a result of our lack of access to
unsecured bank and public credit sources, we drew down the entire $7.0
billion available to us under our Revolving Credit Agreement (the "Old
Revolver"), primarily to maintain financial flexibility and pay down
debt obligations as they came due.
. On October 23, 2001, Standard & Poors (S&P) reduced its rating of our
senior debt to below investment grade, further constraining our ability
to enter into new derivative agreements, and requiring us to
immediately repurchase certain of our then-outstanding out-of-the-money
interest-rate and cross-currency interest-rate derivative agreements
for a total of $148 million.
. To minimize the resulting interest and currency exposures from these
events, we have subsequently restored some derivative trading, with
several counterparties, on a limited basis. However, virtually all such
new arrangements either require us to post cash collateral against all
out-of-the-money positions, or else have very short terms (e.g., as
short as one week). Both of these types of arrangements potentially use
more cash than standard derivative arrangements would otherwise
require.
. On May 1, 2002, Moody's further reduced its rating of our senior debt,
requiring us to post additional collateral against certain derivative
agreements currently in place. This downgrade also constituted a
termination event under
27
our existing $290 million U.S. trade receivable securitization
facility, which we are currently renegotiating with the counterparty,
as described more fully below.
. On June 11 and 21, 2002, S&P lowered and affirmed its rating of our
senior unsecured and senior secured debt, which to date has not had any
incremental adverse effects on our liquidity.
As of June 26, 2002, our senior and short-term debt ratings and outlooks were as
follows:
Senior Debt Rating Short Term Debt Rating Outlook
Moody's B1 Not Prime Negative
S&P* BB-/B+* B* Negative*
Fitch BB B Stable
*Effective June 11, 2002, S&P lowered our Corporate credit rating, and
downgraded our senior debt, to BB- and maintained us on CreditWatch with
Negative implications. Upon receipt of commitments from the banks who are party
to our New Credit Facility, S&P affirmed the Corporate credit rating and our
senior secured debt at BB-with a Negative Outlook, and downgraded our senior
unsecured debt to B+.
We expect our limited access to unsecured credit sources to result in higher
borrowing costs going forward, and to potentially result in Xerox Corporation
having to increase its level of intercompany lending to affiliates and/or to
guarantee portions of their debt.
Actions Taken to Address Liquidity Issues:
In the fourth quarter of 2000, as a result of the various factors described
above, we began accumulating cash in an effort to maintain financial
flexibility, rather than continuing our historical practice of using available
cash to voluntarily pay down debt. To the extent possible, and except as
otherwise prohibited under the New Credit Facility described below, we expect to
continue this practice of accumulating cash for the foreseeable future.
New Credit Facility:
On June 21, 2002, we entered into an Amended and Restated Credit Agreement (the
"New Credit Facility") with a group of lenders, replacing the Old Revolver. At
that time, we permanently repaid $2.8 billion of the $7 billion Revolving Credit
Agreement (the "Old Revolver"). Accordingly, there is currently $4.2 billion
outstanding under the New Credit Facility, consisting of three tranches of term
loans totaling $2.7 billion and a $1.5 billion revolving facility that includes
a $200 million letter of credit sub-facility. The three term loan tranches
include a $1.5 billion amortizing "Tranche A" term loan, a $500 million "Tranche
B" term loan, and a $700 million "Tranche C" term loan maturing on September 15,
2002. Xerox Corporation is currently, and will remain, the borrower of all of
the term loans. The revolving loans are available, without sub-limit, to Xerox
Corporation, Xerox Canada Capital Limited (XCCL), Xerox Capital Europe plc (XCE)
and other foreign subsidiaries, as requested by us from time to time, that meet
certain qualifications. We are required to repay a total of $400 million of the
Tranche A loan and $5 million of the Tranche B loan in semi-annual installments
in 2003, and a total of $600 million of the Tranche A loan and $5 million of the
Tranche B loan in semi-annual installments in 2004. The remaining portions of
the Tranche A and Tranche B term loans and the revolving facility contractually
mature on April 30, 2005. We could be required to repay portions of the loans
earlier than their scheduled maturities upon the occurrence of certain events,
as described below. In addition, all loans under the New Credit Facility mature
upon the occurrence of a change in control.
Subject to certain limits described in the following paragraph, all obligations
under the New Credit Facility are secured by liens on substantially all domestic
assets of Xerox Corporation and by liens on the assets of substantially all of
our U.S. subsidiaries (excluding Xerox Credit Corporation), and are guaranteed
by substantially all of our U.S. subsidiaries. In addition, revolving loans
outstanding from time to time to XCE (currently $605 million) are also secured
by all of XCE's assets and are also guaranteed on an unsecured basis by certain
foreign subsidiaries that directly or indirectly own all of the outstanding
stock of XCE. Revolving loans outstanding from time to time to XCCL (currently
$300 million) are also secured by all of XCCL's assets and are also guaranteed
on an unsecured basis by our material Canadian subsidiaries, as defined
(although the guaranties of the Canadian subsidiaries will become secured by
their assets in the future if certain events occur).
Under the terms of certain of our outstanding public bond indentures, the
outstanding amount of obligations under the New Credit Facility that can be
secured by assets (the "Restricted Assets") of (i) Xerox Corporation and (ii)
our non-financing subsidiaries that have a consolidated net worth of at least
$100 million, without triggering a requirement to also secure these indentures,
is limited to the excess of (a) 20 percent of our consolidated net worth (as
defined in the public bond indentures) over (b) a portion of the outstanding
amount of certain other debt that is secured by the Restricted Assets.
Accordingly, the amount of the debt secured under the New Credit Facility by the
Restricted Assets (the "Restricted Asset Security Amount")
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will vary from time to time with changes in our consolidated net worth. The
Restricted Assets secure the Tranche B loan up to the Restricted Asset Security
Amount; any Restricted Asset Security Amount in excess of the outstanding
Tranche B loan secures, on a ratable basis, the other outstanding loans under
the New Credit Facility. The assets of XCE, XCCL and many of the subsidiaries
guarantying the New Credit Facility are not Restricted Assets because those
entities are not restricted subsidiaries as defined in our public bond
indentures. Consequently, the amount of debt under the New Credit Facility
secured by their assets is not subject to the foregoing limits.
The New Credit Facility loans generally bear interest at LIBOR plus 4.50
percent, except that the Tranche B loan bears interest at LIBOR plus a spread
that varies between 4.00 percent and 4.50 percent depending on the Restricted
Asset Security Amount in effect from time to time. Specified percentages of any
net proceeds we receive from capital market debt issuances, equity issuances or
asset sales during the term of the New Credit Facility must be used to reduce
the amounts outstanding under the New Credit Facility, and in all cases any such
amounts will first be applied to reduce the Tranche C loan. Once the Tranche C
loan has been repaid, or to the extent that such proceeds exceed the outstanding
Tranche C loan, any such prepayments arising from debt and equity proceeds will
first permanently reduce the Tranche A loans, and any amount remaining
thereafter will be proportionally allocated to repay the then-outstanding
balances of the revolving loans and the Tranche B loans and to reduce the
revolving commitment accordingly. Any such prepayments arising from asset sale
proceeds will first be proportionally allocated to permanently reduce any
outstanding Tranche A loans and Tranche B loans, and any amounts remaining
thereafter will be used to repay the revolving loans and to reduce the revolving
commitment accordingly (except that the revolving loan commitment cannot be
reduced below $1 billion as a result of such prepayments).
The New Credit Facility contains affirmative and negative covenants including
limitations on issuance of debt and preferred stock, certain fundamental
changes, investments and acquisitions, mergers, certain transactions with
affiliates, creation of liens, asset transfers, hedging transactions, payment of
dividends, intercompany loans and certain restricted payments, and a requirement
to transfer excess foreign cash, as defined, and excess cash of Xerox Credit
Corporation to Xerox Corporation in certain circumstances. The New Credit
Facility does not affect our ability to continue to monetize receivables under
the agreements with GE Capital and others, which are discussed below. No cash
dividends can be paid on our Common Stock for the term of the New Credit
Facility. Cash dividends may be paid on preferred stock provided there is then
no event of default. In addition to other defaults customary for facilities of
this type, defaults on debt of, or bankruptcy of, Xerox Corporation or certain
subsidiaries would constitute a default under the New Credit Facility.
The New Credit Facility also contains financial covenants which the Old Revolver
did not contain, including:
. Minimum EBITDA (rolling four quarters, as defined)
. Maximum Leverage (total adjusted debt divided by EBITDA, as defined)
. Maximum Capital Expenditures (annual test)
. Minimum Consolidated Net Worth (quarterly test, as defined)
Failure to be in compliance with any material provision of the New Credit
Facility could have a material adverse effect on our liquidity, financial
position and results of operations.
We expect total fees and expenses incurred in connection with the New Credit
Facility to approximate $125 million, the majority of which was paid at closing.
These amounts will be deferred and amortized over the three year term of the New
Credit Facility.
Turnaround Program:
In 2000 we announced a global Turnaround Program which included initiatives to
sell certain assets, improve operations and liquidity, and reduce annual costs
by at least $1 billion. Through December 31, 2001, and since that time, we have
made significant progress toward these objectives.
With respect to asset sale initiatives:
. In the fourth quarter of 2000 we sold our China operations to Fuji Xerox,
generating $550 million of cash and transferring $118 million of debt to
Fuji Xerox.
. In March 2001, we sold half of our interest in Fuji Xerox to Fuji Photo
Film Co., Ltd. for $1,283 million in cash.
. In the fourth quarter of 2001, we received cash proceeds of $118 million
related to the sales to Flextronics of certain of our manufacturing
facilities, and in 2002 we received additional net cash proceeds of $29
million related to the sales of additional facilities under that
agreement.
29
With respect to operational and liquidity improvements, we have announced major
initiatives with GE Capital and other vendor financing partners, and we have
completed several transactions, including (1) implementation of third-party
vendor financing programs in the Netherlands, the Nordic countries, Brazil,
Mexico, and Italy and (2) monetizations of portions of our existing finance
receivables portfolios. We have several other similar transactions currently
being negotiated, and we continue to actively pursue alternative forms of
financing. These initiatives, when completed, are expected to significantly
improve our liquidity going forward.
In connection with general financing initiatives:
. During 2001, we retired $377 million of long-term debt through the
exchange of 41.1 million shares of our common stock, which increased
our net worth by $351 million.
. In November 2001, we sold $1,035 million of Convertible Trust Preferred
Securities, and placed $229 million of the proceeds in escrow to fund
the first three-years' distribution requirements. Total proceeds, net
of escrowed funds and transaction costs, were $775 million.
. In January 2002, we sold $600 million of 9 3/4 percent Senior Notes and
(euro)225 million of 9 3/4 percent Senior Notes, for cash proceeds
totaling $746 million, which is net of fees and original-issue
discount. These notes mature on January 15, 2009, and contain several
affirmative and negative covenants which are similar to those in the
New Credit Facility. Taken as a whole, the Senior Notes covenants are
less restrictive than the covenants contained in the New Credit
Facility. In addition, our Senior Notes do not contain any financial
maintenance covenants or scheduled amortization payments. The Senior
Notes covenants (1) restrict certain transactions, including new
borrowings, investments and the payment of dividends, unless we meet
certain financial measurements and ratios, as defined, and (2) restrict
our use of proceeds from certain other transactions including asset
sales. In connection with the June 21, 2002 closing of the New Credit
Facility, substantially all of our U.S. subsidiaries guaranteed these
notes. In order to reduce the immediate cost of this borrowing, we
entered into derivative agreements to swap the cash interest
obligations under the dollar portion of these notes to LIBOR plus 4.44
percent. We will be required to collateralize any out-of-the-money
positions on these swaps.
In connection with vendor financing and related initiatives:
. In 2001, we received $885 million in financing from GE Capital, secured
by portions of our finance receivable portfolios in the United Kingdom.
At December 31, 2001, the remaining balances of these loans totaled
$521 million.
. In the second quarter 2001, we sold our leasing businesses in four
Nordic countries to Resonia Leasing AB for $352 million in cash plus
retained interests in certain finance receivables for total proceeds of
approximately $370 million. These sales are part of an agreement under
which Resonia will provide on-going, exclusive equipment financing to
our customers in those countries.
. In July 2001, we transferred U.S. lease contracts to a trust, which in
turn sold $513 million of floating-rate asset-backed notes. We received
cash proceeds of $480 million, net of $3 million of fees, plus a
retained interest of $30 million, which we will receive when the notes
are repaid, which we expect to occur in August 2003. The transaction
was accounted for as a secured borrowing. At December 31, 2001, the
remaining debt totaled $395 million.
. In September 2001, we announced a U.S. Framework Agreement (the "USFA")
with GE Capital's Vendor Financial Services group, under which GE
Capital will become the primary equipment-financing provider for our
U.S. customers. We expect funding under the USFA to be in place in 2002
upon completion of systems and process modifications and development.
. In November 2001, we entered into an agreement with GE Capital which
provides for a series of loans, secured by certain of our finance
receivables in the United States, up to an aggregate of $2.6 billion,
provided that certain conditions are met at the time the loans are
funded. These conditions, all of which we currently meet, include
maintaining a specified minimum debt rating with respect to our senior
debt. In the fourth quarter of 2001, we received two secured loans from
GE Capital totaling $1,175 million. Cash proceeds of $1,053 million
were net of $115 million of escrow requirements and $7 million of fees.
At December 31, 2001, the remaining balances of these loans totaled
$1,149 million. In March 2002, we received our third secured loan from
GE Capital totaling $266 million. Cash proceeds of $229 million were
net of $35 million of escrow requirements and $2 million of fees. In
May 2002, we received our fourth secured loan from GE Capital, totaling
$499 million. Cash proceeds of $496 million were net of $3 million of
fees. Through June 26, 2002 approximately $1.9 billion of loans have
been funded under this agreement.
. In November 2001, we announced a Canadian Framework Agreement (the
"CFA") with the Canadian division of GE Capital's Vendor Financial
Services group, similar to the agreement in the U.S., under which GE
Capital will become the primary equipment-financing provider for our
Canadian customers. We expect the CFA to be completed in 2002. In
February 2002 we received a $291 million loan from GE Capital, secured
by certain of our finance
30
receivables in Canada. Cash proceeds of $281 million were net of $8
million of escrow requirements and $2 million of fees.
. In December 2001, we announced that we would be forming a joint
venture with De Lage Landen International BV (DLL) to manage equipment
financing, billing and collections for our customers' financed
equipment orders in the Netherlands. This joint venture was formed and
began funding in the first quarter of 2002. DLL owns 51 percent of the
venture and provides the funding to support new customer leases, and
we own the remaining 49 percent of this unconsolidated venture.
. In December 2001, we announced European framework agreements with GE
Capital's European Equipment Finance group, under which GE Capital
will become the primary equipment-financing provider for our customers
in France and Germany. We expect these agreements to be completed in
2002.
. In March 2002, we signed agreements with third parties in Brazil and
Mexico, under which those third parties will be our primary equipment
financing provider in those countries. Funding under both of these
arrangements commenced in the second quarter of 2002.
. In April 2002, we sold our leasing business in Italy to a third party
for $207 million in cash plus the assumption of $20 million of debt.
We can also receive retained interests up to approximately $30
million, based on the occurrence of certain future events. This sale
is part of an agreement under which the third-party will provide
on-going, exclusive equipment financing to our customers in Italy.
. In May 2002, we received an additional loan from GE Capital of $106
million secured by portions of our lease receivable portfolio in the
U.K.
. In May 2002, we received a $77 million loan from GE Capital, secured
by certain of our finance receivables in Germany. Cash proceeds of $65
million were net of $12 million of escrow requirements.
Cash and Debt Positions:
With $4.0 billion of cash and cash equivalents on hand at December 31, 2001,
(and approximately $1.8 billion on hand as of June 26, 2002, after giving effect
to the refinancing under the New Credit Facility) we believe our liquidity is
sufficient to meet current operating cash flow requirements and to satisfy all
scheduled debt maturities through December 31, 2002.
As a result of the New Credit Facility discussed above, our debt maturities have
changed. Significantly less debt will now mature in 2002 and 2003 than would
have become due had the Old Revolver not been refinanced. In addition, a portion
of our available cash has been used to retire some of the debt under the Old
Revolver. The following represents our aggregate debt maturity schedules by
quarter for 2002 and 2003, and reflects the New Credit Facility and related
principal payments discussed above (in billions):
2002 2003
---- ----
First Quarter $0.7 $0.5
Second Quarter 4.0 1.1
Third Quarter 1.0 0.3
Fourth Quarter 0.9 1.3
---- ----
Full Year $6.6 $3.2
==== ====
Additionally, as discussed throughout this Annual Report, we have reached a
settlement with the SEC as to all matters that were under investigation. It is
our expectation that the resolution of these matters will restore our ability to
access the public capital markets and reduce our earlier reliance on other
funding sources including non-public capital markets. Our current plans include
accessing the public capital markets in 2002, however, we are not dependent on
such access to maintain adequate liquidity in 2002.
Plans to Strengthen Liquidity and Financial Flexibility Beyond 2002:
Our ability to maintain sufficient liquidity beyond 2002 is highly dependent on
achieving expected operating results, including capturing the benefits from
restructuring activities, and completing announced vendor financing and other
initiatives. There is no assurance that these initiatives will be successful.
Failure to successfully complete these initiatives could have a material adverse
effect on our liquidity and our operations, and could require us to consider
further measures, including deferring planned capital expenditures, modifying
current restructuring plans, reducing discretionary spending, selling additional
assets and, if necessary, restructuring existing debt.
We also expect that improvements in our debt ratings, and our related ability to
fully access certain unsecured public debt markets, namely the commercial paper
markets, will depend on (1) our ability to demonstrate sustained EBITDA growth
and operating cash generation and (2) continued progress on our vendor financing
initiatives, as discussed above. Until such
31
time, we expect some bank lines to continue to be unavailable, and we intend to
access other segments of the capital markets as business conditions allow, which
could provide significant sources of additional funds until full access to the
unsecured public debt markets is restored.
Contractual Cash Obligations and Other Commercial Commitments and Contingencies:
At December 31, 2001, we had the following contractual cash obligations and
other commercial commitments and contingencies:
Contractual Cash Obligations:
2002 2003 2004 2005 2006 Thereafter
---- ---- ---- ---- ----
(In millions)
Long term debt/(1)/ ...................... $ 6,584 $ 3,247 $ 2,567 $ 3,370 $ 30 $ 914
Minimum operating lease commitments ...... 250 207 165 135 112 359
------- ------- ------- ------- ----- -----
Total contractual cash obligations ... $ 6,834 $ 3,454 $ 2,732 $ 3,505 $ 142 $1,273
======= ======= ======= ======= ===== =====
/(1)/ The long-term debt obligations reflect the refinancing of our New Credit
Facility on June 21, 2002.
Cumulative Preferred Securities:
As of December 31, 2001, we have four series of outstanding preferred securities
as summarized below. The redemption requirements and the annual cumulative
dividend requirements on our outstanding preferred stock are as follows:
. Series B Convertible Preferred Stock (ESOP shares): The balance at
December 31, 2001 was $605 million, and is redeemable in shares of
common stock or cash, at our option, as employees with vested shares
leave the Company. Annual cumulative dividend requirements are $6.25
per share. In 2001, we suspended these dividends, but the unpaid
dividends are cumulative and amount to approximately $40 million at
December 31, 2001.
. 7 1/2 percent Convertible Trust Preferred Securities: The balance at
December 31, 2001 was $1,005 million, and is putable in 2004 in cash
or in shares of common stock at a redemption value of $1,035 million.
Annual cumulative distribution requirements are $3.75 per Preferred
Security on 20.7 million securities. The first three years' dividend
requirements were funded at issuance and are invested in U.S. Treasury
securities held by a separate trust.
. 8 percent Convertible Trust Preferred Securities: The balance at
December 31, 2001 was $639 million, and is o redeemable in 2027 at a
redemption value of $650 million. Annual cumulative dividend
requirements are $80 per security on 650,000 securities.
. Canadian Deferred Preferred Stock: The balance at December 31, 2001
was $43 million, and is redeemable in 2006. o Annual cumulative
non-cash dividend requirements will increase this amount to its 2006
redemption value of approximately $56 million.
Other Commercial Commitments and Contingencies:
- -----------------------------------------------
Flextronics: As previously discussed, in 2001 we outsourced certain
manufacturing activities to Flextronics under a five-year agreement. At December
31, 2001 we anticipate that we will purchase approximately $1 billion of
inventory from Flextronics during 2002 and expect to maintain this level in the
future.
Fuji Xerox: We had product purchases from Fuji Xerox totaling $598 million, $812
million, and $740 million in 2001, 2000 and 1999, respectively. Our purchase
commitments with Fuji Xerox are in the normal course of business and typically
have a lead time of three months.
Other Purchase Commitments: We enter into other purchase commitments with
vendors in the ordinary course of business. Our policy with respect to all
purchase commitments is to record any losses when they are probable and
reasonably estimable.
EDS Contract: We have an information management (IM) contract with Electronic
Data Systems Corp (EDS). We can terminate the contract with six months notice
upon the payment of termination fees, as defined in the contract. Although there
are no minimum payments due under the contract, the IM function is integral to
our operations and at this time, we anticipate making the following payments to
EDS over the next five years (in millions): 2002--$381; 2003--$354; 2004--$351;
2005--$354; 2006--$345.
32
Other Funding Arrangements:
Securitizations, and Use of Special Purpose Entities:
From time to time, we have generated liquidity by selling or securitizing
portions of our finance and accounts receivable portfolios. We have typically
utilized special-purpose entities (SPEs) in order to implement these
transactions in a manner that isolates, for the benefit of the securitization
investors, the securitized receivables from our other assets which would
otherwise be available to our creditors. These transactions are typically
credit-enhanced through over-collateralization. Such use of SPEs is standard
industry practice, is typically required by securitization investors and makes
the securitizations easier to market. None of our officers, directors or
employees or those of any of our subsidiaries or affiliates hold any direct or
indirect ownership interests in any of these SPEs. We typically act as service
agent and collect the securitized receivables on behalf of the securitization
investors. Under certain circumstances, including the downgrading of our debt
ratings by one or more rating agencies, we can be terminated as servicing agent,
in which event the SPEs may engage another servicing agent and we would cease to
receive a servicing fee. Although the debt rating downgrade provisions have been
triggered in some of our securitization agreements, the securitization investors
and/or their agents have not elected to remove us as administrative servicer as
of this time. We are not liable for non-collection of securitized receivables or
otherwise required to make payments to the SPEs except to the limited extent
that the securitized receivables did not meet specified eligibility criteria at
the time we sold the receivables to the SPEs or we fail to observe agreed-upon
credit and collection policies and procedures.
Most of our SPE transactions were accounted for as borrowings, with the debt and
related assets remaining on our balance sheets. Specifically, in addition to the
July 2001 asset-backed notes transaction and the U.S. loans from GE Capital
discussed above, which utilized SPEs as part of their structures, as of December
31, 2001, we have entered into the following similar transactions which were
accounted for as debt on our balance sheets:
. In the third quarter 2000, Xerox Credit Corporation (XCC) securitized
certain finance receivables in the United States, generating gross
proceeds of $411 million. As of December 31, 2001, the remaining debt
under this facility totaled approximately $154 million.
. In 1999, XCC securitized certain finance receivables in the United
States, generating gross proceeds of $1,150 million. At December 31,
2001, the remaining obligations in this facility totaled $94 million,
and were substantially repaid as of June 26, 2002.
We have also entered into the following SPE transactions which were accounted
for as sales of receivables:
. In 2000, Xerox Corporation and Xerox Canada Limited (XCL) securitized
certain accounts receivable in the U.S. and Canada, generating gross
proceeds of $315 million and $38 million, respectively. In December
2000, as a result of the senior debt downgrade by Moody's discussed
above, both entities negotiated waivers with their respective
counterparties to prevent the facilities from entering "wind-down"
mode. As part of its waiver negotiation, Xerox Corporation
renegotiated the $315 million U.S. facility, reducing its size to $290
million. The May 2002 Moody's downgrade constituted an event of
termination under this agreement, which we are currently
renegotiating. Failure to successfully renegotiate the facility could
result in the suspension of its revolving features, whereupon we would
be unable to sell new accounts receivable into the facility, and our
availability would wind down. In February 2002, the size of the
Canadian facility was reduced in order to make certain receivables
eligible under the GE Capital Canadian transaction described above.
Also in February 2002, a downgrade of our Canadian debt by Dominion
Bond Rating Service caused the Canadian counterparty to withdraw its
waiver, in turn causing the remaining Canadian facility at that time
to enter into wind-down mode. This facility has subsequently been
fully repaid.
. In 1999, XCL securitized certain finance receivables, generating gross
proceeds of $345 million. At December 31, 2001, the remaining
obligations in this facility totaled $93 million, and we expect them
to be fully paid in 2002. At December 31, 2001, this is the only
outstanding SPE transaction with recourse provisions that could be
asserted against us.
. In 1999, Xerox Corporation and certain of its subsidiaries securitized
accounts receivable, generating aggregate gross proceeds of $231
million. No amounts remained outstanding as of December 31, 2001.
In summary, at December 31, 2001, amounts owed by these receivable-related SPEs
to their investors totaled $2,210 million, of which $418 million represented
transactions we treated as asset sales, and the remaining $1,792 million is
reported as Debt in our Consolidated Balance Sheet. A detailed discussion of the
terms of these transactions, including descriptions of our retained interests,
is included in Note 5 to the Consolidated Financial Statements. We also utilized
SPEs in our Trust Preferred Securities transactions. Refer to Note 17 to the
Consolidated Financial Statements for a detailed description of these
transactions.
Secured Debt - Summary:
33
As of March 31, 2002, after giving effect to the New Credit Facility, we have
approximately $930 million of debt which is secured by assets that are measured
against the 20 percent consolidated net worth limitation described above. In
addition, we have $3,802 million of debt which is secured by assets that are not
measured against that 20 percent limitation, in most cases because the
applicable borrowing entities are considered financing subsidiaries under the
public indenture definitions.
Equity Put Options:
During 2000 and 1999, we sold 7.5 million and 0.8 million equity put options,
respectively, for proceeds of $24 million and $0.4 million. We did not sell any
such options in 2001. Equity put options give the counterparty the right to sell
our common shares back to us at a specified strike price. In January 2001, we
paid $28 million to settle the put options we issued in 1999, which we funded by
issuing 5.9 million unregistered common shares. In the fourth quarter 2000, we
were required to pay $92 million to settle the put options that we issued in
2000. In 1999, we paid $5 million to settle put options that we issued in 1998.
There were no put options outstanding as of December 31, 2001.
Cash Management:
Xerox and its material subsidiaries and affiliates manage their worldwide cash,
cash equivalents and liquidity resources through internal cash management
systems, which include established policies and procedures. They are subject to
(1) the statutes, regulations and practices of the local jurisdictions in which
the companies operate, (2) the legal requirements of the agreements to which the
companies are parties and (3) the policies and cooperation of the financial
institutions utilized by the companies to maintain such cash management systems.
At December 31, 2001, 2000 and 1999, cash and cash equivalents on hand totaled
$3,990 million, $1,750 million and $132 million, respectively, and total debt
was $16,765 million, $18,637 million, and $16,147 million, respectively. Total
debt net of cash (Net Debt) decreased by $4,112 million in 2001, increased by
$872 million in 2000, and increased by $769 million in 1999. The consolidated
ratio of total debt to common and preferred equity was 6.9:1, 7.6:1 and 4.5:1 as
of December 31, 2001, 2000 and 1999, respectively. The decrease in this ratio in
2001 reflects debt-for-equity exchanges, a curtailment of dividends, and debt
repayments funded by asset sales and working capital improvements, offset
partially by a net loss and the impacts of currency devaluation. The increase in
2000 reflects the 2000 net loss, an increase in debt to fund the CPID
acquisition, cash payments required to settle outstanding put options on our
common stock, cash dividends, and the impact of currency devaluation. The
increases in both 2001 and 2000 compared to 1999 also reflect our decision,
beginning in 2000, to accumulate cash to maintain financial flexibility rather
than continue our historical practice of paying down debt with available cash.
The following represents the results of our cash flows for the last three years
included within our Statement of Cash Flows in our consolidated financial
statements (in millions):
2001 2000 1999
---- ---- ----
Operating Cash Flows $ 1,566 $ 207 $ 551
Investing Cash Flows (Usage) 873 (855) (789)
Financing Cash Flows (Usage) (189) 2,255 300
Foreign Currency Impacts (10) 11 (9)
-------- --------- --------
Net Change in Cash Balance 2,240 1,618 53
Cash - Beginning of year 1,750 132 79
-------- --------- --------
Cash - End of year $ 3,990 $ 1,750 $ 132
======== ========= ========
2001 operating cash flows improved significantly compared to 2000, primarily due
to working capital improvements. Although our sales declined, which normally
leads to a reduction in receivables and payables balances, our collections of
receivables exceeded our payments on accounts payable and other current
liability accounts by approximately $500 million. We further reduced our
inventory balances and spending for on-lease equipment by approximately $480
million. We also had a short-term benefit of approximately $350 million
associated with the timing of taxes due on the gain from our sale of half our
interest of Fuji Xerox, which we did not have to pay until first quarter 2002.
The overall impact of our reported net loss on our operating cash flows, after
considering the impacts of non-cash items associated with restructuring charges,
provisions, tax valuation allowances and gains did not vary significantly
between 2001 and 2000.
Investing cash flows were higher in 2001 primarily due to $1,768 million of cash
received from the sales of businesses, including Fuji Xerox and our leasing
businesses in the Nordic European countries. These cash proceeds were greater
than those received from the sale of businesses in 2000, which resulted in
proceeds of $640 million. In 2001 we also reduced
34
capital spending and internal-use software spending significantly. Other factors
contributing to the 2001 improvement were the acquisition of CPID in 2000, which
utilized cash of $856 million, while in 2001 we were required to fund $628
million of certain escrow and insurance trusts based on contractual
requirements.
Our 2001 financing activities largely consisted of a net repayment of
approximately $1.1 billion of debt, offset by a private placement of $1.0
billion of trust preferred securities. Our suspension of dividends on our common
and preferred stock also had a positive impact on our cash flows in 2001.
Refer to our EBITDA-based cash flows discussion below to understand the way we
look at cash flows from a treasury and cash management perspective, and for
explanations of cash flows for 2000 and 1999.
Historically, we separately managed the capital structures of our non-financing
operations and our captive financing operations. Consistent with our continuing
efforts to exit the customer equipment financing business, we now use EBITDA and
operating cash flow to measure our liquidity, and we no longer distinguish
between financing and non-financing operations in our liquidity management
processes. We define EBITDA as earnings before interest expense, income taxes,
depreciation, amortization, minorities' interests, equity in income of
unconsolidated affiliates, and non-recurring and non-operating items. We believe
that EBITDA provides investors and analysts with a useful measure of liquidity
generated from recurring operations. EBITDA is not intended to represent an
alternative to either operating income or cash flows from operating activities
(as those terms are defined in GAAP). While EBITDA is frequently used to analyze
companies, the definition of EBITDA we employ, as presented herein, may differ
from definitions of EBITDA employed by other companies.
The following is a summary of EBITDA, operating and other cash flows for the
years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
---- ---- ----
Restated Restated
-------- --------
Non-financing revenues $ 15,879 $ 17,589 $ 17,820
Non-financing cost of sales 10,050 11,233 10,529
-------- -------- --------
Non-financing gross profit 5,829 6,356 7,291
Research and development expense (997) (1,064) (1,020)
Selling, administrative and general expenses (4,728) (5,518) (5,204)
Depreciation and amortization expense, excluding goodwill and 1,238 1,158 1,040
-------- -------- --------
intangibles
Adjusted EBITDA 1,342 $ 32 2,107
Working capital and other changes 794 694 (319)
On-Lease equipment spending (271) (506) (387)
Capital spending (219) (452) (594)
Restructuring payments (484) (387) (441)
-------- -------- --------
Operating Cash Flow* 1,162 281 366
Interest payments (1,074) (1,050) (848)
Financing cash flow 1,374 494 292
Debt borrowings (repayments), net (1,242) 2,917 793
Net proceeds from Trust Preferred Securities 775 - -
Dividends and other non-operating items (541) (808) (508)
Proceeds from sales of businesses 1,768 640 65
Acquisitions 18 (856) (107)
-------- -------- --------
Net Increase in Cash $ 2,240 $ 1,618 $ 53
======== ======== ========
*The primary difference between this amount and the Cash Flows from Operations
reported in our GAAP Statements of Cash Flows, is the inclusion of Capital
Spending in, and the exclusion of Financing Cash Flow and Interest Payments
from, the amount shown above.
2001 EBITDA operating cash flow of $1,162 million increased by $881 million,
from $281 million in the prior year. The improvement was driven by cost
reductions, lower on-lease equipment spending, lower capital spending, and
modest working capital improvements, and was partially offset by higher
restructuring payments and lower revenues. The decline in capital spending was
due primarily to significant spending constraints as well as completion in 2000
of our remaining Ireland projects described below. The decline in on-lease
equipment spending reflected declining rental placement activity and
populations, particularly in our older-generation light lens products.
35
The increase in EBITDA financing cash flow in 2001 reflected lower finance
receivable originations resulting from lower equipment sales in 2001 compared to
2000. Dividends and other non-operating items used $541 million of cash in 2001,
compared to usage of $808 million in 2000. This improvement was largely due to
cash savings of approximately $500 million resulting from our elimination and
suspension of our common and Series B Preferred dividends, respectively, which
we announced in July 2001, and lower payments required to terminate derivative
contracts, partially offset by a $255 million payment related to our funding of
trusts to replace Ridge Reinsurance letters of credit.
In 2001, we generated $1,768 million of cash from the sales of businesses,
including the sale of half our interest in Fuji Xerox, our leasing businesses in
four European countries, and certain of our manufacturing-related assets to
Flextronics, as discussed below. These asset sales, together with net proceeds
of $775 million from the sale of trust preferred securities and the significant
improvements in operating and financing cash flows, funded net repayments of
debt totaling $1,242 million in 2001, compared to incremental borrowings of
$2,917 million in 2000 which included funding for the CPID acquisition.
EBITDA operating cash flow was $281 million in 2000, including $328 million of
accounts receivable securitizations, compared to $366 million in 1999.
Significant improvements in working capital and lower capital spending
essentially offset lower EBITDA, which reflected lower revenues and higher costs
compared to 1999. Capital spending in 2000 included production tooling and our
investments in Ireland, where we consolidated European customer support centers
and invested in inkjet supplies manufacturing. The significant decline in 2000
spending versus 1999 is due primarily to substantial completion of several
aspects of the Ireland projects as well as significant spending constraints.
Investments in on-lease equipment reflected growth in our document outsourcing
business.
The significant increase in interest payments in 2000 largely reflects higher
debt levels.
In 2000, we generated $640 million of cash from the sales of businesses,
including the sale of our China operations to Fuji Xerox for $550 million, and
we used $856 million of cash for the acquisition of the CPID division of
Tektronix. The increased spending in Dividends and other non operating items
reflected cash payments of $68 million to settle put options on our common
stock, plus payments of $108 million to settle out-of-the-money currency and
interest rate derivatives which were cancelled upon one of our debt downgrades
discussed below. Together with increased interest costs, only partially offset
by modest increases in operating and financing cash flows, these cash decreases
required us to borrow an incremental $2,917 million in 2000.
Cash restructuring payments were $484 million, $387 million, and $441 million in
2001, 2000 and 1999, respectively. We expect that substantially all of the
remaining restructuring reserves as of December 31, 2001 of $282 million will be
paid in 2002. The status of the restructuring reserves is discussed in Note 3 to
the Consolidated Financial Statements.
Financial 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. Accordingly, we
have historically entered into derivative contracts, including interest rate
swap agreements, forward exchange contracts and foreign currency swap
agreements, to manage such interest rate and foreign currency exposures. The
fair market values of all of our derivative contracts change with fluctuations
in interest rates and/or currency rates, and are designed so that any change in
their values is offset by changes in the values of the underlying exposures. Our
derivative instruments are held solely to hedge economic exposures; we do not
enter into such transactions for trading purposes, and we employ long-standing
policies prescribing that derivative instruments are only to be used to achieve
a set of very limited objectives. As described above, our ability to currently
enter into new derivative contracts is severely constrained. Therefore, while
the following paragraphs describe our overall risk management strategy, our
current ability to employ that strategy effectively has been severely limited.
Currency derivatives are primarily arranged to manage the risk of exchange rate
fluctuations associated with assets and liabilities that are denominated in
foreign currencies. Our primary foreign currency market exposures include the
Japanese Yen, Euro, Brazilian Real, British Pound Sterling and Canadian Dollar.
For each of our legal entities, we have historically hedged a significant
portion of all foreign-currency-denominated cash transactions. From time to time
(when cost-effective) foreign-currency-denominated debt and foreign-currency
derivatives have been used to hedge international equity investments.
Virtually all customer-financing assets earn fixed rates of interest. Therefore,
we have historically sought to "lock in" an interest rate spread by arranging
fixed-rate liabilities with maturities similar to those of the underlying
assets, and we have funded the assets with liabilities in the same currency. As
part of this overall strategy, pay-fixed-rate/receive-variable-rate
36
interest rate swaps are often used in place of more expensive fixed-rate debt.
Additionally, pay-variable-rate/receive-fixed-rate interest rate swaps are used
from time to time to transform longer-term fixed-rate debt into variable-rate
obligations. The transactions performed within each of these categories enable
more cost-effective management of interest rate exposures by eliminating the
risk of a major change in interest rates. We refer to the effect of these
practices as "match funding" customer financing assets.
Consistent with the nature of economic hedges, unrealized gains or losses from
interest rate and foreign currency derivative contracts are designed to offset
any corresponding changes in the value of the underlying assets, liabilities or
debt.
Assuming a 10 percent appreciation or depreciation in foreign currency exchange
rates from the quoted foreign currency exchange rates at December 31, 2001, the
potential change in the fair value of foreign currency-denominated assets and
liabilities in each entity would aggregate approximately $31 million, and a 10
percent appreciation or depreciation of the U.S. Dollar against all currencies
from the quoted foreign currency exchange rates at December 31, 2001, would have
a $335 million impact on our Cumulative Translation Adjustment portion of
equity. The amount permanently invested in foreign subsidiaries and affiliates
- -- primarily Xerox Limited, Fuji Xerox and Xerox do Brasil -- and translated
into dollars using the year-end exchange rates, was $3.3 billion at December 31,
2001, net of foreign currency-denominated liabilities designated as a hedge of
our net investment.
Pay fixed-rate and receive variable-rate swaps are often used in place of more
expensive fixed-rate debt. Additionally, pay variable-rate and receive
fixed-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. On a
consolidated basis, including the impact of our hedging activities,
weighted-average interest rates for 2001, 2000 and 1999 approximated 5.5
percent, 6.2 percent and 5.7 percent, respectively.
Many of the financial instruments we use are sensitive to changes in interest
rates. Interest rate changes result in fair value gains or losses on our term
debt and interest rate swaps, due to differences between current market interest
rates and the stated interest rates within the instrument. The loss in fair
value at December 31, 2001, from a 10 percent change in market interest rates
would be approximately $161 million for our interest rate sensitive financial
instruments. 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, 2001 and 2002,
together with the recently-concluded SEC investigation, significantly reduced
our access to capital markets. Furthermore, several of the debt downgrades
triggered various contractual provisions which required us to collateralize or
repurchase a number of derivative contracts which were then outstanding. While
we have been able to replace some derivatives on a limited basis, our current
debt ratings restrict our ability to utilize derivative agreements to manage the
risks associated with interest rate and some foreign currency fluctuations,
including our ability to continue effectively employing our match funding
strategy. For this reason, we anticipate increased volatility in our results of
operations due to market changes in interest rates and foreign currency rates.
Forward-Looking Cautionary Statements
This Annual Report contains forward-looking statements and information relating
to Xerox that are based on our beliefs, as well as assumptions made by and
information currently available to us. The words "anticipate," "believe,"
"estimate," "expect," "intend," "will" and similar expressions, as they relate
to us, are intended to identify forward-looking statements. Actual results could
differ materially from those projected in such forward-looking statements.
Information concerning certain factors that could cause actual results to differ
materially is included in our 2001 Annual Report on Form 10-K filed with the
SEC. We do not intend to update these forward-looking statements.
37
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Xerox Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and common shareholders'
equity present fairly, in all material respects, the financial position of Xerox
Corporation and its subsidiaries at December 31, 2001 and 2000, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2, the Company has restated its consolidated financial
statements for the years ended December 31, 2000 and 1999, previously audited by
other independent accountants.
PricewaterhouseCoopers LLP
Stamford, Connecticut
June 26, 2002
38
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31
2001 2000 1999
---- ---- ----
Restated Restated
Note 2 Note 2
(in millions, except per-share data)
Revenues
Sales ..................................................................................... $ 7,443 $ 8,839 $ 8,967
Service, outsourcing and rentals .......................................................... 8,436 8,750 8,853
Finance income ............................................................................ 1,129 1,162 1,175
------- ------- -------
Total Revenues ........................................................................ 17,008 18,751 18,995
------- ------- -------
Costs and Expenses
Cost of sales ............................................................................. 5,170 6,080 5,631
Cost of service, outsourcing and rentals .................................................. 4,880 5,153 4,898
Equipment financing interest .............................................................. 457 498 435
Research and development expenses ......................................................... 997 1,064 1,020
Selling, administrative and general expenses .............................................. 4,728 5,518 5,204
Restructuring and asset impairment charges ................................................ 715 475 12
Gain on sale of half of interest in Fuji Xerox ............................................ (773) -- --
Gain on affiliate's sale of stock ......................................................... (4) (21) --
Purchased in-process research and development ............................................. -- 27 --
Gain on sale of China operations .......................................................... -- (200) --
Other expenses, net ....................................................................... 473 524 507
------- ------- -------
Total Costs and Expenses .............................................................. 16,643 19,118 17,707
------- ------- -------
Income (Loss) before Income Taxes (Benefits), Equity Income, Minorities'
Interests, Extraordinary Gain and Cumulative Effect of
Change in Accounting Principle .......................................................... 365 (367) 1,288
Income taxes (benefits) ................................................................... 485 (70) 446
------- ------- -------
(Loss) Income before Equity Income,
Minorities' Interests, Extraordinary Gain and Cumulative Effect of
Change in Accounting Principle .......................................................... (120) (297) 842
Equity in net income of unconsolidated affiliates ......................................... 53 66 48
Minorities' interests in earnings of subsidiaries ......................................... (42) (42) (46)
------- ------- -------
(Loss) Income before Extraordinary Gain and Cumulative Effect of Change in Accounting
Principle ............................................................................... (109) (273) 844
Extraordinary gain on extinguishment of debt, net of taxes of $26 ......................... 40 -- --
Cumulative effect of change in accounting principle ....................................... (2) -- --
------- ------- -------
Net (Loss) Income ......................................................................... $ (71) $ (273) $ 844
======= ======= =======
Basic (Loss) Earnings per Share/(1)/
(Loss) Income before Extraordinary Gain and Cumulative Effect of Change in
Accounting Principle ................................................................. $ (0.17) $ (0.48) $ 1.20
======= ======= =======
Net (Loss) Earnings per Share ......................................................... $ (0.12) $ (0.48) $ 1.20
======= ======= =======
Diluted (Loss) Earnings per Share/(1)/
(Loss) Income before Extraordinary Gain and Cumulative Effect of Change in
Accounting Principle ................................................................. $ (0.17) $ (0.48) $ 1.17
======= ======= =======
Net (Loss) Earnings per Share ......................................................... $ (0.12) $ (0.48) $ 1.17
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
/(1)/ Basic and diluted (loss) earnings per share is determined using income or
loss available to common shareholders, which is calculated as net (loss)
income less accrued preferred dividends. See Note 19.
39
CONSOLIDATED BALANCE SHEETS
December 31
2001 2000
------ ------
Restated
Note 2
(in millions)
Assets
Cash and cash equivalents .................................................................... $ 3,990 $ 1,750
Accounts receivable, net ..................................................................... 1,896 2,269
Finance receivables, net ..................................................................... 3,922 4,392
Inventories .................................................................................. 1,364 1,983
Deferred taxes and other current assets ...................................................... 1,428 1,078
-------- --------
Total Current Assets ..................................................................... 12,600 11,472
Finance receivables due after one year, net .................................................. 5,756 6,406
Equipment on operating leases, net ........................................................... 804 1,266
Land, buildings and equipment, net ........................................................... 1,999 2,527
Investments in affiliates, at equity ......................................................... 632 1,270
Intangible and other assets, net ............................................................. 4,453 3,763
Goodwill, net ................................................................................ 1,445 1,549
-------- --------
Total Assets ............................................................................. $ 27,689 $ 28,253
======== ========
Liabilities and Equity
Short-term debt and current portion of long-term debt ........................................ $ 6,637 $ 3,080
Accounts payable ............................................................................. 704 1,050
Accrued compensation and benefits costs ...................................................... 724 645
Unearned income .............................................................................. 244 233
Other current liabilities .................................................................... 1,951 1,536
-------- --------
Total Current Liabilities ................................................................ 10,260 6,544
Long-term debt ............................................................................... 10,128 15,557
Postretirement medical benefits .............................................................. 1,233 1,197
Deferred taxes and other liabilities ......................................................... 2,018 1,925
-------- --------
Total Liabilities ........................................................................ 23,639 25,223
Deferred ESOP benefits ....................................................................... (135) (221)
Minorities' interests in equity of subsidiaries .............................................. 73 87
Obligation for equity put options ............................................................ -- 32
Company-obligated, mandatorily redeemable preferred securities of subsidiary
trusts holding solely subordinated debentures of the Company ............................... 1,687 684
Preferred stock .............................................................................. 605 647
Common stock, including additional paid in capital ........................................... 2,622 2,231
Retained earnings ............................................................................ 1,031 1,150
Accumulated other comprehensive loss ......................................................... (1,833) (1,580)
-------- --------
Total Liabilities and Equity ............................................................ $ 27,689 $ 28,253
======== ========
Shares of common stock issued and outstanding were (in thousands) 722,314 and
668,576 at December 31, 2001 and December 31, 2000, respectively.
The accompanying notes are an integral part of the consolidated financial
statements.
40
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31
----------------------
2001 2000 1999
---- ---- ----
Restated Restated
Note 2 Note 2
(in millions)
Cash Flows from Operating Activities
Net (loss) income .......................................................................... $ (71) $ (273) $ 844
Adjustments required to reconcile net (loss) income to cash flows from operating
activities:
Depreciation and amortization ........................................................... 1,332 1,244 1,090
Provisions for receivables and inventory ................................................ 748 848 594
Restructuring and other charges ......................................................... 715 502 12
Cash payments for restructurings ........................................................ (484) (387) (441)
Gain on early extinguishment of debt .................................................... (66) -- --
Gains on sales of businesses and assets ................................................. (765) (288) (78)
Minorities' interests in earnings of subsidiaries ....................................... 42 42 46
Undistributed equity in income of affiliated companies .................................. (20) (25) (10)
Decrease (increase) in inventories ...................................................... 319 74 (165)
Increase in on-lease equipment .......................................................... (271) (506) (387)
Decrease (increase) in finance receivables .............................................. 162 (701) (1,246)
Proceeds from sale of finance receivables ............................................... -- -- 345
Decrease (increase) in accounts receivable .............................................. 115 (385) (484)
Proceeds from sale of accounts receivable ............................................... -- 328 231
(Decrease) increase in accounts payable and accrued compensation and benefits costs ..... (270) 59 21
Net change in current and deferred income taxes ......................................... 456 (421) 210
(Decrease) increase in other current and non-current liabilities ........................ (160) 55 218
Early termination of derivative contracts ............................................... (148) (108) --
Other, net .............................................................................. (68) 149 (249)
------- -------- --------
Net cash provided by operating activities ............................................... 1,566 207 551
------- -------- --------
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment ......................................... (219) (452) (594)
Proceeds from sales of land, buildings and equipment ....................................... 69 44 99
Cost of additions to internal use software ................................................. (124) (211) (241)
Proceeds from divestitures ................................................................. 1,768 640 65
Acquisitions, net of cash acquired ......................................................... 18 (856) (107)
Funds placed in escrow and other restricted cash ........................................... (628) -- --
Other, net ................................................................................. (11) (20) (11)
------- -------- --------
Net cash provided by (used in) investing activities ..................................... 873 (855) (789)
------- -------- --------
Cash Flows from Financing Activities
Net (decrease) increase in debt ............................................................ (1,098) 2,917 793
Proceeds from issuance of mandatorily redeemable preferred ................................. 1,004 -- --
Dividends on common and preferred stock .................................................... (93) (587) (586)
Proceeds from issuances of common stock .................................................... 28 -- 128
Settlements of equity put options, net ..................................................... (28) (68) (5)
Dividends to minority shareholders ......................................................... (2) (7) (30)
------- -------- --------
Net cash (used in) provided by financing activities ...................................... (189) 2,255 300
------- -------- --------
Effect of exchange rate changes on cash and cash equivalents ............................... (10) 11 (9)
------- -------- --------
Increase in cash and cash equivalents ...................................................... 2,240 1,618 53
Cash and cash equivalents at beginning of year ............................................. 1,750 132 79
======= ======== ========
Cash and cash equivalents at end of year ................................................... $ 3,990 $ 1,750 $ 132
======= ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
41
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
Accumulated
Common Common Additional Other Treasury Treasury
Stock Stock Paid-In Reatined Comprehensive Stock Stock
Shares Amount Capital Earnings Loss/(1)/ Shares Amount Total
------ ------ ------- -------- --------- ------ ------ -----
(In millions, except share data)
Balance at December 31, 1998, as reported...... 657,196 $660 $ 1,265 $ 3,482 $ (755) (409) $(19) $ 4,633
Effect of restatement (Note 2) ................ -- -- 63 (1,781) 111 -- -- (1,607)
------- ---- ------- ------- -------- ---- ---- -------
Balance at December 31, 1998, as restated* .... 657,196 $660 $ 1,328 $ 1,701 $ (644) (409) $(19) $ 3,026
Net income .................................... 844 844
Translation adjustments ....................... (547) (547)
Minimum pension liability ..................... (33) (33)
Comprehensive income ........................ 264
Stock option and incentive plans .............. 5,331 6 134 (5) 270 12 147
Xerox Canada exchangeable stock ............... 1,362
Convertible securities ........................ 1,267 1 63 (52) 139 7 19
Cash dividends declared .......................
Common stock ($0.80 per share) .............. (532) (532)
Preferred stock ($6.25 per share) ........... (54) (54)
Settlement of put options ..................... (5) (5)
Tax benefits on benefit plans ................. 80 8 88
------- ---- ------- ------- -------- ---- ---- -------
Balance at December 31, 1999, as restated* .... 665,156 667 1,600 1,910 (1,224) -- -- 2,953
------- ---- ------- ------- -------- ---- ---- -------
Net loss ...................................... (273) (273)
Translation adjustments ....................... (356) (356)
Minimum pension liability ..................... 5 5
Unrealized loss on securities ................. (5) (5)
Comprehensive loss .......................... (629)
Stock option and incentive plans .............. 940 1 32 33
Xerox Canada exchangeable stock ............... 29
Convertible securities ........................ 2,451 2 28 (8) 22
Cash dividends declared .......................
Common stock ($0.65 per share) .............. (434) (434)
Preferred stock ($6.25 per share) ........... (52) (52)
Put options, net .............................. (100) (100)
Tax benefits on benefit plans ................. 1 7 8
------- ---- ------- ------- -------- ---- ---- -------
Balance at December 31, 2000, as restated* .... 668,576 670 1,561 1,150 (1,580) -- -- 1,801
------- ---- ------- ------- -------- ---- ---- -------
Net loss ..................................... (71) (71)
Translation adjustments ....................... (210) (210)
Minimum pension liability ..................... (40) (40)
Unrealized gain on securities ................. 4 4
FAS 133 transition adjustment ................. (19) (19)
Net changes on cash flow hedges ............... 12 12
Comprehensive loss .......................... (324)
Stock option and incentive plans .............. 546 1 5 6
Xerox Canada exchangeable stock ............... 312
Convertible securities ........................ 5,865 6 36 42
Cash dividends declared .......................
Common stock ($0.05 per share) .............. (34) (34)
Preferred stock ($1.56 per share) ........... (14) (14)
Put options, net .............................. 4 4
Equity for debt exchanges ..................... 41,154 41 270 311
Issuance of unregistered shares ............... 5,861 6 22 28
------- ---- ------- ------- -------- ---- ---- -------
Balance at December 31, 2001 .................. 722,314 $724 $ 1,898 $ 1,031 $ (1,833) -- $ -- $ 1,820
======= ==== ======= ======= ======== ==== ==== =======
__________________
/(1)/ As of December 31, 2001, Accumulated Other Comprehensive Loss is composed
of cumulative translation adjustments of $(1,758), minimum pension
liability of $(67), unrealized loss on securities of $(1) and net SFAS
No. 133 related items of $(7).
The accompanying notes are an integral part of the consolidated financial
statements.
* See Note 2.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 1--Summary of Significant Accounting Policies
Description of Business and Basis of Presentation. Xerox Corporation is The
Document Company and a leader in the global document market, selling equipment
and providing document solutions including hardware and services that enhance
our customers' work processes and business results. Our activities encompass
developing, manufacturing, marketing, servicing, and financing a complete range
of document processing products, solutions and services designed to make
organizations around the world more productive.
Liquidity. Historically, our primary sources of funding have been cash flows
from operations, borrowings under our commercial paper and term funding
programs, and securitizations of accounts and finance receivables. Funds were
used to finance customers' purchases of our equipment, and to fund working
capital requirements, capital expenditures and business acquisitions. Our
specific business challenges, including revenue declines over the past few
years, coupled with significant competitive and industry changes and adverse
economic conditions, began to negatively affect our operations and liquidity in
2000. These challenges, which were exacerbated by significant technology and
acquisition spending, impacted our cash availability and created marketplace
concerns regarding our liquidity, which led to credit rating downgrades and
restricted access to capital markets.
Our access to many of the aforementioned sources is currently limited due to our
below investment grade rating on our debt. Our debt rating has been reduced
several times since October 2000. These rating downgrades have had a number of
significant negative impacts on us, including the unavailability of uncommitted
bank lines, very limited ability to utilize derivative instruments to hedge
foreign and interest currency exposures, thereby increasing volatility to
changes in exchange rates, and higher interest rates on borrowings.
Additionally, as more fully disclosed below, we are required to maintain minimum
cash balances in escrow on certain borrowings, securitizations, swaps and
letters of credit. These restricted cash balances are not considered cash or
cash equivalents on our balance sheet.
On June 21, 2002, we permanently repaid $2.8 billion on our then outstanding
revolving credit facility. An amended $4.2 billion facility replaced the
previous $7 billion facility. However, we currently have no incremental
borrowing capacity under the facility as the entire $4.2 billion is outstanding
as of such date.
The new facility is disclosed in more detail in Note 12. The new facility
contains more stringent financial covenants than the prior facility, including
the following:
. Minimum EBITDA (based on rolling quarters, as defined)
. Maximum leverage (total adjusted debt divided by EBITDA, as defined)
. Maximum capital expenditures (annual test)
. Minimum consolidated net worth (quarterly test, as defined)
We expect to be in full compliance with the covenants and other provisions of
the new credit facility through December 31, 2002 and beyond. Failure to be in
compliance with any material provision of the new facility could have a material
adverse effect on our financial position, results of operations and cash flows.
In addition, as part of our Turnaround Plan (see Note 3), we have taken
significant steps to improve our liquidity, including asset sales, monetizations
of portions of our receivables portfolios, and general financings including
issuance of high yield debt and preferred securities. Since early 2000, we have
been restructuring our cost base. We have implemented a series of plans to
resize our workforce and reduce our cost structure through such restructuring
initiatives. Key factors influencing our liquidity include our ability to
generate cash flow from an appropriate combination of operating improvements
anticipated in our Turnaround Plan and continued execution of the initiatives
described above. We believe our projected liquidity is sufficient to meet our
current operating cash flow requirements and satisfy our 2002 scheduled debt
maturities and other cash flow requirements. However, our ability to meet our
obligations beyond 2002 is dependent on our ability to generate positive cash
flow from a combination of operating improvements, capital markets transactions,
third party vendor financing programs and receivable monetizations. Failure to
implement these initiatives could have a material adverse effect on our
liquidity and our operations and we would need to implement alternative plans
that could include additional asset sales, additional reductions in operating
costs, deferral of capital expenditures, further reductions in working capital
and further
43
debt restructurings. While we believe we could successfully complete the
alternative plans, if necessary, there can be no assurance that such
alternatives would be available or that we would be successful in their
implementation.
Basis of Consolidation. The consolidated financial statements include the
accounts of Xerox Corporation and all of its controlled subsidiary companies
(collectively the Company). All significant intercompany accounts and
transactions have been eliminated. References herein to "we" or "our" refer to
Xerox and consolidated subsidiaries unless the context specifically requires
otherwise.
Investments in business entities in which the Company does not have control, but
has the ability to exercise significant influence over operating and financial
policies (generally 20 to 50 percent ownership), are accounted for by the equity
method.
Upon the sale of stock by a subsidiary, we recognize a gain or loss in our
Consolidated Statements of Operations equal to our proportionate share of the
increase or decrease in the subsidiary's equity.
Operating results of acquired businesses are included in the Consolidated
Statements of Operations from the date of acquisition. See Note 4.
Income (Loss) before Income Taxes (Benefits), Equity Income, Minorities'
Interests, Extraordinary Gain and Cumulative Effect of Change in Accounting
Principle. Throughout the Notes to Consolidated Financial Statements, we refer
to the effects of certain changes in estimates and other adjustments on Income
(Loss) before Income Taxes (Benefits), Equity Income, Minorities' Interests,
Extraordinary Gain and Cumulative Effect of Change in Accounting Principle. For
convenience and ease of reference, that financial statement caption is hereafter
referred to as "pre-tax income (loss).
Use of Estimates. The preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Significant estimates and
assumptions are used for, but not limited to: allocation of revenues and fair
values in multiple element arrangements; accounting for residual values;
economic lives of leased assets; allowance for doubtful accounts; retained
interests associated with the sales of accounts or finance receivables;
inventory valuation; merger, restructuring and other related charges; asset
impairments; depreciable lives of assets; useful lives of intangible assets and
goodwill; pension and postretirement benefit plans; discontinued operations
reinsurance obligations; and tax valuation allowances. Future events and their
effects cannot be predicted with certainty; accordingly, our accounting
estimates require the exercise of judgment. The accounting estimates used in the
preparation of our consolidated financial statements will change as new events
occur, as more experience is acquired, as additional information is obtained and
as the Company's operating environment changes. Actual results could differ from
those estimates.
The following table summarizes the more significant charges which require
management estimates:
(in millions) Year ended December 31
----------------------
2001 2000 1999
---- ---- ----
Restated Restated
Note 2 Note 2
Restructuring provisions and asset impairments ............................... $ 715 $ 475 $ 12
Amortization of goodwill and intangible assets ............................... 94 86 50
Provisions for receivables ................................................... 506 613 450
Provisions for obsolete and excess inventory ................................. 242 235 144
Depreciation of equipment on operating leases ................................ 657 626 560
Depreciation of land, buildings and equipment ................................ 402 417 416
Amortization of capitalized software ......................................... 179 115 64
Pension benefits - net periodic benefit cost ................................. 99 44 102
Other benefits - net periodic benefit cost ................................... 130 109 107
Deferred tax asset valuation allowance provisions ............................ 247 12 92
Changes in Estimates. In the ordinary course of accounting for items discussed
above, we make changes in estimates as appropriate in the circumstances. Such
changes and refinements in estimation methodologies are reflected in reported
results of operations in the period in which the changes are made and, if
material, their approximate effects are disclosed in the Notes to Consolidated
Financial Statements.
44
Accounting Changes. Effective January 1, 2001, we adopted Statement of Financial
Accounting Standards, No. 133, "Accounting for Derivative Instruments and
Hedging Activities" (SFAS No. 133), which requires companies to recognize all
derivatives as assets or liabilities measured at their fair value, regardless of
the purpose or intent of holding them. Gains or losses resulting from changes in
the fair value of derivatives are 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. Changes in fair value for derivatives not designated as hedging
instruments and the ineffective portions of hedges are recognized in earnings in
the current period. The adoption of SFAS No. 133 resulted in a net cumulative
after-tax loss of $2 in the 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 assets and a
$424 increase in liabilities. See Note 13.
New Accounting Standards
Business Combinations: In 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 141, "Business Combinations"
(SFAS No. 141). SFAS No. 141 requires the use of the purchase method of
accounting for business combinations and prohibits the use of the pooling of
interests method. We have not historically engaged in transactions that qualify
for the use of the pooling of interests method and therefore, this aspect of the
new standard will not have an impact on our financial results. SFAS No. 141 also
changes the definition of intangible assets acquired in a purchase business
combination, providing specific criteria for the initial recognition and
measurement of intangible assets apart from goodwill. As a result, the purchase
price allocation of future business combinations may be different than the
allocation that would have resulted under the previous rules. SFAS No. 141 also
requires that upon adoption of Statement of Financial Accounting Standards No.
142 "Goodwill and Other Intangible Assets" (SFAS No. 142), we reclassify the
carrying amounts of certain intangible assets into or out of goodwill, based on
certain criteria as discussed below. All business acquisitions initiated after
June 30, 2001 must apply provisions of this standard.
Goodwill and Intangible Assets: SFAS No. 142, also issued in 2001, addresses
financial accounting and reporting for acquired goodwill and other intangible
assets subsequent to their initial recognition. This statement recognizes that
goodwill has an indefinite useful life and will no longer be subject to periodic
amortization. However, goodwill is to be tested at least annually for
impairment, using a fair value methodology, in lieu of amortization. The
provisions of this standard also require that amortization of goodwill related
to equity method investments be discontinued, and that these goodwill amounts
continue to be evaluated for impairment in accordance with Accounting Principles
Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common
Stock." We are in the process of assessing the impacts of SFAS No. 142 which
includes making determinations as to what our reporting units will be and what
amounts of goodwill, intangible assets and other assets and liabilities should
be allocated to those reporting units. The provisions of SFAS No. 142 were
effective January 1, 2002.
In connection with the adoption of SFAS No. 142, we expect to reclassify
approximately $60 of previously identified intangible assets to goodwill. We
will no longer record approximately $60 of annual amortization expense relating
to our existing goodwill, as adjusted, for the reclassification previously
mentioned. Additionally, approximately $5 of annual amortization expense of
goodwill related to equity method investments will no longer be recorded.
SFAS No. 142 also requires we perform annual and transitional impairment tests
on goodwill using a two-step approach. The first step is to identify a potential
impairment and the second step is to measure the amount of any impairment loss.
We have six months from the date of adoption of the standard to complete step
one of the transitional impairment test and, if required, to the end of fiscal
2002 to complete step two of the transitional impairment test. Any impairment
loss that results from the transitional goodwill impairment tests will be
reflected as a cumulative effect of a change in accounting principle in the
first quarter of 2002. We continue to assess the effects of the impairment
testing provisions of SFAS No. 142. We anticipate completion of the first step
of the impairment test in connection with our second quarter of 2002.
Asset Retirement Obligations: In 2001, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 143, "Accounting for
Asset Retirement Obligations." The Statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and associated asset retirement costs. We are required to implement this
standard on January 1, 2003. We do not expect this Statement will have a
material effect on our financial position or results of operations.
Impairment or Disposal of Long-Lived Assets: In 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The Statement
primarily supercedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." The Statement
retains the previously existing accounting requirements related to the
45
recognition and measurement of the impairment of long-lived assets to be held
and used, while expanding the measurement requirements of long-lived assets to
be disposed of by sale to include discontinued operations. It also expands on
the previously existing reporting requirements for discontinued operations to
include a component of an entity that either has been disposed of or is
classified as held for sale. We implemented this standard on January 1, 2002,
and do not expect this Statement will have a material effect on our financial
position or results of operations.
In 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13 and Technical Corrections." The
Statement rescinds Statement 4 which required all gains and losses from
extinguishment of debt to be aggregated and, when material, classified as an
extraordinary item net of related income tax effect. Statement 145 also amends
Statement 13 to require that certain lease modifications having economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. We are required to implement this standard for
transactions occurring after May 15, 2002 and do not expect this Statement will
have a material effect on our financial position or results of operations. We
implemented the provisions related to the rescission of Statement 4 in the
second quarter of 2002.
Revenue Recognition. In the normal course of business, we generate revenue
through the sale and rental of equipment, service, and supplies and income
associated with the financing of our equipment sales. Revenue is recognized when
earned. More specifically, revenue related to sales of our products and services
is recognized as follows:
Equipment: Revenues from the sale of equipment including those from sales-type
leases, are recognized at the time of sale or at the inception of the lease, as
appropriate. For equipment sales which require us to install the product at the
customer location, revenue is recognized when the equipment has been delivered
to and installed at the customer location. Sales of customer installable and
retail products are recognized upon shipment or receipt by the customer
according to the customer's shipping terms. Revenues from equipment under other
leases and similar arrangements are accounted for by the operating lease method
and are recognized as earned over the lease term, which is generally on a
straight-line basis.
Service: Service revenues are derived primarily from maintenance contracts on
our equipment sold to customers and are recognized over the term of the
contracts. A substantial portion of our products are sold with full service
maintenance agreements for which the customer typically pays a base service fee
plus a variable amount based on usage. As a consequence we do not have any
significant product warranty obligations including for any obligations under
customer satisfaction programs.
Supplies: Supplies revenue generally is recognized upon shipment or utilization
by customer in accordance with sales terms.
Revenue Recognition for Sales-Type Leases Under Bundled Arrangements: We sell
most of our products and services under bundled contract arrangements, which
contain multiple deliverable elements. These arrangements typically include
equipment, service and supplies, and financing components for which the customer
pays a single negotiated price for all elements. These arrangements typically
also include a variable service component for page volumes in excess of stated
minimums. When separate prices are listed in multiple element customer
contracts, they may not be representative of the fair values of those elements
because the prices of the different components of the arrangement may be
modified in customer negotiations, although the aggregate consideration may
remain the same. Therefore, revenues under these arrangements are allocated
based upon estimated fair values of each element. Our revenue allocation
methodology first begins by determining the fair value of the service component
as well as other executory costs and any profit thereon and second, by
determining the fair value of the equipment based on comparison of the equipment
values in our accounting systems to a range of cash selling prices. The
resultant implicit interest rate is compared to fair market value rates to
assess reasonableness of the overall allocations to the multiple elements.
Finance income is earned on an accrual basis under an effective annual yield
method over the lease term.
Determination of Appropriate Revenue Recognition for Sales-Type Leases: Our
accounting for leases involves specific determination under SFAS No. 13 which
often involves complex judgements. The general criteria for SFAS No. 13, at
least one of which is required to be met in order to account for a lease as a
sale versus as a rental, are (a) whether ownership transfers by the end of the
lease term, (b) whether there is a bargain purchase option at the end of the
lease term which is exercisable by the lessee, (c) whether the lease term is
equal to or greater than at least 75 percent of the economic life of the
equipment and (d) whether the present value of the minimum lease payments, as
defined, are equal to or greater than 90 percent of the fair market value of the
equipment. In addition to these criteria, there are also important criteria that
are required to be assessed including whether collectibility of the lease
payments
46
is reasonably predictable and that there are important uncertainties related to
costs that we have yet to incur with respect to the lease.
The critical elements of SFAS No. 13 that we analyze with respect to our lease
accounting are the determination of economic life and the fair market value of
equipment, including our estimates of residual values. Accounting for sales-type
lease transactions requires management to make estimates with respect to
economic lives and expected residual value of the equipment in accordance with
specific criteria as set forth in generally accepted accounting principles.
Those estimates are based upon historical experience with economic lives of all
of our equipment products. We consider the most objective measure of historical
experience, for purposes of estimating the economic life, to be the original
contract term since most equipment is returned by lessees at or near the end of
the contracted term. The most frequent contractual lease term for our principal
products is five years, and only a small percentage of our leases are for
original terms longer than five years. Accordingly, we have estimated the
economic life of most of our products to be five years. We believe that this is
representative of the period during which the equipment is expected to be
economically usable, with normal repairs and maintenance, for the purpose for
which it was intended at the inception of the lease. Residual values are
established at lease inception using estimates of fair value at the end of the
lease term. Our residual values are established with due consideration to
forecasted supply and demand for our various products, product retirement and
future product launch plans, end of lease customer behavior, remanufacturing
strategies, used equipment markets (to the extent they exist for the particular
product), competition and technological changes. Unguaranteed residual values
are assigned primarily to our high volume copying, printing and production
publishing products. We review residual values regularly and, when appropriate,
adjust them based on estimates of forecasted demand including the impacts of
future product launches. Impairment charges are recorded when available
information indicates that the decline is other than temporary and it is
probable that we will not be able to fully recover the recorded values. See Note
6.
Cash and Cash Equivalents. Cash and cash equivalents consist of cash on hand and
investments with original maturities of three months or less.
Restricted Cash and Investments. At December 31, 2001, we had the following
amounts of restricted cash: $115 of cash held in escrow as security for our
performance of services related to the lease contracts transferred under the
secured borrowings with General Electric Capital Corporation; $229 of cash held
in escrow related to the scheduled distribution payments for trust preferred
securities sold in November 2001; $111 of cash held as collateral related to our
swaps and letters of credit; and $30 of cash held in escrow related to our
asset-backed security transaction entered in July 2001. As discussed in Note 11,
we also have $684 of cash and investments in trust as support for our
discontinued operations reinsurance obligations. These restricted amounts are
included in either Deferred taxes and other current assets or Intangible and
other assets, net, as appropriate, in the Consolidated Balance Sheets.
Securitizations and Transfers of Receivables. Sales, transfers and
securitizations of recognized financial assets are accounted for under Statement
of Financial Accounting Standards No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No.
140). From time to time, in the normal course of business, we may securitize or
sell finance receivables and accounts receivable with or without recourse and/or
discounts. The receivables are removed from the Consolidated Balance Sheet at
the time they are sold and the risk of loss has transferred to the purchaser.
However, we maintain risk of loss on our retained interest in such receivables.
Sales and transfers that do not meet the criteria for surrender of control or
were sold to a consolidated special purpose entity (non-qualified special
purpose entity) under SFAS No. 140 are accounted for as secured borrowings.
When we sell receivables in securitizations of finance receivables or accounts
receivable, we retain servicing rights, beneficial interests, and, in some
cases, a cash reserve account, all of which are retained interests in the
securitized receivables. The value assigned to the retained interests in
securitized trade receivables is based on the relative fair values of the
interest retained and sold in the securitization. We estimate fair value based
on the present value of future expected cash flows using management's best
estimates of the key assumptions, consisting of receivable amounts, anticipated
credit losses and discount rates commensurate with the risks involved.
Gains or losses on the sale of the receivables depend in part on the previous
carrying amount of the financial assets involved in the transfer, allocated
between the assets sold and the retained interests based on their relative fair
value at the date of transfer.
Provisions for Losses on Uncollectible Receivables. The provisions for losses on
uncollectible trade and finance receivables are determined principally on the
basis of past collection experience applied to ongoing evaluations of our
receivables and evaluations of the risks of repayment. Allowances for doubtful
accounts on our accounts receivable balances at December 31, 2001 and 2000
amounted to $306 and $289, respectively.
Inventories. Inventories are carried at the lower of average cost or realizable
values.
47
Land, Buildings and Equipment and Equipment on Operating Leases. Land, buildings
and equipment are recorded at cost. Buildings and equipment are depreciated over
their estimated useful lives. Leasehold improvements are depreciated over the
shorter of the lease term or the estimated useful life. Equipment on operating
leases is depreciated to its estimated residual value over the term of the
lease. Depreciation is computed using principally the straight-line method.
Significant improvements are capitalized; maintenance and repairs are expensed.
See Notes 7 and 8.
Internal Use Software. We capitalize direct costs incurred during the
application development stage and the implementation stage for developing,
purchasing or otherwise acquiring software for internal use. These costs are
included in Intangible and other assets and are amortized over the estimated
useful lives of the software, generally three to five years. All costs incurred
during the preliminary project stage, including project scoping, identification
and testing of alternatives, are expensed as incurred. See Note 8.
Goodwill and Other Intangible Assets. Goodwill represents the cost of acquired
businesses in excess of the fair value of identifiable tangible and intangible
net assets purchased, and is amortized on a straight-line basis over periods
ranging from 5 to 40 years. Other intangible assets represent the fair value of
identifiable intangible assets acquired in purchase business combinations and
include an acquired customer base, distribution network, assembled workforce,
technology and trademarks. Goodwill and other intangible assets are reported net
of accumulated amortization. Total accumulated amortization at December 31, 2001
and 2000 was $334 and $253, respectively.
Impairment of Long-Lived Assets. We review the recoverability of our long-lived
assets, including buildings, equipment, goodwill, internal use software and
other intangible assets, when events or changes in circumstances occur that
indicate that the carrying value of the asset may not be recoverable. The
assessment of possible impairment is based on our ability to recover the
carrying value of the asset from the expected future pre-tax cash flows
(undiscounted and without interest charges) of the related operations. If these
cash flows are less than the carrying value of such asset, an impairment loss is
recognized for the difference between estimated fair value and carrying value.
The measurement of impairment requires management to make estimates of these
cash flows related to long-lived assets, as well as other fair value
determinations.
Foreign Currency Translation. The functional currency for most foreign
operations is the local currency. Net assets are translated at current rates of
exchange, and income, expense and cash flow items are translated at the average
exchange rate for the year. The translation adjustments are recorded in
Accumulated Other Comprehensive Income. The U.S. dollar is used as the
functional currency for certain subsidiaries that conduct their business in U.S.
dollars or operate in hyperinflationary economies. A combination of current and
historical exchange rates is used in remeasuring the local currency transactions
of these subsidiaries, and the resulting exchange adjustments are included in
income. Aggregate foreign currency gains were $29, $103 and $7 in 2001, 2000 and
1999, respectively, and are included in Other expenses, net in the Consolidated
Statements of Operations. Effective January 1, 2002, we changed the functional
currency of our Argentina operation from the U.S. dollar to the Peso as a result
of operational changes made subsequent to the government's new economic plan.
Note 2--Restatement
On April 11, 2002, we reached a settlement with the Securities and Exchange
Commission (SEC) relating to matters that had been under investigation by the
SEC since June 2000. In connection with the settlement, we agreed to restate our
financial statements as of and for the years ended December 31, 1997 through
2000 as well as undertake a review of our material internal controls and
accounting policies. In addition, as a result of the re-audit of our 2000 and
1999 consolidated financial statements, additional adjustments were recorded.
The restatement reflects adjustments which are corrections of errors made in the
application of U.S. generally accepted accounting principles (GAAP) and includes
(i) adjustments related to the application of the provisions of Statement of
Financial Accounting Standards No. 13 "Accounting for Leases" (SFAS No. 13) and
(ii) adjustments that arose as a result of other errors in the application of
GAAP. The principal adjustments are discussed below.
Application of SFAS No. 13
Revenue allocations in bundled arrangements: We sell most of our products and
services under bundled lease arrangements which contain multiple deliverable
elements. These multiple element arrangements typically include separate
equipment, service, supplies and financing components for which a customer pays
a single fixed negotiated price on a monthly basis, as well as a variable amount
for page volumes in excess of stated minimums. The restatement primarily
reflects adjustments related to the allocation of revenue and the resultant
timing of revenue recognition for sales-type leases under these bundled lease
arrangements.
The methodology we used in prior years for allocating revenue to our sales-type
leases involved first, estimating the fair market value of the service and
financing components of the leases. Specifically, with respect to the financing
component,
48
we estimated the overall interest rate to be applied to transactions to be the
rate we targeted to achieve a fair return on equity for our financing
operations. This is effectively a discounted cash flow valuation methodology. In
estimating this interest rate we considered a number of factors including our
cost of funds, debt levels, return on equity, debt to equity ratios, income
generated subsequent to the initial lease term, tax rates, and the financing
business overhead costs. We made service revenue allocations based, primarily,
on an analysis of our service gross margins. After deducting service and finance
values from the minimum payments due under the lease, the equipment value was
derived. These allocation procedures resulted in adjustments to values initially
reflected in our accounting systems, such that values attributed to the service
and financing components were generally decreased and the values assigned to the
equipment components were generally increased.
We have determined that the allocation methodology used in prior years did not
comply with SFAS No. 13, therefore, we have utilized a different methodology to
account for our sales-type leases involving multiple element arrangements. This
methodology begins by determining the fair value of the service component, as
well as other executory costs and any profit thereon, and second, by determining
the fair value of the equipment based on a comparison of the equipment values in
our accounting system to a range of cash selling prices. The resultant implicit
interest rate is then compared to fair market value rates to assess the
reasonableness of the overall allocations to the multiple elements.
We conducted an extensive analysis of available verifiable objective evidence of
fair value (VOE) based on cash sales prices and compared these prices to the
range of equipment values recorded in our lease accounting systems. With the
exception of Latin America, where operating lease accounting is applied as
discussed below, the range of cash selling prices supports the reasonableness of
the range of equipment lease prices as originally recorded, at the inception of
the lease, in our accounting systems. In applying our new methodology described
above, we have therefore concluded that the revenue amounts allocated by our
accounting systems to the equipment component of a multiple element arrangement
represents a reasonable estimate of the fair value of the equipment. As a
consequence, $541 and $650 of previously recorded equipment sale revenue during
the years ended December 31, 2000 and 1999, respectively, have been reversed and
we have recognized additional service and finance income of $463 and $393, which
represents the impact of reversing amounts previously recorded as equipment
sales-type leases and recognizing such amounts over the lease term. The net
cumulative reduction in revenue, as a result of this change, was $335 for the
two-year period ended December 31, 2000.
Transactions not qualifying as sales-type leases: We re-evaluated the
application of SFAS No. 13 for leases originally accounted for as sales-type
leases in our Latin American operations, and we determined that these leases
should have been recorded as operating leases. This determination was made after
we conducted an in-depth review of the historical effective lease terms compared
to the contractual terms of our lease agreements. Since historically, and during
all periods presented, a majority of leases were terminated significantly prior
to the expiration of the contractual lease term, we concluded that such leases
did not qualify as sales-type leases under certain provisions of SFAS No. 13.
Specifically, because we generally do not collect the receivable from the
initial transaction, upon termination of the contract or during the subsequent
lease term, the recoverability of the lease investment was not predictable at
the inception of the original lease term. As a consequence, $459 and $300 of
previously recorded equipment sale revenue during the years ended December 31,
2000 and 1999, respectively, have been reversed and we have recognized
additional rental revenue of $401 and $357, which represents the impact of
changing the classification of previously recorded sales-type leases to
operating leases. The net cumulative reduction in revenue, as a result of this
change, was $1 for the two-year period ended December 31, 2000.
During the course of the restatement process, we concluded that the estimated
economic life used for classifying leases for the majority of our products
should have been five years versus the three to four years we previously
utilized. This resulted from an in-depth review of our lease portfolios, for all
periods presented, which indicated that the most frequent term of our lease
contracts was 60 months. We believe that this has been and is representative of
the period during which the equipment is expected to be economically usable,
with normal repairs and maintenance, for the purpose for which it was intended
at the inception of the lease. As a consequence, many shorter duration leases
did not meet the criteria of SFAS No. 13 to be accounted for as sales-type
leases. Additionally, other lease arrangements were found to not meet other
requirements of SFAS No. 13 for treatment as sales-type leases. As a consequence
$74 and $160 of equipment revenue recorded during the two years ended December
31, 2000 and 1999, respectively, have been reversed and we have recognized
additional rental revenue of $131 and $100, which represents the impact of
changing the classification of previously recorded sales-type leases to
operating leases. The net cumulative reduction in revenue, as a result of this
change was $3 for the two-year period ended December 31, 2000.
Accounting for the sale of equipment subject to operating leases: We have
historically sold pools of equipment subject to operating leases to third party
finance companies (the counterparty) or through structured financings with third
parties and recorded the transaction as a sale at the time the equipment is
accepted by the counterparty. These transactions increased equipment sale
revenue, primarily in Latin America, in 2000 and 1999 by $148 and $400,
respectively. Upon additional review of the terms and conditions of these
contracts, it was determined that the form of the transactions at inception
49
included retained ownership risk provisions or other contingencies that
precluded these transactions from meeting the criteria for sale treatment under
the provisions of SFAS No. 13. The form of these transactions notwithstanding,
these risk of loss or contingency provisions have resulted in only minor impacts
on our operating results. These transactions have however been restated and
recorded as operating leases in our consolidated financial statements. As a
consequence $111 and $342 of equipment revenue recorded during the years ended
December 31, 2000 and 1999, respectively, have been reversed and we have
recognized additional rental revenue of $235 and $99, which represents the
impact of changing the classification of previously recorded sales-type leases
to operating leases. The net cumulative reduction in revenue, as a result of
this change was $119 for the two-year period ended December 31, 2000.
Additionally, for transactions in which cash proceeds were received up-front we
have recorded these proceeds as secured borrowings. The remaining balance of
these borrowings aggregated $55 and $123 at December 31, 2001 and 2000,
respectively.
Other adjustments
In addition to the aforementioned revenue related adjustments, other errors in
the application of GAAP were identified. These include the following:
Sales of receivables transactions: During 1999, we sold $1,395 of U.S. finance
receivables originating from sales-type leases. These transactions were
accounted for as sales of receivables. These sales were made to special purpose
entities (SPEs), which qualified for non-consolidation in accordance with then
existing accounting requirements. As a result of the changes in the estimated
economic life of our equipment to five years, certain leases transferred in
these transactions did not meet the sales-type lease requirements and were
accounted for as operating leases. This change in lease classification affected
a number of the leases that were sold into the aforementioned SPEs resulting in
these entities now holding operating leases as assets. This change disqualified
the SPEs from non-consolidation and effectively required us to record the
proceeds received on these sales as secured borrowings. This increased our net
finance receivables by $367 and debt by $418 as of December 31, 2000. The debt
balance remaining was $94 at December 31, 2001. These transactions are also
discussed in Note 6 to the Consolidated Financial Statements.
During 1999, we sold $288 of accounts receivables, to financial institutions.
Upon additional review of the terms and conditions of these transactions, we
determined that $57 (including $14 which was restated in connection with the
prior restatement of our financial statements) did not qualify for sale
treatment as a result of our agreeing to reacquire the receivables in 2000.
Accordingly, we have restated our previously reported results for these
transactions and they are now reported in our Consolidated Financial Statements
as short-term borrowings. This change increased Accounts receivable, net and
debt by $57 as of December 31, 1999; the transaction was settled in early 2000.
No similar transactions have occurred since 1999.
South Africa deconsolidation: We determined that we inappropriately consolidated
our South African affiliate since 1998 as the minority joint venture partner has
substantive participating rights. Accordingly, we have deconsolidated all
assets, liabilities, revenues and expenses. We now account for this investment
on the equity method of accounting. The reduction in revenues was $72 and $71
for the years ended December 31, 2000 and 1999, respectively, and there was no
impact on net income or common shareholders equity.
Purchase accounting reserves: In connection with the 1998 acquisition of XL
Connect Solutions, Inc. (XLConnect), we recorded liabilities aggregating $65 for
contingencies identified at the date of the acquisition. During 2000 and 1999,
we determined that certain of these contingent liabilities were no longer
required, and $29 of the liabilities were either reversed into income or we
charged certain costs related to ongoing activities of the acquired business
against these liabilities. Upon additional review it was subsequently determined
that approximately $51 of these contingent liabilities did not meet the criteria
to initially be recorded as acquisition liabilities. Accordingly, we have
adjusted the goodwill and liabilities at the date of acquisition and corrected
the 2000 and 1999 income statement impacts.
Restructuring reserves: During 2000 and 1998, we recorded restructuring charges
associated with our decisions to exit certain activities of the business. Upon
additional review we determined that certain adjustments made to the original
charges were not in accordance with GAAP. The adjustments to decrease pre-tax
loss in 2000 of $65 consist primarily of corrections to the timing of the
release of reserves originally recorded under the March 2000 restructuring
program. We should have reversed the applicable reserves in late 2000 when the
information was available that our original plan had changed indicating that
such reserves were no longer necessary. Previously, the reversal was recorded in
early 2001. Similarly, the adjustment of $12 to decrease 1999 pre-tax income
relates primarily to the inappropriate release of restructuring reserves which
should have been recorded in 1998 based on information available at the time.
50
Tax refunds: In 1995, we received a final favorable court decision that entitled
us to refunds of certain tax amounts paid in the U.S., plus accrued interest on
the tax. The court established the legal precedent upon which the refunds were
to be based. We recorded the income associated with the tax refund and the
related interest from 1995 through 1999. We determined that the benefit should
have been recorded in periods prior to 1997. These adjustments decreased pre-tax
income by $14 for the year ended December 31, 1999.
Other adjustments: In addition to the above items and in connection with our
review of prior year's financial records we determined that other accounting
errors were made with respect to the accounting for certain non-recurring
transactions, the timing of recording and reversing certain liabilities and the
timing of recording certain asset write-offs. We have restated our 2000 and 1999
Consolidated Financial Statements for such items. These adjustments increased
pre-tax loss by $89 for the year ended December 31, 2000 and decreased pre-tax
income by $131 for the year ended December 31, 1999.
The following table presents the effects of the aforementioned adjustments on
total revenue:
Increase (decrease) to total revenue:
Year ended December 31,
2000 1999
---- ----
Revenue, previously reported $18,701 $19,567
Application of SFAS No. 13:
Revenue allocations in bundled arrangements (78) (257)
Latin America - operating lease accounting (58) 57
Other transactions not qualifying as sales-type leases 57 (60)
Sales of equipment subject to operating leases 124 (243)
------ ------
Subtotal 45 (503)
Other revenue restatement adjustments:
Sales of receivables transactions 61 (6)
South Africa deconsolidation (72) (71)
Other revenue items, net 16 8
------- -------
Subtotal 5 (69)
Increase (decrease) in total revenue 50 (572)
------- -------
Revenue, restated $18,751 $18,995
======= =======
The following table presents the effects of the aforementioned adjustments on
pre-tax income (loss): Increase (decrease) to pre-tax (loss) income:
Year ended December 31,
2000 1999
---- ----
Pre-tax (loss) income, previously reported $ (384) $1,908
Revenue restatement adjustments:
Revenue allocations in bundled arrangements (74) (252)
Latin America - operating lease accounting 80 39
Other transactions not qualifying as sales-type leases 12 (50)
Sales of equipment subject to operating leases 11 (162)
Sales of receivables transactions 18 (32)
South Africa deconsolidation (11) (8)
Other revenue items, net 12 22
-------- -------
Subtotal 48 (443)
Other restatement adjustments:
Purchase accounting reserves (7) (20)
Restructuring reserves 65 (12)
Tax refunds - (14)
Other, net (89) (131)
------- --------
Subtotal (31) (177)
51
Increase (decrease) in pre-tax (loss) income 17 (620)
----- ------
Pre-tax (loss) income, restated $(367) $1,288
===== ======
These adjustments resulted in a cumulative net reduction of Common Shareholders'
Equity of $1,692 as of December 31, 2000. The following table presents the
impact of the restatement adjustments on Common Shareholders' Equity as of
January 1, 1999:
Increase (decrease) in Common Shareholders' Equity:
Common Shareholders Equity balance, January 1, 1999, previously reported $4,633
------
Revenue allocations in bundled arrangements (589)
Latin America - operating lease accounting (1,836)
Other transactions not qualifying as sales-type leases (166)
Sales of equipment subject to operating leases (66)
Other items, net 216
Income tax impacts of above adjustments 834
------
Decrease in Common Shareholders' Equity (1,607)
------
Common Shareholders Equity balance, January 1, 1999, restated $3,026
======
The following tables present the impact of the restatements on a condensed
basis:
As
Previously As
Reported Restated
-------- --------
Year ended December 31, 2000
Statement of operations:
Total Revenues $18,701 $18,751
Sales 10,059 8,839
Service, outsourcing and rentals 7,718 8,750
Finance income 924 1,162
Total Costs and Expenses 19,085 19,118
Net loss (257) (273)
Basic loss per share $(0.44) $(0.48)
Diluted loss per share $(0.44) $(0.48)
Balance Sheet:
Accounts receivable, net $ 2,281 $2,269
Current finance receivables, net 5,097 4,392
Inventories 1,932 1,983
Deferred taxes and other current assets 1,247 1,078
Total Current Assets 12,298 11,472
Finance receivables due after one year, net 7,957 6,406
Equipment on operating leases, net 724 1,266
Land, buildings and equipment, net 2,495 2,527
Investments in affiliates, at equity 1,362 1,270
Intangible and other assets, net 3,061 3,763
Goodwill, net 1,578 1,549
Total Assets 29,475 28,253
Short-term debt and current portion of long-term debt 2,693 3,080
Accounts payable 1,033 1,050
Accrued compensation and benefit costs 662 645
Unearned income 250 233
Other current liabilities 1,630 1,536
Total Current Liabilities 6,268 6,544
Long-term debt 15,404 15,557
Deferred taxes and other liabilities 1,876 1,925
52
Total Liabilities 24,745 25,223
Common Shareholders' Equity 3,493 1,801
Total Liabilities and Equity $29,475 $28,253
As
Previously As
Reported Restated
-------- --------
Year ended December 31, 1999
Statement of operations:
Total Revenues $19,567 $18,995
Sales 10,441 8,967
Service, outsourcing and rentals 8,045 8,853
Finance income 1,081 1,175
Total Costs and Expenses 17,659 17,707
Net income 1,339 844
Basic earnings per share $ 1.96 $ 1.20
Diluted earnings per share $ 1.85 $ 1.17
Note 3--Restructuring Programs
Since early 2000, we have engaged in several restructuring programs, as we have
responded to economic weakness, as well as company-specific challenges,
including the poor execution of a major sales force realignment, the disruptive
consolidation of our U.S. customer administrative centers and increased
competition. We engaged in a series of plans related to resizing our employee
base, exiting certain businesses, outsourcing some internal functions and
engaging in other actions designed to reduce our cost structure.
We accomplished these objectives through the undertaking of three separate
restructuring initiatives as follows:
RESTRUCTURING ACTION INITIATION OF PLAN
. Turnaround Program October 2000
. SOHO Disengagement June 2001
. March 2000 Restructuring March 2000
These actions were in addition to a worldwide restructuring program we initiated
in 1998. The execution of the actions and payments of obligations continued
through December 31, 2001, with each plan initiative in various stages of
completion. As management continues to evaluate the business, there may be
supplemental charges for new plan initiatives as well as changes in estimates to
amounts previously recorded as payments are made or actions are completed. Asset
impairment charges were incurred in connection with these restructuring actions
for those assets made obsolete or redundant as a result of the plans. The
details of the restructuring actions are explained below.
Turnaround Program. As noted above, beginning in October 2000, we engaged in a
series of actions to reduce costs, improve operations, transition customer
equipment financing to third-party vendors and sell certain assets that we
believe will positively affect our capital resources and liquidity position when
completed.
As an initial step in this program, in the fourth quarter 2000, we provided
$105, consisting of $71 for severance and related costs and $34 for asset
impairments associated with the disposition of a non-core business. Over half of
these charges related to our Production segment, with the remainder relating to
our Office, DMO and Other segments. During 2001, we provided $403 of
restructuring costs, net of reversals of $26. The reversals related to the
change of certain initiatives. Of the amounts provided, $339 was for severance
and other employee separation costs (including $21 for pension curtailment
charges), $28 was for asset impairments and $36 was for lease cancellation and
other exit costs. The majority of these charges relate to our Production and
Office segments. The aggregate 2001 and 2000 severance and other employee
separation costs are related to the elimination of approximately 7,800 positions
worldwide reflecting continued streamlining of existing work processes,
elimination of redundant resources and the consolidation of activities into
other existing operations. By December 31, 2001, approximately 5,900 employees
had left the Company under the Turnaround Program. The lease cancellation and
other exit costs and asset impairments related primarily to manufacturing
operations. Included in 2001 restructuring charges are $24, primarily for
severance and other employee separation costs, related to the outsourcing of
certain Office segment manufacturing to Flextronics, as discussed further in
Note 5. The Turnaround Program reserve balance at December 31, 2001 was $223.
The remaining balance primarily relates to severance costs and is expected to be
substantially utilized in 2002.
53
As discussed in Note 5, we have completed several divestitures and the
outsourcing of some of our manufacturing operations in 2001. In addition, we
have actively engaged in our plan to transition customer financing to third
parties, as described in Note 6.
SOHO Disengagement. In 2001, we began a separate restructuring program
associated with the disengagement from our worldwide small office/home office
(SOHO) business. In connection with exiting this business, we recorded a pretax
charge of $239, net of reversals. Reversals of $26 were primarily related to a
higher than anticipated number of employees redeployed and better than expected
experience on certain contract terminations. The charge included provisions for
the elimination of approximately 1,200 jobs worldwide by the end of 2001, the
closing of facilities and the write-down of certain assets to net realizable
value. The restructuring provision associated with this action included $164 for
asset impairments, $49 for lease cancellation, purchase decommitments and other
exit costs, and $26 for severance and employee separation costs. An additional
provision of $34 related to excess inventory was recorded as a charge to Cost of
sales. As of December 31, 2001, approximately 800 employees had left the Company
under the SOHO disengagement program. The SOHO disengagement reserve balance at
December 31, 2001 was $23. The remaining balance primarily relates to severance
costs and is expected to be substantially utilized in 2002.
During the fourth quarter 2001, we depleted our inventory of personal inkjet and
xerographic printers, copiers, facsimile machines and multifunction devices
which were sold primarily through retail channels to small offices, home offices
and personal users (consumers). 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 needs.
March 2000 Restructuring. In March 2000, we announced details of a worldwide
restructuring program and recorded pre-tax provisions and charges of $489 which
included severance and employee separation costs of $424, asset impairments of
$30 and other exit costs of $35. An additional provision of $84 related to
excess inventory primarily resulting from the planned consolidation of certain
warehousing operations was recorded as a charge to Cost of sales. The severance
related to the elimination of 5,200 positions worldwide. Approximately 65
percent, 20 percent and 15 percent of the positions related to the U.S., Europe,
and Latin America, respectively. In late 2000, as a result of weakening business
conditions and poor operating results, we reevaluated the remaining plan. After
considering the 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,
we determined that adjustments to the remaining reserve were necessary. As such,
and in connection with the Turnaround Program discussed above, $71 of the
original $489 provision was reversed in the fourth quarter 2000. The amount
reversed consisted of $59 related to severance costs associated with 1,000
positions and $12 related to other exit costs. During 2001, we recorded
additional provisions of $70 for instances when the actual cost of certain
initiatives exceeded the amount estimated at the time of the original charge. We
also recorded reversals of $17 associated with the delay or the cancellation of
certain initiatives, primarily in service and manufacturing. As of December 31,
2001, the March 2000 restructuring program has been substantially completed.
1998 Restructuring. In 1998, we announced a worldwide restructuring program and
recorded a pre-tax provision of $1,393. During 2001, we recorded additional
provisions for changes in estimates of $15 and reversals of $8, primarily as a
result of changes in certain manufacturing initiatives. Cash charges against the
reserve during 1999 were $366 for severance and related costs and $54 for lease
cancellation and other costs. Also, during 1999 we provided an additional
provision of $12, net of reversals, related to changes in estimates. As of
December 31, 2001, the 1998 Restructuring program has been substantially
completed.
54
The following table summarizes the activity in the restructuring reserves for
the two years ended December 31, 2001:
1999 2000 2001
Balance Provision Reversal Charges Balance Provision Reversals Charges Balance
------- --------- -------- ------- ------- --------- --------- ------- -------
Turnaround Program:
Severance and related costs ........... $ -- $ 71 $ -- $ -- $ 71 $ 364 $ (25) $ (211) $ 199
Lease cancellation and other costs .... -- -- -- -- -- 37 (1) (4) 32
----- ----- ----- ----- ----- ------ ----- ------ -----
Subtotal ............................ -- 71 -- -- 71 401 (26) (215) 231
Currency changes ........................ -- -- -- -- -- -- -- (8) (8)
----- ----- ----- ----- ----- ------ ----- ------ -----
Total ................................... -- 71 -- -- 71 401 (26) (223) 223
----- ----- ----- ----- ----- ------ ----- ------ -----
SOHO Disengagement:
Severance and related costs ........... -- -- -- -- -- 37 (11) (12) 14
Lease cancellation and other costs .... -- -- -- -- -- 64 (15) (39) 10
----- ----- ----- ----- ----- ------ ----- ------ -----
Subtotal ............................ -- -- -- -- -- 101 (26) (51) 24
Currency changes ........................ -- -- -- -- -- -- -- (1) (1)
----- ----- ----- ----- ----- ------ ----- ------ -----
Total ................................... -- -- -- -- -- 101 (26) (52) 23
----- ----- ----- ----- ----- ------ ----- ------ -----
March 2000 Restructuring:
Severance and related costs ........... -- 424 (97) (151) 176 68 (17) (183) 44
Lease cancellation and other .......... -- 35 (23) (10) 2 2 -- (4) --
----- ----- ----- ----- ----- ------ ----- ------ -----
Subtotal ............................ -- 459 (120) (161) 178 70 (17) (187) 44
Currency changes ........................ -- -- -- (15) (15) -- -- (17) (32)
----- ----- ----- ----- ----- ------ ----- ------ -----
Total ................................... -- 459 (120) (176) 163 70 (17) (204) 12
1998 Restructuring:
Severance and related costs ........... 334 6 (5) (197) 138 10 (8) (40) 100
Lease cancellation and other costs .... 50 -- -- (29) 21 5 -- (12) 14
----- ----- ----- ----- ----- ------ ----- ------ -----
Subtotal ............................ 384 6 (5) (226) 159 15 (8) (52) 114
Currency changes ........................ (45) -- -- (21) (66) -- -- (24) (90)
----- ----- ----- ----- ----- ------ ----- ------ -----
Total ................................... 339 6 (5) (247) 93 15 (8) (76) 24
===== ===== ===== ===== ===== ====== ===== ====== =====
Total of all programs ................... $ 339 536 (125) $ 423 $ 327 $ 587 (77) $ (555) $ 282
----- ----- ----- ----- ----- ------ ----- ------ -----
Total asset impairments ................. 64 -- 205 --
----- ----- ------ -----
Subtotal ................................ $ 600 (125) $ 792 (77)
----- ----- ------ -----
Total restructuring and asset
impairment provision .................. $ 475 $ 715
===== =====
Note 4--Acquisitions
CPID Division of Tektronix, Inc.: In January 2000, we and Fuji Xerox completed
the acquisition of the Color Printing and Imaging Division of Tektronix, Inc.
(CPID). CPID manufactures and sells color printers, ink and related products,
and supplies. The original aggregate consideration paid of $925 in cash,
including $73 paid directly by Fuji Xerox, was subject to customary purchase
price adjustments pending the finalization of net asset values. During 2001, we
were reimbursed $18 in cash upon finalization of these values which was recorded
as a reduction to Goodwill. The acquisition was accounted for in accordance with
the purchase method of accounting.
The excess of cash paid over the fair value of net assets acquired has been
allocated to identifiable intangible assets and Goodwill using a discounted cash
flow approach. The value of the identifiable intangible assets included $27 for
purchased in-process research and development which was written off in 2000. The
charge represented the fair value of certain acquired research and development
projects that were determined not to have reached technological feasibility as
of the date of the acquisition, and was determined based on a methodology that
utilized the projected after-tax cash flows of the products expected to result
from in-process research and development activities and the stage of completion
of the individual projects. Other identifiable intangible assets are exclusive
of intangible assets acquired by Fuji Xerox, and include the installed customer
base, the distribution network, the existing technology, the workforce, and
trade-marks. These identifiable assets are included in Intangibles and other
assets, net in the Consolidated Balance Sheets.
55
Other identifiable intangible assets and Goodwill are being amortized on a
straight-line basis over their estimated useful lives which range from 7 to 25
years. During 2001, certain intangible asset useful lives were revised. As a
result of these revisions, we recorded an additional $9 in amortization expense
during 2001.
In connection with this acquisition, we recorded approximately $45 for
anticipated costs associated with exiting certain activities of the acquired
operations. These activities included: the consolidation of duplicate
distribution facilities; the rationalization of the service organization; and
the exiting of certain lines of the CPID business. The costs associated with
these activities include inventory write-offs, severance charges, contract
cancellation costs and fixed asset impairment charges. During 2001, we revised
our originally planned initiatives related to the acquired European service
organization and our estimate of the costs to complete the exit from our
distribution facilities in Europe. These changes, along with certain other
changes, resulted in the reversal of $9 of the originally recorded reserves,
with a corresponding reduction in Goodwill.
Omnifax: In August 1999, we purchased the OmniFax division from Danka Business
Systems for $45 in cash. OmniFax is a supplier of business laser multifunction
fax systems. The acquisition resulted in goodwill of $20, which is being
amortized over 15 years.
India Operations: In 1999, we paid $62 to increase our ownership in our India
operations from approximately 40 percent to 68 percent. This transaction
resulted in additional goodwill of $51, which is being amortized over 40 years.
See Note 1 for a discussion of the impact of the adoption of SFAS No. 142 on the
intangible assets acquired.
Note 5--Divestitures
Flextronics Manufacturing Outsourcings: In October 2001, we announced a
manufacturing outsourcing agreement with Flextronics, a global electronics
manufacturing services company. The agreement includes a five-year supply
contract for Flextronics to manufacture certain office equipment and components,
and a sale agreement providing for the purchase by Flextronics of inventory,
property and equipment at a premium over book value, and the assumption of
certain liabilities. The premium will be amortized over the life of the
five-year supply contract. Inventory purchased from us by Flextronics remains in
our inventory balance until sold to an end user, and a corresponding liability
is recognized for proceeds received. This inventory totaled $27 at December 31,
2001. Additionally, we are required to repurchase inventory not utilized by
Flextronics within 180 days. In total, the agreement with Flextronics will
represent approximately 50 percent of our overall worldwide manufacturing
operations when all phases are complete.
In the 2001 fourth quarter, we completed the sales of our plants in Toronto,
Canada; Aguascalientes, Mexico; and Penang, Malaysia to Flextronics for
approximately $118, plus the assumption of certain liabilities. The sale is
subject to certain closing adjustments. Approximately 2,500 Xerox employees in
these operations transferred to Flextronics upon closing. In January 2002, we
completed the sale of our office manufacturing operations in Venray, The
Netherlands and Resende, Brazil for $29, plus the assumption of certain
liabilities. Approximately 1,600 Xerox employees in these operations transferred
to Flextronics upon closing.
By the end of the third quarter 2002, we anticipate all production at our
printed circuit board factories in El Segundo, California and Mitcheldean,
England and our customer replaceable unit plant in Utica, New York will be fully
transferred to Flextronics' facilities. Included in the 2001 Turnaround Program
are restructuring charges of $24 related to the closing of these facilities. See
Note 3.
Delphax: In December 2001, we sold Delphax Systems and Delphax Systems, Inc.
(Delphax) to Check Technology Canada LTD and Check Technology Corporation for
$14 in cash subject to purchase price adjustments. The transaction was
essentially at book value. Delphax designs, manufactures and supplies high-speed
electron beam imaging digital printing systems and related parts, supplies and
maintenance services.
56
Nordic Leasing Business: In April 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 which
approximated book value. These sales are part of an agreement under which
Resonia will provide ongoing, exclusive equipment financing to our customers in
those countries.
Fuji Xerox Interest: In March 2001, we completed the sale of half of our
ownership interest in Fuji Xerox to Fuji Photo Film Co., Ltd (FujiFilm) for
$1,283 in cash. In connection with the sale, we recorded a pre-tax gain of $773
and recognized in income $16 of net accumulated currency translation losses.
Under the agreement, FujiFilm's ownership interest in Fuji Xerox increased from
50 percent to 75 percent. While our ownership interest decreased to 25 percent,
we retain significant rights as a minority shareholder. All product and
technology agreements between us and Fuji Xerox continue, ensuring that the two
companies retain uninterrupted access to each other's portfolio of patents.
Xerox China: In December 2000, we sold our China operations to Fuji Xerox for
$550. In connection with the sale, Fuji Xerox also assumed $118 of indebtedness.
We recorded a pre-tax gain of $200 in connection with this transaction. Our
China operations had revenue of $262 and $198 in the years ended December 31,
2000 and 1999, respectively.
Commodity Paper Product Line: In June 2000, we entered into an agreement to sell
our U.S. and Canadian commodity paper product line and customer list, including
an exclusive license for the Xerox brand, to Georgia Pacific and recorded a
pre-tax gain of $40 which is included in Other, net. In addition to the proceeds
from the sale, we are receiving royalty payments on future sales of Xerox
branded commodity paper by Georgia Pacific and are earning commissions on any
Xerox originated sales of commodity paper as an agent for Georgia Pacific.
ContentGuard: In April 2000, we sold a 25 percent ownership interest in our
wholly owned subsidiary, ContentGuard, to Microsoft, Inc. for $50 and recognized
a pre-tax gain of $23, which is included in Other, net. An additional pre-tax
gain of $27 was deferred, pending the achievement of certain performance
criteria. In May 2002, we repaid Microsoft $25 as the performance criteria had
not been achieved. In connection with the sale, ContentGuard also received $40
from Microsoft for a non-exclusive license of its patents and other intellectual
property and a $25 advance against future royalty income from Microsoft on sales
of products incorporating ContentGuard's technology. The license payment is
being amortized over the life of the license agreement of 10 years and the
royalty advance will be recognized in income as earned. These amounts are not
refundable.
Note 6--Receivables, Net
Finance Receivables. Finance receivables result from installment arrangements
and sales-type leases arising from the marketing of our equipment. These
receivables are typically collateralized by a security interest in the
underlying assets. The components of Finance receivables, net at December 31,
2001 and 2000 follow:
2001 2000
---- ----
Gross receivables ............................... $11,466 $12,455
Unearned income ................................. (1,834) (1,820)
Unguaranteed residual values .................... 414 508
Allowance for doubtful accounts ................. (368) (345)
------- -------
Finance receivables, net ........................ 9,678 10,798
Less current portion ............................ 3,922 4,392
------- -------
Amounts due after one year, net ................. $ 5,756 $ 6,406
------- -------
Contractual maturities of our gross finance receivables subsequent to December
31, 2001 follow:
2002 2003 2004 2005 2006 Thereafter
---- ---- ---- ---- ---- ----------
$4,528 $3,191 $2,104 $1,142 $388 $113
Our experience has shown that a portion of these finance receivables will be
prepaid prior to maturity. Accordingly, the preceding schedule of contractual
maturities should not be considered a forecast of future cash collections. In
addition, our strategy of exiting the direct financing of customers' purchases
may result in further acceleration of the collection of these receivables as a
result of associated asset securitizations.
57
Secured Borrowings and Collateral. In November 2001, we entered into a secured
loan agreement with General Electric Capital Corporation (GECC) which provided
for the sale by Xerox of certain lease contracts in the U.S. to a special
purpose entity (SPE). The purchase of the contracts by the SPE is funded through
secured loans by GECC up to a maximum amount of $2.6 billion. We and GECC intend
the transfers of the lease contracts to the SPE to be "true sales at law," and
have received an opinion to that effect from outside legal counsel. As a result,
the assets of the SPE are not available to satisfy any of our other obligations.
However, the transaction was accounted for as a secured borrowing because the
SPE is non-qualifying in accordance with the provisions of SFAS No. 140.
Therefore, we consolidate the SPE in our financial statements. During 2001,
lease contracts were transferred to the SPE for cash proceeds of $1,175. Net
fees of $7 were paid in connection with the transaction and have been
capitalized as debt issuance costs. In connection with these transactions, $115
of the $1,175 in proceeds was required to be held in reserve by the SPE, as
security for our supply and service obligations inherent in the transferred
contracts and is included in Intangible and other assets, net. The amount held
will be released ratably as the underlying borrowing is repaid. At December 31,
2001, the remaining secured borrowing balance was $1,149 and is included in
Debt.
In July 2001, we transferred domestic lease contracts to a consolidated trust,
which in turn sold $513 of floating-rate asset-backed notes (notes). We received
cash proceeds of $480, net of $3 of expenses and fees. An additional $30 of
proceeds are being held in reserve by the trust until the notes are repaid,
which is currently estimated to be in or around August 2003. Since the trust is
consolidated in our financial statements, we effectively recorded the
transaction as a secured borrowing. Although the transferred assets remain
included in our Total Assets, we did receive an opinion from outside legal
counsel that the transfer to the trust was deemed to be a "true sale at law". As
a result, the assets of the trust are not available to satisfy any of our other
obligations. At December 31, 2001, the remaining secured borrowing balance was
$395 and is included in Debt. The $30 of proceeds held by the trust is included
in Intangible and other assets, net.
During 2001, we received $885 in financing from GE Capital Equipment Finance
Limited (a subsidiary of GECC), secured by our portfolios of lease receivables
in the United Kingdom. At December 31, 2001, the remaining secured borrowing
balance is $521 and is included in Debt.
In 2000, we transferred domestic lease contracts to a SPE, for gross proceeds of
$411. The proceeds received were accounted for as a secured borrowing. At
December 31, 2001, the remaining secured borrowing balance was $154 and is
included in Debt.
In 1999, we sold certain finance receivables in the U.S. generating gross
proceeds of $1,150. The transactions were accounted for as secured borrowings.
At December 31, 2001, the remaining secured borrowing balance was $94 and is
included in Debt. The remaining balances due are expected to be paid off during
the first half of 2002.
As of December 31, 2001, $1,919 of finance receivables are held as collateral in
various trusts and SPEs, as security for the borrowings noted above.
Accounts Receivable. In 2000, we established two revolving accounts receivable
securitization facilities in the U.S. and Canada aggregating $330. The
agreements enable us to sell, on an ongoing basis, undivided interests in a
portion of our accounts receivable, meeting certain credit criteria, in exchange
for cash. The portion of the receivables pool not sold are held by us as
retained interests. At December 31, 2001, unrelated third parties held an
undivided interest of $326 in an accounts receivable pool balance of $785. The
balance of $459, which represents our retained interests, is included in
Accounts receivable, net in the Consolidated Balance Sheets. Each period, this
balance may differ depending on the volume of receivables generated that meet
the defined terms applicable to the facility.
Under the terms of the agreements, new receivables are added to the facility
pool as collections reduce previously sold accounts receivable. Third party
undivided interest investors have a priority collection right in the entire pool
of receivables transferred, and, as a result, we have a retained credit risk on
the first dollar loss on the receivable pool to the extent of its retained
interest. This risk is estimated and reserved for as part of the allowance for
doubtful accounts and is included as an offset to the balance of retained
interests referred to above. The amount of the allowance for doubtful accounts
associated with the transferred pool of receivables was approximately $100 at
December 31, 2001. We continue to service the pool of receivables and receive a
servicing fee which is adequate to compensate us for such services. The
investors in the securitized accounts receivable have no recourse to our assets
for failure of obligors to pay when due beyond our retained interests in the
accounts receivable pool. Excluding credit losses we may have incurred, expenses
and fees associated with these transactions amounted to $19 and $10 in 2001 and
2000, respectively, and are included in Other, net in the Consolidated
Statements of Operations. The increase is primarily due to the facilities being
outstanding for a full year in 2001.
58
In May 2002, one of our credit rating agencies downgraded our credit status,
which had the resultant effect of causing an event of default under the U.S.
facility. The undivided interest sold under the U.S. facility amounted to $290
at December 31, 2001, of the $326 aggregate total noted above. The Canadian
facility, which had undivided interests of $36 at December 31, 2001 was also
impacted by a downgrade in debt, which led to a similar event of default. As of
June 21, 2002, we are currently in the process of renegotiating terms of the
U.S. facility. We continue to sell receivables to the U.S. facility up to its
limit of $290. Failure to successfully renegotiate this facility could result in
the suspension of its revolving features, whereupon we would be unable to sell
new accounts receivable into the facility. However, if that event occurs, there
would not be any requirement of us to repurchase any of the undivided interests
sold. The practical effect would be only that of timing, as the cash flows from
the pooled receivables would first be used to pay the undivided interests
investor, while we would collect all remaining cash from the residual
receivables in the pool. The Canadian facility was not renegotiated and the
balance of the undivided interests of $36 at December 31, 2001, has subsequently
been fully repaid.
Total proceeds from the collections reinvested in these facilities were $5,261
and $1,363, respectively for the years ended December 31, 2001 and 2000.
In 1999, we sold accounts receivable, generating aggregate gross proceeds of
$231. These short-term transactions were accounted for as sales of receivables.
These transactions have all been fully completed and no balances remain
outstanding at December 31, 2001.
Note 7--Inventories and Equipment on Operating Leases, Net
The components of inventories at December 31, 2001 and 2000 follow:
2001 2000
---- ----
Finished goods ..................................... $ 960 $1,485
Work in process .................................... 97 147
Raw materials ...................................... 307 351
------ ------
Total inventories .................................. $1,364 $1,983
====== ======
Equipment on operating leases and similar arrangements consists of our equipment
rented to customers and depreciated to estimated salvage value. Equipment on
operating leases is presented in our Consolidated Statements of Cash Flows in
the operating activities section as a non-cash adjustment, reflecting the
transfer from our inventories. Equipment on operating leases and the related
accumulated depreciation at December 31, 2001 and 2000 follow:
2001 2000
---- ----
Equipment on operating leases ........................ $ 2,433 $3,329
Less: Accumulated depreciation ....................... (1,629) (2,063)
------- ------
Equipment on operating leases, net ................... $ 804 $1,266
======= ======
Depreciable lives generally vary from three to four years. Our equipment
operating lease terms vary, generally from 12 to 36 months. Scheduled minimum
future rental revenues on operating leases with original terms of one year or
longer are:
2002 2003 2004 2005 Thereafter
----- ---- ---- ---- ----------
$708 $489 $291 $77 $9
Total contingent rentals, principally usage charges in excess of minimum
allowances relating to operating leases, for the years ended December 31, 2001,
2000 and 1999 amounted to $235, $286 and $321, respectively.
59
Note 8--Land, Buildings and Equipment, Net
The components of land, buildings and equipment, net at December 31, 2001 and
2000 follow:
Estimated
Useful
Lives
(Years) 2001 2000
------- ---- ----
Land ..................................... $ 58 $ 70
Buildings and building equipment ......... 25 to 50 1,080 1,061
Leasehold improvements ................... Lease term 425 426
Plant machinery .......................... 5 to 12 1,713 1,985
Office furniture and equipment ........... 3 to 15 1,159 1,304
Other .................................... 4 to 20 147 199
Construction in progress ................. 129 295
------ ------
Subtotal ................................. 4,711 5,340
Less: accumulated depreciation ........... (2,712) (2,813)
------ ------
Land, buildings and equipment, net ....... $1,999 $2,527
====== ======
Depreciation expense was $402, $417 and $416 for the years ended December 31,
2001, 2000 and 1999, respectively.
We lease certain land, buildings and equipment, substantially all of which are
accounted for as operating leases. Total rent expense under operating leases for
the years ended December 31, 2001, 2000 and 1999 amounted to $332, $344 and
$397, respectively. Future minimum operating lease commitments that have
remaining non-cancelable lease terms in excess of one year at December 31, 2001
follow:
2002 2003 2004 2005 2006 Thereafter
---- ---- ---- ---- ---- ----------
$250 $207 $165 $135 $112 $359
In certain circumstances, we sublease space not currently required in
operations. Future minimum sublease income under leases with non-cancelable
terms in excess of one year amounted to $31 at December 31, 2001.
Included in Intangibles and other assets, net in the Consolidated Balance Sheets
are capitalized direct costs associated with developing, purchasing or otherwise
acquiring software for internal use. These costs are amortized on a
straight-line basis over the expected useful life of the software, beginning
when the software is implemented. The software useful lives generally vary from
3 to 5 years. Capitalized software balances, net of accumulated amortization,
were $479 and $505 at December 31, 2001 and 2000, respectively.
In 2001, we extended our information technology contract with Electronic Data
Systems Corp. (EDS) for five years through June 2009. Services to be provided
under this contract include support of global mainframe system processing,
application maintenance, desktop and helpdesk support, voice and data network
management and server management. We have the right, upon 180 days' notice, to
terminate for convenience each newly negotiated framework agreement after its
second anniversary, subject to making a payment of reasonable vendor costs
associated with such termination. There are no minimum payments due EDS under
the contract. Payments to EDS were $445, $555 and $601 for the years ended
December 31, 2001, 2000 and 1999, respectively.
Note 9--Investments in Affiliates, at Equity
Investments in corporate joint ventures and other companies in which we
generally have a 20 to 50 percent ownership interest at December 31, 2001 and
2000 follow:
2001 2000
---- ----
Fuji Xerox/(1)/ ..................................... $532 $1,160
Other investments ................................... 100 110
---- ------
Investments in affiliates, at equity ................ $632 $1,270
==== ======
/(1)/ Our investment in Fuji Xerox of $532 at December 31, 2001, differs from
our implied 25 percent interest in the underlying net assets, or $592, due
primarily to the deferred gains resulting from sales of assets by us to Fuji
Xerox, as offset by goodwill we had recorded at the time we acquired such
interest.
60
Fuji Xerox is headquartered in Tokyo and operates in Japan and other areas of
the Pacific Rim, Australia and New Zealand. As discussed in Note 5, we sold half
of our interest in Fuji Xerox to Fuji Photo Film Co., Ltd. in March 2001.
Condensed financial data of Fuji Xerox for its last three fiscal years follow:
2001/(1)/ 2000 1999
---- ---- ----
Summary of Operations
Revenues ................................................. $7,684 $8,398 $7,710
Costs and expenses ....................................... 7,316 8,076 7,371
------ ------ ------
Income before income taxes ............................... 368 322 339
Income taxes ............................................. 167 146 201
Minorities' interests in equity of subsidiaries .......... 35 36 29
------ ------ ------
Net income ............................................... $ 166 $ 140 $ 109
====== ====== ======
Balance Sheet Data
Assets
Current assets ........................................... $2,783 $3,162
Non-current assets ....................................... 3,455 3,851
------ ------
Total assets ......................................... $6,238 $7,013
====== ======
Liabilities and Shareholders' Equity
Current liabilities ...................................... $2,242 $3,150
Long-term debt ........................................... 796 445
Other non-current liabilities ............................ 632 649
Minorities' interests in equity of subsidiaries .......... 201 203
Shareholders' equity ..................................... 2,367 2,566
------ ------
Total liabilities and shareholders' equity ........... $6,238 $7,013
====== ======
/(1)/ Fuji Xerox changed its fiscal year end in 2001 from December to March.
The 2001 condensed financial data consists of the last three months of
Fuji Xerox's fiscal year 2001 and the first nine months of fiscal year
2002.
Note 10--Segment Reporting
In 2001, we realigned our reportable segments to be consistent with how we
manage the business and reflect the markets we serve. As a result of this
realignment our reportable segments are as follows: Production, Office,
Developing Markets Operations, Small Office/Home Office, and Other. Prior years'
segments have been restated to reflect our new reporting structure.
The Production segment includes our DocuTech family of products, 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 multifunction
products, color laser, solid ink and monochrome laser desktop printers, digital
and light-lens copiers under 90 pages per minute, 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 Developing Markets Operations segment (DMO) includes our operations in Latin
America, the Middle East, India, Eurasia, Russia and Africa. This segment
includes sales of products that are typical to the aforementioned segments,
however management serves and evaluates these markets on an aggregate
geographic, rather than product, basis.
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 3, in June 2001 we announced the disengagement from the
worldwide SOHO business.
61
The segment classified as Other, includes several units, none of which met the
thresholds for separate segment reporting. This group primarily includes Xerox
Engineering Systems (XES) and Xerox Supplies Group (XSG) (predominantly paper).
Other segment profit (loss) includes certain costs which have not been allocated
to the businesses including non-financing interest and other non-allocated
costs. Other segments' total assets include XES, XSG, and our investment in Fuji
Xerox. The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies.
Operating segment profitability and selected asset information for the years
ended December 31, 2001, 2000 and 1999 is as follows:
Developing
Production Office Markets SOHO Other Total
---------- ------ ------- ---- ----- -----
2001
Information about profit or loss
Revenues from external customers ........................... $5,336 $ 6,340 $2,001 $ 402 $1,800 $15,879
Finance income ............................................. 563 536 26 1 3 1,129
Intercompany revenues ...................................... -- 50 -- 4 (54) --
------ ------- ------ ----- ------ -------
Total segment revenues ................................... 5,899 6,926 2,027 407 1,749 17,008
Interest expense/(1)/ ...................................... 274 247 48 -- 334 903
Segment profit (loss)/(2)/ ................................. 454 341 (157) (197) (39)/(4)/ 402
Equity in net income of unconsolidated affiliates .......... -- -- 4 -- 49 53
Information about assets
Investments in affiliates, at equity ....................... 7 6 12 -- 607 632
Total assets ............................................... 11,214 11,905 1,671 492 2,407 27,689
Cost of additions to land, buildings and equipment ......... 60 74 32 23 30 219
2000
Information about profit or loss
Revenues from external customers ........................... $5,749 $ 6,518 $2,573 $ 592 $2,157 $17,589
Finance income ............................................. 583 528 46 1 4 1,162
Intercompany revenues ...................................... -- 14 -- 6 (20) --
------ ------- ------ ----- ------ -------
Total segment revenues ................................... 6,332 7,060 2,619 599 2,141 18,751
Interest expense/(1)/ ...................................... 275 235 103 -- 477 1,090
Segment profit (loss)/(2)/ ................................. 463 (180) (93) (293) 225/(4)/ 122
Equity in net income (loss) of unconsolidated
affiliates/(3)/ ........................................... (2) (2) 4 -- 103 103
Information about assets
Investments in affiliates, at equity ....................... 7 6 13 -- 1,244 1,270
Total assets ............................................... 11,158 11,362 2,240 806 2,687 28,253
Cost of additions to land, buildings and equipment ......... 132 122 88 90 20 452
1999
Information about profit or loss
Revenues from external customers ........................... $6,337 $ 6,343 $2,415 $ 566 $2,159 $17,820
Finance income ............................................. 596 510 35 9 25 1,175
Intercompany revenues ...................................... -- -- -- -- -- --
------ ------- ------ ----- ------ -------
Total segment revenues ................................... 6,933 6,853 2,450 575 2,184 18,995
Interest expense/(1)/ ...................................... 238 210 79 4 311 842
Segment profit (loss)/(2)/ ................................. 1,236 49 48 (188) 203/(4)/ 1,348
Equity in net income (loss) of unconsolidated affiliates ... -- -- (2) -- 50 48
Information about assets
Investments in affiliates, at equity ....................... 8 8 12 -- 1,507 1,535
Total assets ............................................... 10,549 9,946 2,739 973 3,596 27,803
Cost of additions to land, buildings and equipment ......... 189 180 96 87 42 594
62
/(1)/ Interest expense includes equipment financing interest as well as
non-financing interest, which is a component of Other expenses, net.
/(2)/ Depreciation and amortization expense is recorded in cost of sales,
research and development expenses and selling, administrative and general
expenses and is included in the segment profit (loss) above. This
information is not identified and reported separately to our chief
operating decision maker. These expenses are recorded by our operating
units in the accounting records based on individual assessments as to how
the related assets are used. The separate identification of this
information for purposes of segment disclosure is impracticable, as it is
not readily available and the cost to develop it would be excessive.
/(3)/ Excludes our $37 share of a restructuring charge recorded by Fuji Xerox.
/(4)/ Other segment profit (loss) includes net corporate expenses of $35, $116
and $(172) for the years ended December 31, 2001, 2000 and 1999,
respectively.
The following is a reconciliation of segment profit to total company pre-tax
income (loss):
Years ended December 31, 2001 2000 1999
---- ---- ----
Total segment profit $ 402 $ 122 $1,348
Unallocated items:
Restructuring and impairment charges (715) (475) (12)
Restructuring related inventory write-down charges (42) (84) --
In process research and development charges -- (27) --
Gains on sales of businesses 773 200 --
Allocated item:
Equity in net income of unconsolidated affiliates (53) (103) (48)
----- ----- ------
Pre-tax income (loss) $ 365 $(367) $1,288
===== ===== ======
Geographic area data follow:
Revenues Long-Lived Assets/(1)/
-------- --------------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
Information about Geographic Areas
United States ........................................ $10,034 $10,706 $10,655 $1,880 $2,423 $2,473
Europe ............................................... 5,039 5,511 6,039 767 940 848
Other Areas .......................................... 1,935 2,534 2,301 706 1,052 1,051
------- ------- ------- ------ ------ ------
Total ............................................ $17,008 $18,751 $18,995 $3,353 $4,415 $4,372
======= ======= ======= ====== ====== ======
/(1)/ Long-lived assets are comprised of land, buildings and equipment, net,
on-lease equipment, net, and capitalized software costs, net.
Note 11--Discontinued Operations
Our remaining investment in our Insurance and Other Financial Services (IOFS)
and Third-Party Financing and Real Estate discontinued businesses, which is
included in the Consolidated Balance Sheets in Intangible and other assets, net
total $749 and $534 at December 31, 2001 and 2000, respectively.
Over half of the remaining investment at December 31, 2001 relates to a
performance-based instrument, originally valued at $462, received in partial
consideration from the sale of one of the Talegen Holdings, Inc. (Talegen)
insurance companies to The Resolution Group, Inc. (TRG). Cash distributions are
paid on the instrument, based on 72.5 percent of TRG's available cash flow as
defined in the sale agreement. During 2001, we received cash distributions of
$28 which were accounted for as a reduction to this instrument. Current cash
flow projections indicate that we expect to fully recover the remaining $434 by
2018.
Xerox Financial Services, Inc. (XFSI), a wholly owned subsidiary, continues to
provide aggregate excess of loss reinsurance coverage (the Reinsurance
Agreements) to one of the former Talegen units, Crum and Forster Inc. (C&F), and
TRG through Ridge Re Insurance Limited (Ridge Re), a wholly owned subsidiary of
XFSI. The coverage limits for these two remaining Reinsurance Agreements total
$578, which is exclusive of $234 in C&F coverage that Ridge Re reinsured during
1998.
Both the Company and XFSI have guaranteed that Ridge Re will meet all of its
financial obligations under the two remaining Reinsurance Agreements. Related
premium payments to Ridge Re are made by XFSI and guaranteed by us. As of
December 31, 2001, there was one remaining annual installment of $41, including
finance charges, which was paid by XFSI in January 2002. During 2001 we replaced
$660 of letters of credit, which supported Ridge Re ceded reinsurance
obligations, with trusts which included the then existing Ridge Re investment
portfolio of approximately $405 plus $255 in cash. These trusts are required to
provide security with respect to aggregate excess of loss reinsurance
obligations under the two remaining
63
Reinsurance Agreements. The balance of the investments, consisting primarily of
marketable securities, in the trusts at December 31, 2001 was $684.
XFSI may also be required, under certain circumstances, to purchase, over time,
additional redeemable preferred shares of Ridge Re, up to a maximum of $301.
Our remaining net investment in Ridge Re was $348 and $88 at December 31, 2001
and 2000, respectively. Based on Ridge Re's current projections of investment
portfolio returns and reinsurance obligation payments, we expect to fully
recover our remaining investment. The projected reinsurance obligation payments
are based on actuarial estimates provided to Ridge Re by TRG.
Note 12--Debt
Short-Term Debt. Short-term borrowings data at December 31, 2001 and 2000
follow:
Weighted
Average Interest
Rates at
12/31/01 2001 2000
-------- ---- ----
Notes payable ....................................... 11.07% $ 53 $ 169
commercial paper .................................... -- -- 140
------ ------
Total short-term debt ............................... 53 309
Current maturities of long-term debt ................ 6,584 2,771
------ ------
Total ........................................... $6,637 $3,080
====== ======
Debt classification. At December 31, 2001 and 2000, our debt has been classified
in the Consolidated Balance Sheets based on the contractual maturity dates of
the underlying debt instruments or as of the earliest call date available to the
debt holders except for $3.5 billion of the aggregate $7.0 billion Revolving
credit agreement borrowing which is classified as long-term because we have
refinanced the debt subsequent to December 31, 2001 on a long-term basis as a
result of the New Credit Facility. We defer costs associated with debt issuance
over the applicable term or to the first redemption date, in the case of
convertible debt.
64
Long-Term Debt. A summary of long-term debt by final contractual maturity date
at December 31, 2001 and 2000 follows:
Weighted
Average Interest
Rates at
12/31/01 2001 2000
-------- ---- ----
U.S. Operations
Xerox Corporation (parent company)
Guaranteed ESOP notes due 2001-2003 ........................................ 7.22% $ 135 $ 221
Notes due 2001 ................................................................ -- -- 687
Yen notes due 2001 ............................................................ -- -- 50
Notes due 2002 ................................................................ 6.13 300 330
Notes due 2003 ................................................................ 5.65 896 1,313
Notes due 2004 ................................................................ 7.15 197 200
Euro notes due 2004 ........................................................... 3.50 266 283
Notes due 2006 ................................................................ 7.25 15 25
Notes due 2007 ................................................................ 7.38 25 25
Notes due 2008 ................................................................ 2.01 25 25
Notes due 2011 ................................................................ 7.01 50 50
Notes due 2016 ................................................................ 7.20 255 250
Convertible notes due 2018 .................................................... 3.63 600 617
Secured borrowings/(1)/ due 2002-2005 ......................................... 5.06 1,639 419
Revolving credit agreement/(2)/ ............................................... 2.73 4,675 4,400
Other debt due 2000-2018 ...................................................... 8.73 93 185
---- ------- --------
Subtotal .................................................................. 9,171 9,080
------- --------
Xerox Credit Corporation
Notes due 2001 ................................................................ -- -- 326
Notes due 2002 ................................................................ 6.62 229 229
Yen notes due 2002 ............................................................ 0.80 381 437
Notes due 2003 ................................................................ 6.61 465 460
Yen notes due 2005 ............................................................ 1.50 762 904
Yen notes due 2007 ............................................................ 2.00 231 270
Notes due 2008 ................................................................ 6.40 25 25
Notes due 2012 ................................................................ 7.10 125 125
Notes due 2013 ................................................................ 6.50 60 60
Notes due 2014 ................................................................ 6.06 50 50
Notes due 2018 ................................................................ 7.00 25 25
Secured borrowings/(1)/ due 2001-2003 ......................................... 2.32 154 325
Revolving credit agreement/(2)/ ............................................... 2.29 1,020 1,020
Floating rate notes due 2048 .................................................. -- -- --
---- ------- --------
Subtotal .................................................................. 3,527 4,316
------- --------
Total U.S. operations ................................................ $12,698 $ 13,396
======= ========
/(1)/ Refer to Note 6 for further discussion of secured borrowings.
/(2)/ $3.5 billion of the aggregate $7.0 billion Revolving credit agreement
borrowing is classified as long-term because we have refinanced the debt
subsequent to December 31, 2001 on a long-term basis as a result of the
New Credit Facility.
65
Weighted
Average Interest
Rates at
12/31/01 2001 2000
-------- ---- ----
International Operations
Xerox Capital (Europe) plc
Various obligations, payable in:
Euros due 2001-2008 ........................................................ 5.25% $ 661 $ 698
Japanese yen due 2001-2005 ................................................. 0.78 229 950
U.S. dollars due 2001-2008 ................................................. 5.82 1,022 1,025
Revolving credit agreement (U.S. dollars)/(2)/ ............................. 2.80 805 1,080
-------- -------- --------
Subtotal ............................................................... 2,717 3,753
-------- --------
Other International Operations
Various obligations, payable in:
U.S. dollars due 2001-2008 ................................................. 5.36 110 128
Euros due 2001-2008 ........................................................ 5.00 71 221
Canadian dollars due 2001-2007 ............................................. 11.74 47 55
Pounds sterling due 2001-2003 .............................................. -- -- 187
Indian rupees due 2001-2005 ................................................ 11.73 24 45
Egyptian pounds due 2001-2005 .............................................. 13.00 9 11
Secured borrowings/(1)/ due 2001-2003 ...................................... 6.38 521 --
Revolving credit agreement (U.S. dollars)/(2)/ ............................. 2.73 500 500
Other debt due 2001-2004 ................................................... 9.13 15 32
-------- -------- --------
Subtotal ............................................................... 1,297 1,179
-------- --------
Total international operations .................................... 4,014 4,932
-------- --------
Subtotal ............................................................... 16,712 18,328
-------- --------
Less current maturities .................................................... 6,584 2,771
-------- --------
Total long-term debt .............................................. $ 10,128 $ 15,557
======== ========
/(1)/ Refer to Note 6 for further discussion of secured borrowings.
/(2)/ $3.5 billion of the aggregate $7.0 billion Revolving credit agreement
borrowing is classified as long-term because we have refinanced the debt
subsequent to December 31, 2001 on a long-term basis as a result of the
New Credit Facility.
Consolidated Long-Term Debt Maturities.
Scheduled payments due on long-term debt for the next five years and thereafter
follow:
2002 2003 2004 2005 2006 Thereafter
---- ---- ---- ---- ---- ----------
$6,584 $3,247 $2,567 $3,370 $30 $914
Certain of our debt agreements allow us to redeem outstanding debt prior to
scheduled maturity. The actual decision as to early redemption will be made at
the time the early redemption option becomes exercisable and will be based on
liquidity, prevailing economic and business conditions, and the relative costs
of new borrowing.
Convertible Debt. In 1998, we issued convertible subordinated debentures for net
proceeds of $575. The original scheduled amount due upon maturity in April 2018
was $1,012 which corresponded to an effective interest rate of 3.625 percent per
annum, including 1.003 percent payable in cash semiannually beginning in October
1998. These debentures are convertible at any time at the option of the holder
into 7.808 shares of our stock per $1,000 principal amount at maturity of the
debentures. This debt contains a put option which requires us to purchase any
debenture, at the option of the holder, on April 21, 2003, for a price of $649
per $1,000 principal amount at maturity of the debentures. We may elect to
settle the obligation in cash, shares of common stock, or any combination
thereof. During 2001, we retired $61 of this convertible debt through the
exchange of approximately 6 million shares of common stock valued at $49. As a
result of these retirements, the amount currently due is $600 and is projected
to accrete to $913 upon maturity in April 2018.
66
Lines of Credit. As of December 31, 2001, we had $7 billion of loans outstanding
under a revolving credit agreement (Old Revolver) entered into in 1997 with a
group of banks, which had a stated maturity date of October 22, 2002. The Old
Revolver was also accessible by the following wholly owned subsidiaries: Xerox
Credit Corporation (up to a $7 billion limit) and Xerox Canada Capital Ltd. and
Xerox Capital (Europe) plc (up to a combined $4 billion limit) with our
guarantee. Amounts borrowed under this facility were at rates based, at our
option, on spreads above certain reference rates such as LIBOR. This agreement
contained certain covenants the most restrictive of which required that we
maintain a minimum level of Consolidated Tangible Net Worth and limit the
amounts of outstanding secured borrowings, as defined in the agreement. We were
in compliance with these covenants at December 31, 2001. In addition, our
foreign subsidiaries had an aggregate of $45 of unused committed long-term lines
of credit to back short-term indebtedness in various currencies at prevailing
interest rates.
On June 21, 2002, we entered into an Amended and Restated Credit Agreement with
a group of lenders (New Credit Facility), which replaced the Old Revolver. In
connection with entering into the New Credit Facility we made a partial pay down
on the Old Revolver of $2.8 billion and agreed to make an additional payment of
$700 by not later than September 15, 2002. Accordingly, as of June 21, 2002,
$4.2 billion was outstanding under the New Credit Facility including three
tranches of term debt and a $1.5 billion revolving tranche which may be repaid
and re-borrowed. Within the revolving tranche is a $200 letter of credit
facility. The New Credit Facility has, except as described below, a final stated
maturity of April 30, 2005. In connection with the New Credit Facility we paid
fees and other expenses of approximately $125.
All obligations under the New Credit Facility are, subject to certain limits,
currently secured by liens on substantially all domestic assets of Xerox
Corporation and substantially all of our U.S. subsidiaries (other than Xerox
Credit Corporation) and are guaranteed by substantially all of our U.S.
subsidiaries. In addition, revolving loans outstanding from time to time to
Xerox Capital (Europe) plc (XCE) (currently $605) are also secured by all of
XCE's assets and are also guaranteed on an unsecured basis by certain foreign
subsidiaries that directly or indirectly own all of the outstanding stock of
XCE. Revolving loans outstanding from time to time to Xerox Canada Capital
Limited (XCCL) (currently $300) are also secured by all of XCCL's assets and are
also guaranteed on an unsecured basis by our material Canadian subsidiaries, as
defined (although the guaranties of the Canadian subsidiaries will become
secured by their assets in the future if certain events occur).
Two of the three tranches of term debt and the revolving tranche will bear an
initial rate of interest of LIBOR plus 4.5 percent per annum and the third
tranche of term debt bears initial interest at a rate of LIBOR plus a spread
that varies between 4.0 percent and 4.5 percent per annum, in all cases subject
to adjustment for changes in, primarily, LIBOR. In addition, the interest spread
on one of the term tranches, initially in the principal amount of $500, is
subject to adjustment based upon the amount secured.
The New Credit Facility contains financial covenants requiring the maintenance
of specified minimum consolidated net worth, minimum consolidated EBITDA and
minimum consolidated leverage ratio, and limitations on capital expenditures. In
addition, the New Credit Facility contains affirmative and negative covenants,
including limitations on issuance of debt and preferred stock, incurrence of
liens, certain fundamental changes, investments and acquisitions, asset
transfers, restricted payments, hedging transactions, transactions with
affiliates, restrictions on our ability to grant any lien on property, pay
dividends or intercompany loans or agree to more restrictive provisions than
those contained in the New Credit Facility, and a requirement to transfer, under
certain circumstances, excess foreign cash and excess cash of Xerox Credit
Corporation to Xerox Corporation. No cash dividends can be paid on our Common
Stock for the term of New Credit Facility. Cash dividends on our preferred stock
may be paid provided there is then no event of default. In addition to other
defaults customary for a credit facility of this type, defaults on debt by, or
bankruptcy of, us or certain subsidiaries would constitute a default under the
New Credit Facility.
We are required to make scheduled amortization payments of $202.5 on each of
March 31, 2003 and September 30, 2003, and $302.5 on each of March 31, 2004 and
September 30, 2004. In addition, mandatory prepayments are required, including
those from a portion of the proceeds of certain asset transfers and debt and
equity issuances which would be credited toward the scheduled amortization
payments in direct order of maturity. Our ability to meet the scheduled
amortization payments and mandatory prepayment requirements under the New Credit
Facility is dependent upon generation of positive cash flows in accordance with
our business plan, including sale or securitizations of existing receivables,
implementation of additional cost savings, implementation of third-party vendor
financing, and access to the capital markets in a cost effective and timely
manner.
Our 9 3/4 percent Senior Notes due 2009 issued in January 2002 contain several
similar affirmative and negative covenants as the New Credit Facility, but taken
as a whole they are less restrictive than those contained in the New Credit
Facility. In addition, our Senior Notes do not contain any financial maintenance
covenants or scheduled amortization payments.
67
Guarantees. At December 31, 2001, we have guaranteed the borrowings of our
Employee Stock Ownership Plan (ESOP) and $3,441 of indebtedness of our foreign
wholly owned subsidiaries. This debt is included in our Consolidated Balance
Sheet as of such date.
Interest. Interest paid by us on our short- and long-term debt amounted to
$1,074, $1,050 and $848 for the years ended December 31, 2001, 2000 and 1999,
respectively. Interest expense was $903, $1,090 and $842 for the years ended
December 31, 2001, 2000 and 1999, respectively.
A summary of the cash related changes in consolidated indebtedness for the three
years ended December 31, 2001 follows:
2001 2000 1999
---- ---- ----
Cash payments of short-term debt, net .................................. $ (141) $ (1,277) $(4,136)
Cash proceeds from long-term debt ...................................... 2,507 10,542 6,707
Principal payments on long-term debt ................................... (3,464) (6,348) (1,778)
------- -------- -------
Total net cash changes in debt ..................................... $(1,098)/(1)/ $ 2,917/(2)/ $ 793/(3)/
======= ======== =======
(1) Excludes a $377 non-cash debt for equity exchange (see Note 18), and the
accretion of $16 on convertible debt.
(2) Excludes debt of $118, which was assumed by Fuji Xerox in connection with
the divestiture of our China operations, and accretion of $16 on
convertible debt.
(3) Excludes debt of $51 assumed with the increased ownership in our India
joint venture and accretion of $26 on convertible debt.
Note 13--Financial Instruments
We adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS No. 133), as of January 1,
2001.
The adoption of SFAS No. 133 is expected to increase the future volatility of
reported earnings and other comprehensive income. In general, the amount of
volatility will vary with the level of derivative and hedging activities and the
market volatility during any period. However, as more fully described below, our
ability to enter into new derivative contracts is severely constrained. The
following is a summary of our SFAS No. 133 activity during 2001.
Derivative Financial Instruments. Typical of multinational corporations, 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, foreign currency swap agreements, forward
exchange contracts and purchased foreign currency options, to manage interest
rate and foreign currency exposures. The fair market values of all of our
derivative contracts change with fluctuations in interest rates and/or currency
rates, and are designed so that any change in their values is offset by changes
in the values of the underlying exposures. Our derivative instruments are held
solely to hedge economic exposures; we do not enter into derivative instrument
transactions for trading or other speculative 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 noted above, our ability to
currently enter into new derivative contracts is severely constrained.
Therefore, while the following paragraphs describe our overall risk management
strategy, our current ability to employ that strategy effectively has been
severely limited.
68
We typically enter into simple unleveraged derivative transactions. Our policy
is to only use counterparties with an investment-grade or better rating and to
monitor market risk quarterly on a counterparty-by-counterparty basis. We
attempt to utilize several counterparties to ensure that there are no
significant concentrations of credit risk with any individual counterparty or
groups of counterparties. Based upon our ongoing evaluation of the replacement
cost of our derivative transactions and counterparty credit-worthiness, we
consider the risk of credit default significantly affecting our financial
position or results of operations to be remote.
We employ the use of hedges to reduce the risks that rapidly changing market
conditions may have on the underlying transactions. Typically, our currency and
interest rate hedging activities are not affected by changes in market
conditions, as forward contracts and swaps are arranged and normally held to
maturity in order to lock in currency rates and interest rate spreads related to
underlying transactions.
As described above, the downgrades of our debt during 2000, 2001 and 2002,
together with the recently-concluded SEC investigation, significantly reduced
our access to capital markets. Furthermore, several of the debt downgrades
triggered various contractual provisions which required us to collateralize or
repurchase a number of derivative contracts which were then outstanding.
Repurchases totaled $148 and $108 in 2001 and 2000, respectively. To minimize
the resulting interest and currency exposures from these events, we have
subsequently entered into some derivatives with several counterparties, on a
limited basis. However, virtually all such new arrangements either require us to
post cash collateral against all out-of-the-money positions, or else are very
short term in duration (e.g., as short as one week). Both of these types of
arrangements potentially use more cash than standard derivative arrangements
would otherwise require. While we have been able to replace some derivatives on
a limited basis, our current debt ratings restrict our ability to utilize
derivative agreements to manage the risks associated with interest rate and some
foreign currency fluctuations, including our ability to continue effectively
employing our match funding strategy. For this reason, we anticipate increased
volatility in our results of operations due to market changes in interest rates
and foreign currency rates.
Interest Rate Risk Management.
Interest Rate Swaps--Single Currency: We enter into interest rate swap
agreements to manage interest rate exposure, although the recent downgrades of
our indebtedness have limited our ability to manage this exposure. Virtually all
customer financing assets earn fixed rates of interest. Accordingly, through the
use of interest rate swaps in conjunction with the contractual maturity terms of
outstanding debt, we "lock in" an interest spread by arranging fixed-rate
interest obligations with maturities similar to the underlying assets.
Additionally, in industrialized countries, customer financing assets are funded
with liabilities denominated in the same currency. This practice effectively
eliminates the risk of a major decline in interest margins resulting from
adverse changes in the interest rate environment. Conversely, this practice also
effectively eliminates the opportunity to materially increase margins when
interest rates are declining.
More specifically, pay-fixed/receive-variable interest rate swaps are often used
in place of more expensive fixed-rate debt for the purpose of match funding
fixed-rate customer contracts. Pay-variable/receive-variable interest rate swaps
(basis swaps) are used to transform variable rate, medium-term debt into
commercial paper or local currency LIBOR rate obligations.
Pay-variable/receive-fixed interest rate swaps are used to transform term
fixed-rate debt into variable rate obligations. Where possible, the transactions
performed within each of these three categories have enabled the cost-effective
management of interest rate exposures.
While our existing portfolio of derivative instruments is intended to
economically hedge interest rate risks to the extent possible, differences
between the contract terms of our derivatives and the underlying related debt
reduce our ability to obtain hedge accounting in accordance with SFAS No. 133.
This results in mark-to-market valuation of the majority of our derivatives
directly through earnings, which accordingly leads to increased earnings
volatility.
At December 31, 2001 and 2000 we had outstanding single currency interest rate
swap agreements with aggregate notional amounts of $4,415 and $15,471,
respectively. The asset fair values at December 31, 2001 and 2000 were $111 and
$7, respectively.
Foreign Currency Swap Agreements: We enter into cross-currency interest rate
swap agreements, whereby we issue foreign currency-denominated debt and swap the
proceeds and related interest payments with a counterparty. In return, we
receive and effectively denominate the debt in local currencies. Currency swaps
are utilized as economic hedges of the underlying foreign currency borrowings.
As with our single currency interest rate swaps, we generally did not achieve
hedge accounting on our cross-currency interest rate swaps and therefore we
recorded the mark-to-market valuation through earnings.
69
At December 31, 2001 and 2000, we had outstanding cross-currency interest rate
swap agreements with aggregate notional amounts of $1,481 and $4,222,
respectively. The asset fair values at December 31, 2001 and 2000 were $17 and
$122, respectively. Of the outstanding agreements at December 31, 2001, the
largest single currency hedged was the Japanese yen. Contracts denominated in
Japanese yen, Pound sterling and Euros accounted for over 95 percent of our
cross-currency interest rate swap agreements.
During 2001, as a result of applying the new requirements of SFAS No. 133, we
recorded net gains of $32 from the mark-to-market valuation of our interest rate
derivatives primarily as a result of lower interest rates during the year
combined with a higher notional amount of pay variable/receive fixed interest
rate swaps. Hedge accounting was not applied to any of our single-currency
interest rate swaps during 2001, due to the reasons previously discussed.
Fair Value Hedges--During 2001, certain Japanese yen/U.S. dollar cross-currency
interest rate swaps with a notional amount of 65 billion yen were designated and
accounted for as fair value hedges. The net ineffective portion recorded to
earnings during 2001 was a loss of $7 and is included in Other, net. All
components of each derivatives gain or loss are included in the assessment of
the hedge effectiveness. Hedge accounting was discontinued in the fourth quarter
2001, after the swaps were terminated and moved to a different counterparty,
because the new swaps did not satisfy SFAS No. 133 requirements. Hedge
accounting is not being applied for any of our interest rate swaps as of
December 31, 2001.
The aggregate notional amounts of interest rate swaps by maturity date and type
at December 31, 2001 follow:
Single Currency Swaps 2002 2003 2004 2005 2006 Thereafter Total
- --------------------- ---- ---- ---- ---- ---- ---------- -----
Pay fixed/receive variable ................. $ 190 $ 260 $ 442 $ 261 $ 31 $ -- $1,184
Pay variable/receive variable .............. 37 -- -- -- -- -- 37
Pay fixed/receive fixed .................... -- -- -- -- -- 250 250
Pay variable/receive fixed ................. 930 825 1,164 -- -- 25 2,944
------ ------ ------ ------ ------ ------ ------
Total ...................................... $1,157 $1,085 $1,606 $ 261 $ 31 $ 275 $4,415
====== ====== ====== ====== ====== ====== ======
Interest rate paid ......................... 2.58% 1.70% 3.69% 6.65% 6.02% 6.50% 3.27%
Interest rate received ..................... 5.74% 2.34% 4.82% 2.39% 2.20% 7.48% 4.45%
Cross Currency Swaps 2002 2003 2004 2005 2006 Thereafter Total
- -------------------- ---- ---- ---- ---- ---- ---------- -----
Pay fixed/receive variable ................. $ 424 $ 264 $ 86 $ 8 $ -- $ -- $ 782
Pay fixed/receive fixed .................... 17 -- -- -- -- -- 17
Pay variable/receive fixed ................. 187 -- -- 381 -- 114 682
------ - ---- ------ ------ ------ ------ ------
Total ...................................... $ 628 $ 264 $ 86 $ 389 $ -- $ 114 $1,481
====== = ==== ====== ====== ====== ====== ======
Interest rate paid ......................... 4.20% 4.98% 5.94% 3.12% 3.43% 4.09%
Interest rate received ..................... 1.54% 1.97% 1.94% 1.51% 2.00% 1.67%
Foreign Exchange Risk Management.
Currency Derivatives: We utilize forward exchange contracts/purchased 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 foreign currency
lease and interest 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. These contracts generally mature in six months or less.
Our credit constraints, and resultant inability to effectively engage in
hedging, resulted in significant amounts of unhedged foreign currency
denominated assets and liabilities during the year. In 2001 and 2000, we
recorded net currency gains of $29 and $103, respectively, due to these unhedged
positions, as impacted by changes in the underlying currencies.
At December 31, 2001 and 2000, we had outstanding forward exchange/purchased
option contracts with notional values of $3,900 and $1,788, respectively. The
significant increase reflects a shift in the hedging strategy for our foreign
currency denominated debt from cross-currency interest rate swaps to forward
exchange/purchased option contracts. Of the outstanding contracts at December
31, 2001, the largest single currency hedged was the Pound sterling. Contracts
denominated in Pound sterling, Japanese yen, Euros and Canadian dollars
accounted for approximately 90 percent of our forward exchange contracts. The
asset (liability) fair values of our currency derivatives at December 31, 2001
and 2000 were $8 and $(59), respectively.
70
Accumulated Other Comprehensive Income. The following is a summary of changes in
AOCI resulting from the application of SFAS No. 133 during 2001:
Reclass to Closing
Opening Transition Net Statement of Balance
Balance Gains (Losses) Gains (Losses) Operations* 2001
------- -------------- -------------- ----------- ----
Variable Interest Paid ...................... -- (35) -- 20 (15)
Inventory Purchases ......................... -- -- (5) 5 --
Foreign Currency Interest Payments .......... -- -- (4) 2 (2)
----- ----- ---- ---- ----
Pre-tax subtotal ........................ -- (35) (9) 27 (17)
Tax Expense ............................. -- 14 4 (10) 8
Fuji Xerox, net ......................... -- 2 -- -- 2
----- ----- ---- ---- -----
Total ................................... -- (19) (5) 17 (7)
===== ===== ==== ==== =====
* Includes $12 reclassification of after-tax transition loss of $19.
No amount of ineffectiveness was recorded to the Consolidated Statement of
Operations during 2001 for our designated cash flow hedges and all components of
each derivatives gain or loss are included in the assessment of hedge
effectiveness. The amount reclassified to earnings during 2001 represents the
recognition of deferred gains or losses along with the underlying hedged
transactions. The remaining amount deferred of $(7) at December 31, 2001 is
expected to be reclassified to earnings during 2002.
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 2001, $18 of net after-tax gains related
to hedges of our net investments in Xerox Brazil and Fuji Xerox were recorded in
the cumulative translation adjustments account.
Fair Value of Financial Instruments. The estimated fair values of our financial
instruments at December 31, 2001 and 2000 follow:
2001 2000
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Cash and cash equivalents ....... $ 3,990 $ 3,990 $ 1,750 $ 1,750
Accounts receivable, net ........ 1,896 1,896 2,269 2,269
Short-term debt ................. 6,637 6,503 3,080 2,763
Long-term debt .................. 10,128 9,261 15,557 12,196
The fair value amounts for Cash and cash equivalents and Accounts receivable,
net approximate carrying amounts due to the short maturities of these
instruments.
The fair value of Short- and Long-term debt was estimated based on quoted market
prices for these or similar issues or on the current rates offered to us for
debt of similar maturities. The difference between the fair value and the
carrying value represents the theoretical net premium or discount we would pay
or receive to retire all debt at such date. We have no plans to retire
significant portions of our debt prior to scheduled maturity.
71
Note 14--Employee Benefit Plans
We sponsor numerous pension and other postretirement benefit plans, primarily
retiree health, in our U.S. and international operations. Information regarding
our benefit plans is presented below:
Pension Benefits Other Benefits
---------------- --------------
2001 2000 2001 2000
---- ---- ---- ----
Change in Benefit Obligation
Benefit obligation, January 1 ............................................ $ 8,255 8,418 $ 1,314 $ 1,060
Service cost ............................................................. 174 167 28 24
Interest cost ............................................................ (184) 453 99 85
Plan participants' contributions ......................................... 19 19 -- --
Plan amendments .......................................................... -- 1 -- --
Actuarial loss ........................................................... 76 48 136 218
Currency exchange rate changes ........................................... (99) (197) (3) (2)
Divestitures ............................................................. -- (15) -- --
Curtailments ............................................................. 34 (10) (1) --
Special termination benefits ............................................. -- 34 -- 4
Benefits paid/settlements ................................................ (669) (663) (92) (75)
------- ------- ------- -------
Benefit obligation, December 31 .......................................... 7,606 8,255 1,481 1,314
======= ======= ======= =======
Change in Plan Assets
Fair value of plan assets, January 1 ..................................... 8,626 8,771 -- --
Actual return on plan assets ............................................. (843) 651 -- --
Employer contribution .................................................... 42 84 92 75
Plan participants' contributions ......................................... 19 19 -- --
Currency exchange rate changes ........................................... (135) (218) -- --
Divestitures ............................................................. -- (18) -- --
Benefits paid ............................................................ (669) (663) (92) (75)
------- ------- ------- -------
Fair value of plan assets, December 31 ................................... 7,040 8,626 -- --
======= ======= ======= =======
Funded status (including under-funded and non-funded plans) .............. (566) 371 (1,481) (1,314)
Unamortized transition assets ............................................ (1) (15) -- --
Unrecognized prior service cost .......................................... 8 17 (2) (3)
Unrecognized net actuarial (gain)loss .................................... 434 (433) 250 120
------- ------- ------- -------
Net amount recognized .................................................... $ (125) $ (60) $(1,233) $(1,197)
======= ======= ======= =======
Amounts recognized in the Consolidated Balance Sheets consist of:
Prepaid benefit cost ................................................. $ 597 $ 600 $ -- $ --
Accrued benefit liability ............................................ (785) (690) (1,233) (1,197)
Intangible asset ..................................................... 7 3 -- --
Accumulated other comprehensive income ............................... 56 27 -- --
------- ------- ------- -------
Net amount recognized .................................................... $ (125) $ (60) $(1,233) $(1,197)
======= ======= ======= =======
Under-funded or non-funded plans
Aggregate benefit obligation ......................................... $ 5,778 $ 5,743 $ 1,481 $ 1,314
Aggregate fair value of plan assets .................................. $ 5,039 $ 5,322 $ -- $ --
Plans with under-funded or non-funded accumulated benefit obligations
Aggregate accumulated benefit obligation ............................. $ 4,604 $ 509
Aggregate fair value of plan assets .................................. $ 4,157 $ 180
72
Pension Benefits Other Benefits
---------------- --------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
Weighted average assumptions as of December 31
Discount rate ...................................................... 6.8% 7.0% 7.4% 7.2% 7.5% 8.0%
Expected return on plan assets ..................................... 8.9% 8.9% 8.9%
Rate of compensation increase ...................................... 3.8% 3.8% 4.2%
Our domestic retirement defined benefit plans provide employees a benefit at the
greater of (i) the benefit calculated under a highest average pay and years of
service formula, (ii) the benefit calculated under a formula that provides for
the accumulation of salary and interest credits during an employee's work life,
or (iii) the individual account balance from the Company's prior defined
contribution plan (Transitional Retirement Account or TRA).
Pension Benefits Other Benefits
---------------- --------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
Components of Net Periodic Benefit Cost
Defined benefit plans
Service cost ..................................... $ 174 $ 167 $ 191 $ 28 $ 24 $ 27
Interest cost/(1)/ ............................... (184) 453 1,009 99 85 77
Expected return on plan assets/(2)/ .............. 81 (522) (1,090) -- -- --
Recognized net actuarial loss .................... 7 4 11 3 -- 1
Amortization of prior service cost ............... 9 4 8 -- -- --
Recognized net transition asset .................. (14) (16) (18) -- -- 2
Recognized curtailment/settlement (gain) loss .... 26 (46) (9) -- -- --
------- ------- ------- ------- ------- -------
Net periodic benefit cost .................... 99 44 102 30 109 107
Defined contribution plans ....................... 21 14 28 -- -- --
------- ------- ------- ------- ------- -------
Total ............................................ $ 120 $ 58 $ 130 $ 130 $ 109 $ 107
======= ======= ======= ======= ======= =======
/(1)/ Interest cost includes interest expense on non-TRA obligations of $216,
$225 and $204 and interest (income) expense directly allocated to TRA
participant accounts of $(400), $228 and $805 for the years ended
December 31, 2001, 2000 and 1999, respectively.
/(2)/ Expected return on plan assets includes expected investment income on
non-TRA assets of $319, $294 and $285 and actual investment (losses)
income on TRA assets of $(400), $228 and $805 for the years ended
December 31, 2001, 2000 and 1999, respectively.
Pension plan assets consist of both defined benefit plan assets and assets
legally restricted to the TRA accounts. The combined investment results for
these plans, along with the results for our other defined benefit plans, are
shown above in the actual return on plan assets caption. To the extent that
investment results relate to TRA, such results are charged directly to these
accounts as a component of interest cost.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. For measurement purposes, a 10 percent
annual rate of increase in the per capita cost of covered health care benefits
was assumed for 2002, decreasing gradually to 5.2 percent in 2006 and
thereafter.
73
A one-percentage-point change in assumed health care cost trend rates would have
the following effects:
One-percentage- One-percentage
point increase point decrease
-------------- --------------
Effect on total service and interest cost components ......................... $ 5 $ (4)
Effect on postretirement benefit obligation .................................. $ 72 $ (62)
Employee Stock Ownership Plan (ESOP) Benefits. In 1989, we established an ESOP
and sold to it 10 million shares of Series B Convertible Preferred Stock
(Convertible Preferred) of the Company for a purchase price of $785. Each ESOP
share is presently convertible into six common shares of the Company. The
Convertible Preferred has a $1 par value and a guaranteed minimum value of
$78.25 per share and accrues annual dividends of $6.25 per share which are
cumulative. The ESOP borrowed the purchase price from a group of lenders. The
ESOP debt is included in our Consolidated Balance Sheets because we have
guaranteed the ESOP borrowings. A corresponding amount classified as Deferred
ESOP benefits represents our commitment to future compensation expense related
to the ESOP benefits.
The ESOP will repay its borrowings from dividends on the Convertible Preferred
and from our contributions. The ESOP's debt service is structured such that our
annual contributions (in excess of dividends) essentially correspond to a
specified level percentage of participant compensation. As the borrowings are
repaid, the Convertible Preferred is allocated to ESOP participants and Deferred
ESOP benefits are reduced by principal payments on the borrowings. The ESOP
borrowings are $135 at December 31, 2001 and will mature in 2003 at which time
all ESOP shares will have been allocated to the participants. Most of our
domestic employees are eligible to participate in the ESOP.
During 2001, and in connection with our decision to eliminate the quarterly
dividends on our common stock, dividends on the Convertible Preferred were
eliminated beginning in July. As a result, we increased our annual contribution
to the ESOP in order to meet our debt service obligations as required under the
terms of the plan. The increased contributions resulted in additional
compensation expense being recorded. As of December 31, 2001 two quarterly
dividends had not been paid, amounting to $25 in arrears. Additionally, we did
not pay $12 in dividends that were due in both January and April 2002. If
dividends are not paid for six quarterly dividend periods (whether or not
consecutive) the holders of the ESOP shares have the right to elect two
Directors to our Board of Directors. The Board of Directors intends to restore
the dividend on the Convertible Preferred Stock when circumstances permit.
Information relating to the ESOP for the three years ended December 31, 2001
follows:
2001 2000 1999
---- ---- ----
Interest on ESOP Borrowings .................................. $ 15 $ 24 $ 28
Dividends declared on Convertible Preferred Stock ............ 13 53 54
Cash contribution to the ESOP ................................ 88 49 44
Compensation expense ......................................... 89 48 46
We recognize ESOP costs based on the amount committed to be contributed to the
ESOP plus related trustee, finance and other charges.
Note 15--Income and Other Taxes
The parent company and its domestic subsidiaries file consolidated U.S. income
tax returns. Generally, pursuant to tax allocation arrangements, domestic
subsidiaries record their tax provisions and make payments to the parent company
for taxes due or receive payments from the parent company for tax benefits
utilized.
74
Income (loss) before income taxes for the three years ended December 31, 2001
consists of the following:
2001 2000 1999
---- ---- ----
Domestic income (loss) .................................................. $(155) $ 76 $ 840
Foreign income (loss) ................................................... 520 (443) 448
----- ----- ------
Income (loss) before income taxes ....................................... $ 365 $(367) $1,288
===== ===== ======
Provisions (benefits) for income taxes for the three years ended December 31,
2001 consist of the following:
2001 2000 1999
---- ---- ----
Federal income taxes
Current ......................................................... $ 9 $ (18) $ 178
Deferred ........................................................ (101) (95) 64
Foreign income taxes
Current ......................................................... 474 73 122
Deferred ........................................................ 114 (45) 24
State income taxes
Current ......................................................... (2) 5 41
Deferred ........................................................ (9) 10 17
----- ----- -----
Income taxes ........................................................ $ 485 $ (70) $ 446
===== ===== =====
A reconciliation of the U.S. federal statutory income tax rate to the effective
income tax rate for the three years ended December 31, 2001 follows:
2001 2000 1999
---- ---- ----
U.S. federal statutory income tax rate ...................................................... 35.0% (35.0)% 35.0%
Foreign earnings and dividends taxed at different rates ..................................... 44.2 48.3 (9.4)
Sale of partial ownership interest in Fuji Xerox ............................................ 31.9 -- --
Goodwill amortization ....................................................................... 2.8 3.0 .9
Tax-exempt income ........................................................................... (3.6) (4.3) (1.5)
State taxes ................................................................................. (1.2) 1.1 2.9
Audit resolutions ........................................................................... (38.5) (34.1) --
Dividends on Employee Stock Ownership Plan shares ........................................... (1.0) (3.7) (1.0)
Effect of tax rate change on deferred tax assets and liabilities ............................ (2.9) -- --
Change in valuation allowance for deferred tax assets ....................................... 67.8 3.2 7.1
Other ....................................................................................... (1.6) 2.4 .6
------ ----- ----
Effective income tax rate ................................................................... 132.9% (19.1)% 34.6%
====== ===== ====
The difference between the 2001 effective tax rate of 132.9 percent and the U.S.
federal statutory income tax rate relates primarily to the recognition of
deferred tax asset valuation allowances resulting from our recoverability
assessments, the taxes incurred in connection with the sale of our partial
interest in Fuji Xerox and continued losses in low tax jurisdictions. The gain
for tax purposes on the sale of Fuji Xerox was disproportionate to the gain for
book purposes as a result of a lower tax basis in the investment. Other items
favorably impacting the tax rate included a tax audit resolution and additional
tax benefits arising from prior period restructuring provisions.
On a loss basis, the difference between the 2000 effective tax rate of 19.1
percent and the U.S. federal statutory income tax rate relates primarily to
continued losses in low tax jurisdictions, the recognition of deferred tax asset
valuation allowances resulting from our recoverability assessments and
additional tax benefits arising from the favorable resolution of tax audits.
The 1999 effective tax rate benefited from increases in foreign tax credits as
well as a shift in the mix of our worldwide profits, partially offset by the
recognition of deferred tax asset valuation allowances.
On a consolidated basis, we paid a total of $57, $354 and $238 in income taxes
to federal, foreign and state income-taxing authorities in 2001, 2000 and 1999,
respectively.
75
Total income tax expense (benefit) for the three years ended December 31, 2001
was allocated as follows:
2001 2000 1999
---- ---- ----
Income taxes (benefits) on income (loss) ............... $485 $ (70) $446
Tax benefit included in minorities' interests/(1)/ ..... (23) (20) (20)
Extraordinary gain ..................................... 26 -- --
Discontinued operations ................................ -- -- (26)
Goodwill ............................................... 2 (42) --
Common shareholders' equity/(2)/ ....................... 1 38 (119
---- ----- ----
Total .................................................. $491 $ (94) $281
==== ===== ====
/(1)/ Benefit relates to preferred securities as more fully described in Note
17.
/(2)/ For dividends paid on shares held by the ESOP, tax effects of certain
cumulative translation adjustments, tax benefit on nonqualified stock
options and accounting for certain derivatives.
In substantially all instances, deferred income taxes have not been provided on
the undistributed earnings of foreign subsidiaries and other foreign investments
carried at equity. The amount of such earnings included in consolidated retained
earnings at December 31, 2001 was approximately $3.4 billion. These earnings
have been permanently reinvested and we do not plan to initiate any action that
would precipitate the payment of income taxes thereon. It is not practicable to
estimate the amount of additional tax that might be payable on the foreign
earnings. Since April 1, 2001, deferred taxes of $4 have been provided on the
current year undistributed earnings of Fuji Xerox.
The tax effects of temporary differences that give rise to significant portions
of the deferred taxes at December 31, 2001 and 2000 follow:
2001 2000
---- ----
Tax effect of future tax deductions
Research and development ................... $1,007 $ 866
Depreciation ............................... 438 470
Postretirement medical benefits ............ 464 448
Restructuring reserves ..................... 122 77
Other operating reserves ................... 202 294
Allowance for doubtful accounts ............ 182 145
Deferred compensation ...................... 180 150
Tax credit carryforwards ................... 185 240
Net operating losses ....................... 295 70
Other ...................................... 193 178
------ -------
3,268 2,938
Valuation allowance ............................ (474) (187)
------ -------
Total deferred tax assets ...................... $2,794 $ 2,751
====== =======
Tax effect of future taxable income ............
Installment sales and leases ............... $ (358) $ (316)
Unearned income ............................ (820) (875)
Other ...................................... (150) (281)
------ -------
Total deferred tax liabilities ................. (1,328) $(1,472)
====== =======
Total deferred taxes, net ...................... $1,466 $ 1,279
====== =======
76
The above amounts are classified as current or long-term in the Consolidated
Balance Sheets in accordance with the asset or liability to which they relate.
Current deferred tax assets at December 31, 2001 and 2000 amounted to $548 and
$444, respectively.
The deferred tax assets for the respective periods were assessed for
recoverability and, where applicable, a valuation allowance was recorded to
reduce the total deferred tax asset to an amount that will, more likely than
not, be realized in the future. The valuation allowance for deferred tax assets
as of January 1, 2000 was $180. The net change in the total valuation allowance
for the years ended December 31, 2001 and 2000 was an increase of $287 and $7,
respectively. The valuation allowance relates to certain foreign net operating
loss carryforwards, foreign tax credit carryforwards and deductible temporary
differences for which we have concluded it is more likely than not that these
items will not be realized in the ordinary course of operations.
Although realization is not assured, we have concluded that it is more likely
than not that the deferred tax assets for which a valuation allowance was
determined to be unnecessary will be realized in the ordinary course of
operations based on scheduling of deferred tax liabilities and projected income
from operating activities. The amount of the net deferred tax assets considered
realizable, however, could be reduced in the near term if actual future income
or income tax rates are lower than estimated, or if there are differences in the
timing or amount of future reversals of existing taxable or deductible temporary
differences.
At December 31, 2001, we had tax credit carryforwards of $185 available to
offset future income taxes, of which $143 is available to carryforward
indefinitely while the remaining $42 will begin to expire, if not utilized, in
2004. We also had net operating loss carryforwards for income tax purposes of
$219 that will expire in 2002 through 2006, if not utilized, and $1.4 billion
available to offset future taxable income indefinitely.
Our Brazilian operations have received assessments for indirect taxes totaling
approximately $380 related principally to the internal transfer of inventory. We
do not agree with these assessments and intend to vigorously defend our
position. We, as supported by the opinion of legal counsel, do not believe that
the ultimate resolution of these assessments will materially impact our results
of operations, financial position or cash flows.
Note 16--Litigation and Regulatory Matters
As more fully discussed below, we are a defendant in numerous litigation and
regulatory matters involving securities law, patent law, environmental law,
employment law and ERISA. Should these matters result in an adverse judgment or
be settled for significant amounts, they could have a material adverse effect on
our results of operations, cash flows and financial position in the period or
periods in which such judgment or settlement occurs.
Accuscan, Inc. v. Xerox Corporation: On April 11, 1996, an action was commenced
by Accuscan, Inc. (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 our motion for a new trial on damages. The
trial ended on October 25, 1999 with a jury verdict of $10. Our motion to set
aside the verdict or, in the alternative, to grant a new trial was denied by the
court. We appealed to the Court of Appeals for the Federal Circuit (CAFC) which
found the patent not infringed, thereby terminating the lawsuit subject to an
appeal which has been filed by Accuscan to the U.S. Supreme Court. The decision
of the U.S. Supreme Court was to remand the case (along with eight others) back
to the CAFC to consider its previous decision based on the Supreme Court's May
28, 2002 ruling in the Festo case.
Christine Abarca, et al. v. City of Pomona, et al. (Pomona Water Cases): 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 our 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. In
addition, we have been informed that a similar action will be filed in the near
future on behalf of another six plaintiffs.
77
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 the Company 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.
We deny any liability for the plaintiffs' alleged damages and intend to
vigorously defend these actions. We have 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 before the California Supreme
Court. In February 2002, the California Supreme Court issued its decision
permitting the lawsuits to proceed against all defendants. The trial court is
expected to lift the stay within the next 30 to 90 days for both the six Xerox
cases and the unrelated Southern California ground water case with which they
are coordinated. Based on the stage of the litigation, it is not possible to
estimate the amount of loss or range of possible loss that might result from an
adverse judgment or a settlement of this matter.
In re Xerox Corporation Securities Litigation: A consolidated securities law
action (consisting of 17 cases) is pending in the United States District Court
for the District of Connecticut. Defendants are the Company, Barry Romeril, Paul
Allaire and G. Richard Thoman. The consolidated action purports to be a class
action on behalf of the named plaintiffs and all other purchasers of common
stock of the Company during the period between October 22, 1998 through October
7, 1999 (Class Period). The amended consolidated complaint in the action alleges
that in violation of Section 10(b) and/or 20(a) of the Securities Exchange Act
of 1934, as amended (34 Act), and Securities and Exchange Commission Rule 10b-5
thereunder, each of the defendants is liable as a participant in a fraudulent
scheme and course of business that operated as a fraud or deceit on purchasers
of the Company's common stock during the Class Period by disseminating
materially false and misleading statements and/or concealing material facts. The
amended complaint further alleges that the alleged scheme: (i) deceived the
investing public regarding the economic capabilities, sales proficiencies,
growth, operations and the intrinsic value of the Company's common stock; (ii)
allowed several corporate insiders, such as the named individual defendants, to
sell shares of privately held common stock of the Company while in possession of
materially adverse, non-public information; and (iii) caused the individual
plaintiffs and the other members of the purported class to purchase common stock
of the Company at inflated prices. The amended consolidated complaint seeks
unspecified compensatory damages in favor of the plaintiffs and the other
members of the purported class against all defendants, jointly and severally,
for all damages sustained as a result of defendants' alleged wrongdoing,
including interest thereon, together with reasonable costs and expenses incurred
in the action, including counsel fees and expert fees. On September 28, 2001,
the court denied the defendants' motion for dismissal of the complaint. On
November 5, 2001, the defendants answered the complaint. The parties are engaged
in discovery. The named individual defendants and we deny any wrongdoing and
intend to vigorously defend the action. Based on the stage of the litigation, it
is not possible to estimate the amount of loss or range of possible loss that
might result from an adverse judgment or a settlement of this matter.
In re Xerox Derivative Actions: A consolidated putative shareholder derivative
action is pending in the Supreme Court of the State of New York, County of New
York against several current and former members of the Board of Directors
including William F. Buehler, B.R. Inman, Antonia Ax:son Johnson, Vernon E.
Jordan, Jr., Yotaro Kobayashi, Hilmar Kopper, Ralph Larsen, George J. Mitchell,
N.J. Nicolas, Jr., John E. Pepper, Patricia Russo, Martha Seger, Thomas C.
Theobald, Paul Allaire, G. Richard Thoman, Anne Mulcahy and Barry Romeril, and
KPMG, LLP. The plaintiffs purportedly brought this action in the name of and for
the benefit of the Company, which is named as a nominal defendant, and its
public shareholders.
The second consolidated amended complaint alleges that each of the director
defendants breached their fiduciary duties to the Company and its shareholders
by, among other things, ignoring indications of a lack of oversight at the
Company and the existence of flawed business and accounting practices within the
Company's Mexican and other operations; failing to have in place sufficient
controls and procedures to monitor the Company's accounting practices; knowingly
and recklessly disseminating and permitting to be disseminated, misleading
information to shareholders and the investing public; and permitting the Company
to engage in improper accounting practices. The plaintiffs further allege that
each of the director defendants breached their duties of due care and diligence
in the management and administration of the Company's affairs and grossly
mismanaged or aided and abetted the gross mismanagement of the Company and its
assets. The second amended complaint also asserts claims of negligence,
negligent misrepresentation, breach of contract and breach of fiduciary duty
against KPMG. Additionally, plaintiffs claim that KPMG is liable to Xerox for
contribution, based on KPMG's share of the responsibility for any injuries or
damages for which Xerox is held liable to plaintiffs in related pending
securities class action litigation. On behalf of the Company, the plaintiffs
seek a judgment declaring that the director defendants violated and/or aided and
abetted the breach of their fiduciary duties to the Company and its
shareholders; awarding the Company unspecified compensatory damages against the
director defendants, individually and severally, together with pre-judgement
78
and post-judgement interest at the maximum rate allowable by law; awarding the
Company punitive damages against the director defendants; awarding the Company
compensatory damages against KPMG; and awarding plaintiffs the costs and
disbursements of this action, including reasonable attorneys' and experts' fees.
The individual defendants deny the wrongdoing alleged and intend to vigorously
defend the litigation.
Carlson v. Xerox Corporation, et al.: A consolidated securities law action
(consisting of 21cases) is pending in the United States District Court for the
District of Connecticut against the Company, KPMG LLP (KPMG), and Paul A.
Allaire, G. Richard Thoman, Anne M. Mulcahy, Barry D. Romeril, Gregory Tayler
and Philip Fishbach. 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, the Company during the period between February 17, 1998 through
February 6, 2001 (Class). Among other things, the second consolidated amended
complaint, filed on February 11, 2002, generally alleges that each of the
Company, KPMG, and the individual defendants violated Section 10(b) of the 34
Act and Securities and Exchange Commission Rule 10b-5 thereunder. The individual
defendants are also allegedly liable as "controlling persons" of the Company
pursuant to Section 20(a) of the 34 Act. Plaintiffs claim that the defendants
participated 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
accounting practices and financial condition. The plaintiffs further allege that
this scheme deceived the investing public regarding the true state of the
Company's financial condition and caused the plaintiffs and other members of the
alleged Class to purchase the Company's common stock and bonds at artificially
inflated prices. The second consolidated amended complaint seeks unspecified
compensatory damages in favor of the plaintiffs 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. On May 6, 2002, the Company
and the individual defendants filed a motion to dismiss the second consolidated
amended complaint. KPMG filed a separate motion to dismiss. The individual
defendants and we deny any wrongdoing and intend to vigorously defend the
action. Based on the stage of the litigation, it is not possible to estimate the
amount of loss or range of possible loss that might result from an adverse
judgment or a settlement of this matter.
Bingham v. Xerox Corporation, et al.: A lawsuit filed by James F. Bingham, a
former employee of the Company, is pending in the Superior Court of Connecticut,
Judicial District of Waterbury (Complex Litigation Docket) 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: (i) unspecified compensatory damages in
excess of $15 thousand, (ii) punitive damages, and (iii) the cost of bringing
the action and other relief as deemed appropriate by the court. The parties are
engaged in discovery. The individuals and we deny any wrongdoing and intend to
vigorously defend the action. Based on the stage of the litigation, it is not
possible to estimate the amount of loss or range of possible loss that might
result from an adverse judgment or a settlement of this matter.
79
Berger, et al. v. RIGP: A class was certified in an action originally filed in
the United States District Court for the Southern District of Illinois on July
25, 2000 against the Company's Retirement Income Guarantee Plan (RIGP). The RIGP
represents the primary U.S. pension plan for salaried employees. 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. On
July 3, 2001 the court granted the Plaintiffs' motion for summary judgment,
finding the lump sum calculations violated ERISA. RIGP denies any wrongdoing and
intends to appeal the District Court's ruling. Although the damages sought were
not specified in the complaint, the Plaintiffs submitted papers in December 2001
claiming $284 in damages.
Securities and Exchange Commission Investigation and Review: On April 11, 2002
we announced that we had reached a settlement with the SEC on the previously
disclosed proposed allegations related to matters that had been under
investigation since June 2000. As a result, the Commission filed on April 11,
2002 a complaint, which we simultaneously settled by consenting to the entry of
an Order enjoining us from future violations of Section 17(a) of the Securities
Act of 1933, Sections 10(b), 13(a) and 13(b) of the Securities Exchange Act of
1934 and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder, requiring
payment of a civil penalty of $10, and imposing other ancillary relief. We
neither admitted nor denied the allegations of the complaint.
Under the terms of the settlement, we have restated our financial statements for
the years 1997 through 2000 as well as adjusted previously announced 2001
results. See Note 2 for more information regarding the adjustments and
restatements.
As part of the settlement, and to allow for the additional time required to
prepare the restatement and to make these adjustments, the Commission issued an
Order pursuant to Section 36 of the Exchange Act (Exemptive Order) permitting us
and our subsidiary, Xerox Credit Corporation, to file our respective 2001
Form10-Ks and first-quarter 2002 Form 10-Qs on or before June 30, 2002. The
Exemptive Order provides that such filings made on or before June 30, 2002 will
be deemed to have been filed on the prescribed due date.
We have also agreed as part of the settlement that a special committee of our
Board of Directors will retain an independent consultant to review our material
accounting controls and policies. The Board will share the outcome of this
review with the SEC.
Pitney Bowes, Inc. v. Xerox Corporation and Fuji Xerox Co., Ltd.: 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 the unspecified amount for sales
between June 1995 and May 2000. We filed our answer and counterclaims on October
1, 2001. In December, 2001, a companion case against Lexmark and others on the
patent in suit was transferred out of Connecticut to Kentucky. The Xerox and
Fuji Xerox case was transferred to Kentucky and consolidated with the other
infringement cases. We deny any wrongdoing and intend to vigorously defend the
action. Based on the stage of the litigation, it is not possible to estimate the
amount of loss or range of possible loss that might result from an adverse
judgment or a settlement of this matter.
80
Florida State Board of Administration, et al. v. Xerox Corporation, et al.: On
January 4, 2002, the Florida State Board of Administration, the Teachers'
Retirement System of Louisiana and Franklin Mutual Advisers filed an action in
the United States District Court for the Northern District of Florida
(Tallahassee Division) against the Company, Paul Allaire, G. Richard Thoman,
Barry Romeril, Anne Mulcahy, Philip Fishbach, Gregory Tayler, Eunice M. Filter
and KPMG LLP (KPMG). The plaintiffs allege that each of the Company, the
individual defendants and KPMG violated Sections 10(b) and 18 of the Securities
Exchange Act of 1934, as amended (the 34 Act), Securities and Exchange
Commission Rule 10b-5 thereunder, the Florida Securities Investors Protection
Act, Fl. Stat. ss. 517.301, and the Louisiana Securities Act, R.S. 51:712(A).
The plaintiffs further claim that the individual defendants are each liable as
"controlling persons" of the Company pursuant to Section 20 of the 34 Act and
that each of the defendants is liable for common law fraud and negligent
misrepresentation. The complaint generally alleges that the defendants
participated in a scheme and course of conduct that deceived the investing
public 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 and accounting
practices. The plaintiffs contend that in relying on false and misleading
statements allegedly made by the defendants during the period between February
15, 1998 and February 6, 2001, they bought shares of the Company's common stock
at artificially inflated prices. As a result, they allegedly suffered aggregated
cash losses of almost $100. The plaintiffs seek, among other things, unspecified
compensatory damages against the Company, the individual defendants and KPMG,
jointly and severally, including prejudgment interest thereon, together with the
costs and disbursements of the action, including their actual attorneys' and
experts' fees. On March 8, 2002, the individual defendants and we filed a motion
before the Judicial Panel on Multidistrict Litigation seeking to transfer this
action and any related tagalong actions to the United States District Court for
the District of Connecticut for consolidation or coordination for pre-trial
purposes with the 21 consolidated actions currently pending there under the
caption, Carlson v. Xerox et al. On June 19, 2002, the motion to transfer was
granted. The individual defendants and we deny any wrongdoing alleged in the
complaint and intend to vigorously defend the action. Based on the stage of the
litigation, it is not possible to estimate the amount of loss or range of
possible loss that might result from an adverse judgment or a settlement of this
matter.
Xerox Corporation v. 3Com Corporation, et al.: On April 28, 1997, we commenced
an action against Palm for infringement of the Xerox "Unistrokes" handwriting
recognition Patent by the Palm Pilot using "Graffiti." On January 14, 1999, the
U.S. Patent and Trademark Office (PTO) granted the first of two 3Com/Palm
requests for reexamination of the Unistrokes patent challenging its validity.
The PTO concluded its reexaminations and confirmed the validity of all 16 claims
of the original Unistrokes patent. On June 6, 2000, the judge narrowly
interpreted the scope of the Unistrokes patent claims and, based on that narrow
determination, found the Palm Pilot with Graffiti did not infringe the
Unistrokes patent claims. On October 5, 2000, the Court of Appeals for the
Federal Circuit (CAFC) reversed the finding of no infringement and sent the case
back to the lower court to continue toward trial on the infringement claims. On
December 20, 2001, the District Court granted our motions on infringement and
for a finding of validity thus establishing liability. On December 21, 2001,
Palm appealed to the CAFC. We moved for a trial on damages and an injunction or
bond in lieu of injunction. The District Court denied our motion for a temporary
injunction, but ordered a $50 bond to be posted to protect us against future
damages until the trial. Palm issued a $50 Irrevocable Letter of Credit in favor
of Xerox. The District Court's decision is now on appeal before the Court of
Appeals for the Federal circuit.
Pall v. Buehler, et al.: On May 16, 2002, a shareholder commenced a derivative
action in the United States District Court for the District of Connecticut
against KPMG Peat Marwick (KPMG). The Company was named as a nominal defendant.
Plaintiff purported to bring this action derivatively in the right, and for the
benefit, of the Company. He contended that he is excused from complying with the
prerequisite to make a demand on the Xerox Board of Directors, and that such
demand would be futile, because the directors are disabled from making a
disinterested, independent decision about whether to prosecute this action. In
the original complaint, plaintiff alleged that KPMG, the Company's former
outside auditor, breached its duties of loyalty and due care owed to Xerox by
repeatedly acquiescing in, permitting and aiding and abetting the manipulation
of Xerox's accounting and financial records in order to improve the Company's
publicly reported financial results. He further claimed that KPMG committed
malpractice and breached its duty to use such skill, prudence and diligence as
other members of the accounting profession commonly possess and exercise.
Plaintiff claimed that as a result of KPMG's breaches of duties, the Company has
suffered loss and damage. On May 29, 2002, plaintiff amended the complaint to
add as defendants the present and certain former directors of the Company. He
added claims against each of them for breach of fiduciary duty, and separate
additional claims against the directors who are or were members of the Audit
Committee of the Board of Directors, based upon the alleged failure, inter alia,
to implement, supervise and maintain proper accounting systems, controls and
practices. The amended derivative complaint demands a judgment declaring that
the defendants have violated and/or aided and abetted the breach of fiduciary
and professional duties to the Company and its shareholders; awarding the
Company unspecified compensatory damages, together with pre-judgment and
post-judgment interest at the maximum rate allowable by law; awarding the
Company punitive damages; awarding the plaintiff the costs and disbursements of
the action, including reasonable attorneys' and experts' fees; and granting such
other or further relief as may be just and proper under the circumstances. The
plaintiff has identified this action as a "related case" to Carlson v. Xerox
81
Corporation, et al., a consolidated securities law action currently pending in
the same court. The individual defendants deny the wrongdoing alleged and intend
to vigorously defend the litigation.
Lerner v. Allaire, et al.: On June 6, 2002, a shareholder, Stanley Lerner,
commenced a derivative action in the United States District Court for the
District of Connecticut against Paul A. Allaire, William F. Buehler, Barry D.
Romeril, Anne M. Mulcahy and G. Richard Thoman. The plaintiff purports to bring
the action derivatively, on behalf of the Company, which is named as a nominal
defendant. Previously, on June 19, 2001, Lerner made a demand on the Board of
Directors to commence suit against certain officers and directors to recover
unspecified damages and compensation paid to these officers and directors. In
his demand, Lerner contended, inter alia, that management was aware since 1998
of material accounting irregularities and failed to take action and that the
Company has been mismanaged. At its September 26, 2001 meeting, the Board of
Directors appointed a special committee to consider, investigate and respond to
the demand. The special committee is still deliberating. In this action,
plaintiff alleges that the individual defendants breached their fiduciary duties
of care and loyalty by disguising the true operating performance of the Company
through improper undisclosed accounting mechanisms between 1997 and 2000. The
complaint alleges that the defendants benefited personally, through compensation
and the sale of company stock, and either participated in or approved the
accounting procedures or failed to supervise adequately the accounting
activities of the Company. The plaintiff demands a judgment declaring that
defendants intentionally breached their fiduciary duties to the Company and its
shareholders; awarding unspecified compensatory damages to the Company against
the defendants, individually and severally, together with pre-judgment and
post-judgment interest; awarding the Company punitive damages; awarding the
plaintiff the costs and disbursements of the action, including reasonable
attorneys' and experts' fees; and granting such other or further relief as may
be just and proper. The individual defendants deny the wrongdoing alleged and
intend to vigorously defend the litigation.
Other Matters: It is our policy to carefully investigate, often with the
assistance of outside advisers, allegations of impropriety that may come to our
attention. If the allegations are substantiated, appropriate prompt remedial
action is taken. In India, we have learned of certain improper payments made
over a period of years in connection with sales to government customers by
employees of our majority-owned subsidiary in that country. This activity was
terminated when we became aware of it. We have investigated the activity and
recently reported it to the staff of the SEC. We estimate the amount of such
payments in 2000, the year the activity was stopped, to be approximately $600 to
$700 thousand. In 2000 the Indian company had revenue of approximately $130. We
are investigating certain transactions of our unconsolidated South African
affiliate that appear to have been improperly recorded as part of an effort to
sell supplies outside of its authorized territory. Recently, we received an
anonymous, unsubstantiated allegation, stated to be based upon rumor, that
improper payments were made in connection with government sales in a South
American subsidiary. We have not yet completed a full investigation, however, we
have not found anything that substantiates the allegation as of the date of this
filing. We have discussed these matters recently with the staff of the SEC.
Based on our consideration of these matters to date, we do not believe that they
are material to our financial statements.
Note 17--Preferred Securities
As of December 31, 2001, we have four series of outstanding preferred
securities. In total we are authorized to issue 22 million shares of cumulative
preferred stock, $1 par value.
Convertible Preferred Stock. As more fully described in Note 14, we sold, for
$785, 10 million shares of our Series B Convertible Preferred Stock (ESOP
shares) in 1989 in connection with the establishment of our ESOP. As employees
with vested ESOP shares leave the Company, these shares are redeemed by us. We
have the option to settle such redemptions with either shares of common stock or
cash.
Outstanding preferred stock related to our ESOP at December 31, 2001 and 2000
follows (shares in thousands):
2001 2000
---- ----
Shares Amount Shares Amount
Convertible Preferred Stock .............. 7,730 $605 8,257 $647
Preferred Stock Purchase Rights. We have a shareholder rights plan designed to
deter coercive or unfair takeover tactics and to prevent a person or persons
from gaining control of us without offering a fair price to all shareholders.
Under the terms of the plan, one-half of one preferred stock purchase right
(Right) accompanies each share of outstanding common stock. Each full Right
entitles the holder to purchase from us one three-hundredth of a new series of
preferred stock at an exercise price of $250. Within the time limits and under
the circumstances specified in the plan, the Rights entitle the holder to
acquire either our common stock, the surviving company in a business
combination, or the purchaser of our assets, having a value of two times the
exercise price. The Rights, which expire in April 2007, may be redeemed prior to
becoming
82
exercisable by action of the Board of Directors at a redemption price of $.01
per Right. The Rights are non-voting and, until they become exercisable, have no
dilutive effect on the earnings per share or book value per share of our common
stock.
Company-obligated, Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts Holding Solely Subordinated Debentures of the Company. The components of
Company-obligated, mandatorily redeemable preferred securities of subsidiary
trusts holding solely subordinated debentures of the Company at December 31,
2001 and 2000 follow:
2001 2000
---- ----
Trust II ........................................ $1,005 $ --
Trust I ......................................... 639 638
Deferred Preferred Stock ........................ 43 46
------ ----
Total ...................................... $1,687 $684
====== ====
Trust II. In 2001, Xerox Capital Trust II (Capital II), a trust sponsored and
wholly owned by us, issued 20.7 million 7.5 percent convertible trust preferred
securities to investors for an aggregate liquidation amount of $1,035 and 0.6
million shares of common securities to us for an aggregate liquidation amount of
$32. With the proceeds from these securities, Capital II purchased $1,067
aggregate principal amount of 7.5 percent convertible junior subordinated
debentures due 2021 of Xerox Funding LLC II (Funding), a wholly owned subsidiary
of ours. With the proceeds from these securities, Funding purchased $1,067
aggregate principal amount of 7.5 percent convertible junior subordinated
debentures due 2021 of the Company. Capital II's assets consist principally of
Funding's debentures, and Funding's assets consist principally of our
debentures. On a consolidated basis, we received net proceeds of $1,004 which is
net of $31 of fees and expenses. The initial carrying value is being accreted to
liquidation value through Minorities' interests in earnings of subsidiaries over
three years to the earliest redemption date. As of December 31, 2001, the
initial carrying value had accreted to $1,005. We used the net proceeds from the
issuance of our debentures for general corporate purposes, including the payment
of our indebtedness. Our debentures, along with those of Funding, and related
income statement effects are eliminated in our consolidated financial
statements. Distributions on the trust preferred securities are charged, net of
tax, to Minorities' interests in earnings of subsidiaries and amounted to $4 in
2001. We have effectively guaranteed, fully and unconditionally on a
subordinated basis, the payment and delivery by Funding of all amounts due on
the Funding debentures and the payment and delivery by Capital II of all amounts
due on the trust preferred securities, in each case to the extent required under
the terms of the securities.
The trust preferred securities accrue and pay cash distributions quarterly at a
rate of 7.5 percent per annum of the stated liquidation amount of fifty dollars
per trust preferred security. Concurrently with the initial issuance of the
trust preferred securities, Funding issued 0.2 million common securities to us
for an aggregate liquidation amount of $229, the proceeds of which Funding used
to purchase and deposit with a pledge trustee U.S. treasuries to secure, through
the distribution payment date occurring on November 27, 2004, Funding's
obligations under its debentures. As of December 31, 2001, $74 and $155 are
included in Deferred taxes and other current assets and Intangible and other
assets, net, respectively, representing the amounts pledged by Funding. The
trust preferred securities are convertible at any time, at the option of the
investors, into 5.4795 shares of our common stock per trust preferred security,
subject to adjustment. The trust preferred securities are mandatorily redeemable
upon the maturity of the debentures on November 27, 2021 at fifty dollars per
trust preferred security plus accrued and unpaid distributions. Investors may
require us to cause Capital II to purchase all or a portion of the trust
preferred securities on December 4, 2004, and November 27, 2006, 2008, 2011 and
2016 at a price of fifty dollars per trust preferred security, plus accrued and
unpaid distributions. In addition, if we undergo a change in control on or
before December 4, 2004, investors may require us to cause Capital II to
purchase all or a portion of the trust preferred securities. In either case, the
purchase price for such trust preferred securities may be paid in cash or common
stock of the Company, or a combination thereof. If the purchase price or any
portion thereof consists of common stock, investors will receive such common
stock at a value of 95 percent of its then prevailing market price. Capital II
may redeem all, but not part, of the trust preferred securities for cash prior
to December 4, 2004 only if specified changes in tax and investment law occur,
at a redemption price of 100 percent of their liquidation amount plus accrued
and unpaid distributions. On or at anytime after December 4, 2004, Capital II
may redeem all or a portion of the trust preferred securities for cash at
declining redemption prices, with an initial redemption price of 103.75 percent
of their liquidation amount.
Trust I. In 1997, a trust sponsored and wholly owned by us issued $650 aggregate
liquidation amount of preferred securities (the Original Preferred Securities)
to investors and 20,103 shares of common securities to us, the proceeds of which
were invested by the trust in $670 aggregate principal amount of our newly
issued 8 percent Junior Subordinated Debentures due 2027 (the Original
Debentures). Pursuant to a registration statement filed by us and the trust with
the Securities and Exchange Commission in 1997, Original Preferred Securities
with an aggregate liquidation preference amount of $644 and Original Debentures
with a principal amount of $644 were exchanged for a like amount of preferred
securities (together with the Original Preferred Securities, the Preferred
Securities) and 8 percent Junior Subordinated Debentures due 2027 (together with
the Original Debentures, the Debentures) which were registered under the
Securities Act of 1933. The
83
Debentures represent all of the assets of the trust. The Debentures and related
income statement effects are eliminated in our consolidated financial
statements.
The Preferred Securities accrue and pay cash distributions semiannually at a
rate of 8 percent per annum of the stated liquidation amount of $1,000 per
Preferred Security. These distributions are recorded in Minorities' interests in
earnings of subsidiaries in the Consolidated Statements of Operations. We have
guaranteed (the Guarantee), on a subordinated basis, distributions and other
payments due on the Preferred Securities. The Guarantee and our obligations
under the Debentures and in the indenture pursuant to which the Debentures were
issued and our obligations under the Amended and Restated Declaration of Trust
governing the trust, taken together, provide a full and unconditional guarantee
of amounts due on the Preferred Securities.
The Preferred Securities are mandatorily redeemable upon the maturity of the
Debentures on February 1, 2027, or earlier to the extent of any redemption by us
of any Debentures. The redemption price in either such case will be $1,000 per
share plus accrued and unpaid distributions to the date fixed for redemption.
Total net proceeds were $637, net of $13 in fees and expenses. The initial
carrying value is being accreted to liquidation value over the remaining term.
As of December 31, 2001, the initial carrying value had accreted to $639.
Deferred Preferred Stock. In 1996, a subsidiary of ours issued 2 million
deferred preferred shares for Canadian (Cdn.) $50 ($37 U.S.). These shares are
mandatorily redeemable on February 28, 2006 for Cdn. $90 (equivalent to $56 U.S.
at December 31, 2001). The difference between the redemption amount and the
proceeds from the issue is being amortized, through the redemption date, to
Minorities' interests in earnings of subsidiaries in the Consolidated Statements
of Operations. As of December 31, 2001, $13 remained to be amortized. We have
guaranteed the redemption value.
Note 18--Common Stock
We have 1.05 billion authorized shares of common stock, $1 par value. At
December 31, 2001 and 2000, 113 and 98 million shares, respectively, were
reserved for issuance under our incentive compensation plans. In addition, at
December 31, 2001, 18 million common shares were reserved for the conversion of
$591 of convertible debt, 43 million common shares were reserved for conversion
of ESOP-related Convertible Preferred Stock and 113 million common shares were
reserved for the conversion of Convertible Trust Preferred Securities.
Extraordinary Gain. We retired $377 of long-term debt through the exchange of 41
million shares of common stock valued at $311 in 2001. These retirements
resulted in a pre-tax extraordinary gain of $66 ($40 after taxes) for a net
equity increase of $351.
Treasury Stock. In 1996, the Board of Directors authorized us to repurchase up
to $1 billion of our common stock. No shares were repurchased during 2001, 2000
or 1999. Between 1996 and 1998 we had repurchased 21 million shares for $594.
Common shares issued for stock option exercises, conversion of convertible
securities and other exchanges were partially satisfied by reissuances of
treasury shares. At this time, we are effectively prohibited from purchasing
additional shares as a result of covenants in our recent capital markets
transactions. There were no treasury shares outstanding as of December 31, 2001
or 2000.
Put Options. In connection with the share repurchase program, during 2000 and
1999, we sold 7.5 and 0.8 million put options, respectively, that entitled the
holder to sell one share of our common stock to us at maturity at a specified
price.
In 2000, we recorded the receipt of a premium of approximately $24 on the sale
of equity put options. This premium was recorded as an addition to Common stock,
including additional paid in capital. In October 2000, the holder of these
equity put options exercised their option for early termination and settlement.
The cost of this settlement to us was approximately $92 for 7.5 million shares
with an average strike price of $18.98 per share. This transaction was recorded
as a reduction of Common stock, including additional paid in capital.
At December 31, 2000, 0.8 million put options remained outstanding with a strike
price of $40.56 per share. Under the terms of this contract we had the option of
physical or net cash settlement. Accordingly, this amount was classified as
temporary equity in the Consolidated Balance Sheet at December 31, 2000. In
January 2001 these put options 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.
Stock Option and Long-term Incentive Plans. We have a long-term incentive plan
whereby eligible employees may be granted non-qualified stock options, shares of
common stock (restricted or unrestricted) and performance/incentive unit rights.
Beginning in 1998 and subject to vesting and other requirements,
performance/incentive unit rights are typically paid in our common stock. The
value of each performance/ incentive unit is based on the growth in earnings per
share during the year in which granted. Performance/ incentive units ratably
vest in the three years after the year awarded. Compensation
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expense recorded for performance/incentive units at December 31, 2000 and 1999
was $5 and $18, respectively. No amounts were recorded in 2001 as the balance of
the 1999 and 2000 performance/incentive measures were not met. This plan was
discontinued in 2001.
We granted 1.9, 0.4 and 0.3 million shares of restricted stock to key employees
for the years ended December 31, 2001, 2000 and 1999, respectively. No monetary
consideration is paid by employees who receive restricted shares. Compensation
expense for restricted grants is based upon the grant date market price and is
recorded over the vesting period which on average ranges from 1 to 3 years.
Compensation expense recorded for restricted grants was $15, $18 and $22 in
2001, 2000 and 1999, respectively.
Stock options and rights are settled with newly issued or, if available,
treasury shares of our common stock. Stock options generally vest in three years
and expire between eight and ten years from the date of grant. The exercise
price of the options is equal to the market value of our common stock on the
effective date of grant.
At December 31, 2001 and 2000, 39.7 and 36.0 million shares, respectively, were
available for grant of options or rights. The following table provides
information relating to the status of, and changes in, options granted:
2001 2000 1999
---- ---- ----
Average Average Average
Stock Option Stock Option Stock Option
Employee Stock Options Options Price Options Price Options Price
- ---------------------- ------- ----- ------- ------- ------- -------
(Options in thousands)
Outstanding at January 1 .................... 58,233 $35 43,388 $42 30,344 $33
Granted ..................................... 15,085 5 19,338 22 19,059 51
Cancelled ................................... (4,479) 28 (4,423) 38 (870) 47
Exercised ................................... (10) 5 (70) 22 (5,145) 23
------ ----- ------ ---- ------ -----
Outstanding at December 31 .................. 68,829 29 58,233 35 43,388 42
------ ----- ------ ---- ------ -----
Exercisable at end of year .................. 36,388 23,346 13,467
====== ====== ======
Options outstanding and exercisable at December 31, 2001 are as follows:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Number Average Remaining Weighted Average Number Weighted Average
Range of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------ ----------- ---------------- -------------- ----------- ----------------
In thousands except per-share data
$ 4.75 to $6.98 ................. 12,533 9.00 $4.76 7 $ 4.75
7.13 to 10.35 ................. 1,813 9.71 8.58 -- --
10.94 to 16.38 ................. 266 7.27 14.67 89 15.02
16.91 to 23.25 ................. 20,389 6.36 21.53 11,030 21.33
25.38 to 36.70 ................. 13,726 4.65 31.58 9,872 33.47
41.72 to 60.95 ................. 20,102 5.33 53.13 15,390 52.45
------ ---- ------ ------ ------
$4.75 to $60.95 ................. 68,829 6.29 $29.34 36,388 $37.77
====== ==== ====== ====== ======
We do not recognize compensation expense relating to employee stock options
because the exercise price of the option equals the fair value of the stock on
the effective date of grant. If we had elected to recognize compensation
expense, and therefore determined the compensation based on the value as
determined by the modified Black-Scholes option pricing model, the pro forma net
(loss) income and (loss) earnings per share would have been as follows:
2001 2000 1999
---- ---- ----
Restated Restated
Note 2 Note 2
Net (loss) income--as reported .................... $ (71) $ (273) $ 844
Net (loss) income--pro forma ...................... (145) (374) 755
Basic EPS--as reported ............................ (0.12) (0.48) 1.20
Basic EPS--pro forma .............................. (0.23) (0.63) 1.07
Diluted EPS--as reported .......................... (0.12) (0.48) 1.17
Diluted EPS--pro forma ............................ (0.23) (0.63) 1.05
85
As reflected in the pro forma amounts in the previous table, the fair value of
each option granted in 2001, 2000 and 1999 was $2.40, $7.50 and $15.83,
respectively. The fair value of each option was estimated on the date of grant
using the following weighted average assumptions:
2001 2000 1999
---- ---- ----
Risk-free interest rate .................. 5.1% 6.7% 5.1%
Expected life in years ................... 6.5 7.1 6.2
Expected price volatility ................ 51.4% 37.0% 28.0%
Expected dividend yield .................. 2.7% 3.7% 1.8%
Note 19--Earnings Per Share
Basic earnings per share is computed by dividing income available to common
shareholders (the numerator) by the weighted-average number of common shares
outstanding (the denominator) for the period. Diluted earnings per share assumes
that any dilutive convertible preferred shares, convertible subordinated
debentures, and convertible securities outstanding were converted, with related
preferred stock dividend requirements and outstanding common shares adjusted
accordingly. It also assumes that outstanding common shares were increased by
shares issuable upon exercise of those stock options for which market price
exceeds the exercise price, less shares which could have been purchased by us
with the related proceeds. In periods of losses, diluted loss per share is
computed on the same basis as basic loss per share as the inclusion of any other
potential shares outstanding would be anti-dilutive.
A reconciliation of the numerators and denominators of the basic and diluted EPS
calculation follows:
2001 2000 1999
---- ---- ----
Restated Restated
Note 2 Note 2
Per- Pre- Per-
Share Share Share
Income Shares Amount Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------
(Shares in thousands)
Basic EPS
Net (loss) income before
extraordinary gain
and cumulative effect
of change in
accounting principle ....... (109) $(273) $844
Accrued dividends on
preferred stock, net ........ $ (12) $ (46) (46)
------ ------- ------ ----- ------- ------- ---- ------ -----
Basic EPS before
extraordinary gain
and cumulative effect of
change in accounting
principle .................... $ (121) 704,181 $(0.17) $(319) 667,581 $ (0.48) $798 663,17 $1.20
Extraordinary gain .............. 40 704,181 0.05
Cumulative effect of
change in accounting
principle ..................... (2) 704,181 --
------ ------- ------ ----- ------- ------- ---- ------ -----
Basic EPS ....................... $ (83) 704,181 $(0.12) $(319) 667,581 $ (0.48) $798 663,17 $1.20
------ ------- ------ ----- ------- ------- ---- ------ -----
Diluted EPS
Stock options and other
incentives .................. 8,727
ESOP Adjustment, net
of tax ...................... 51 51,989
Convertible debt, net of
tax 3 5,287
------ ------- ------ ----- ------- ------- ---- ------ -----
Diluted EPS ..................... $(83) 704,181 $(0.12 $(319) 667,581 $ (0.48) $852 729,17 $1.17
====== ======= ====== ===== ======= ======= ==== ====== =====
86
The 2001 and 2000 computation of diluted loss per share did not include the
effects of 69 and 58 million stock options, respectively, because either: i)
their respective exercise prices were greater than the corresponding market
value per share of our common stock or ii) where the respective exercise prices
were less than the corresponding market value per share of our common stock, the
inclusion of such options would have been anti-dilutive.
In addition, the following securities that could potentially dilute basic EPS in
the future were not included in the computation of diluted EPS because to do so
would have been anti-dilutive for 2001 and 2000 (in thousands of shares):
2001 2000
---- ----
Convertible preferred stock ............................. 78,473 50,605
Mandatorily redeemable preferred securities--Trust II ... 113,426 --
3.625% Convertible subordinated debentures .............. 7,129 7,903
Other convertible debt .................................. 1,992 5,287
------- ------
Total ............................................... 201,020 63,795
======= ======
Note 20--Subsequent Events
In June 2002 and as further described in Note 1 and Note 12, we entered into a
$4.2 billion amended and restated credit agreement with a group of lenders which
replaced our previous debt facility.
In May 2002, GE Capital and we launched the Xerox Capital Services (XCS)
venture. XCS manages our customer administration and leasing activities in the
U.S., including various financing programs, credit approval, order processing,
billing and collections.
In May and March 2002, we received additional financing totaling $765 from GE
Capital secured by lease receivables in the U.S. Net fees of $5 were paid in
connection with the transactions and have been capitalized as debt issue costs.
In connection with these transactions, $35 of the $765 in proceeds was required
to be held in reserve, as security for our supply and service obligations
inherent in the transferred contracts. The amount held will be released ratably
as the underlying borrowing is repaid.
In May 2002, we entered into an agreement to transfer part of our financing
operations in Germany to GE Capital. We received a $77 loan from GE Capital
secured by certain of our finance receivables in Germany. Cash proceeds of $65
were net of $12 of escrow requirements.
In May 2002, we received an additional loan from GE Capital of $106 secured by
portions of our lease receivable portfolio in the U.K.
In April 2002, we sold our leasing business in Italy to a third party for
approximately $207 in cash plus the assumption of $20 of debt. We can also
receive retained interests up to approximately $30 based on the occurrence of
certain future events. This sale is part of an agreement under which the third
party will provide ongoing, exclusive equipment financing to our customers in
Italy.
In March 2002, we determined that $72 of our capitalized software was
permanently impaired. This determination was based on our assessment of the
usefulness of such software as of that date. This amount will be reflected as a
charge in our operating results for the first quarter of 2002.
In February 2002, we received a $291 loan from GE Capital, secured by certain of
our finance receivables in Canada. Cash proceeds of $281 were net of $8 of
escrow requirements and $2 of fees.
In January 2002, we completed an unregistered offering in the U.S. ($600) and
Europe ((euro)225) of 9 3/4 percent senior notes due in 2009 and received net
cash proceeds of $746, which includes $559 and (euro)209. The notes were issued
at a 4.833 percent discount and will pay interest semiannually on January 15 and
July 15. In March 2002, we filed a registration statement to exchange registered
notes for these unregistered notes. This registration statement has not yet been
declared effective.
87
QUARTERLY RESULTS OF OPERATIONS (Unaudited) In millions, except per-share data
First Second Third Fourth Full
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- ----
Restated Restated Restated
2001 Note 2 Note 2 Note 2
Revenues .......................................................... $ 4,291 $ 4,283 $ 4,052 $ 4,382 $ 17,008
Costs and Expenses ................................................ 3,653 4,560 4,130 4,300 16,643
-------- -------- -------- -------- --------
Income (Loss) before Income Taxes (Benefits), Equity Income,
Minorities' Interests, Extraordinary Gain, and Cumulative
Effect of Change in Accounting Principle ........................ 638 (277) (78) 82 365
Income taxes (benefits) ........................................... 427 (134) (70) 262 485
Equity in net income of unconsolidated affiliates ................. 3 31 -- 19 53
Minorities' interests in earnings of subsidiaries ................. (7) (10) (9) (16) (42)
(Loss) Income before Extraordinary Gain and Cumulative Effect
of Change in Accounting Principle ............................... 207 (122) (17) (177) (109)
Extraordinary gain, net of taxes .................................. 17 18 1 4 40
Cumulative effect of change in accounting principle ............... (2) -- -- -- (2)
-------- -------- -------- -------- --------
Net (Loss) Income ................................................. $ 222 $ (104) $ (16) $ (173) $ (71)
-------- -------- -------- -------- --------
Basic (Loss) Earnings per Share ................................... $ 0.31 $ (0.15) $ (0.02) $ (0.24) $ (0.12)
-------- -------- -------- -------- --------
Diluted (Loss) Earnings per Share/(2)/ ............................ $ 0.28 $ (0.15) $ (0.02) $ (0.24) $ (0.12)
-------- -------- -------- -------- --------
Restated Restated
2000 Note 2 Note 2
Revenues .......................................................... $ 4,558 $ 4,765 $ 4,474 $ 4,954 $ 18,751
Costs and Expenses ................................................ 4,933 4,566 4,608 5,011 19,118
-------- -------- -------- -------- --------
Income (Loss) before Income Taxes (Benefits), Equity Income,
Minorities' Interests, Extraordinary Gain, and Cumulative
Effect of Change in Accounting Principle ........................ (375) 199 (134) (57) (367)
Income taxes (benefits) ........................................... (143) 77 305 (309) (70)
Equity in net income of unconsolidated affiliates ................. 5 47 11 3 66
Minorities' interests in earnings of subsidiaries ................. (11) (11) (10) (10) (42)
-------- -------- -------- -------- --------
Net (Loss) Income ................................................. $ (238) $ 158 $ (438) $ 245 $ (273)
======== ======== ======== ======== ========
Basic (Loss) Earnings per Share ................................... $ (0.37) $ 0.22 $ (0.67) $ 0.35 $ (0.48)
======== ======== ======== ======== ========
Diluted (Loss) Earnings per Share/(2)/ ............................ $ (0.37) $ 0.21 $ (0.67) $ 0.32 $ (0.48)
======== ======== ======== ======== ========
Previously Reported
First Second Third Fourth Full
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- ----
2001/(1)/
Revenues .............................................................. $ 4,201 $ 4,137 $ 3,902 $ 4,262 $ 16,502
Costs and Expenses .................................................... 3,607 4,620 4,150 4,262 16,639
-------- -------- -------- -------- --------
Income (Loss) before Income Taxes (Benefits), Equity
Income, Minorities' Interests, Extraordinary Gain,
and Cumulative Effect of Change in Accounting Principle ............. 594 (483) (248) -- (137)
Income taxes (benefits) ............................................... 403 (160) (56) 6 193
Equity in net income of unconsolidated affiliates ..................... 3 30 (1) 15 47
Minorities' interests in earnings of subsidiaries ..................... (6) (6) (19) (17) (48)
(Loss) Income before Extraordinary Gain and Cumulative
Effect of Change in Accounting Principle ............................ 188 (299) (212) (8) (331)
Extraordinary gain, net of taxes ...................................... 17 18 1 4 40
Cumulative effect of change in accounting principle ................... (2) -- -- -- (2)
-------- -------- -------- -------- --------
Net (Loss) Income ..................................................... $ 203 $ (281) $ (211) $ (4) $ (293)
-------- -------- -------- -------- --------
Basic (Loss) Earnings per Share ....................................... $ 0.28 $ (0.40) $ (0.29) $ (0.01) $ (0.43)
-------- -------- -------- -------- --------
Diluted (Loss) Earnings per Share/(2)/ ................................ $ 0.25 $ (0.40) $ (0.29) $ (0.01) $ (0.43)
-------- -------- -------- -------- --------
2000
Revenues .............................................................. $ 4,540 $ 4,778 $ 4,503 $ 4,880 $ 18,701
Costs and Expenses .................................................... 4,901 4,531 4,738 4,915 19,085
-------- -------- -------- -------- --------
Income (Loss) before Income Taxes (Benefits), Equity
Income, Minorities' Interests, Extraordinary Gain,
and Cumulative Effect of Change in Accounting Principle ............. (361) 247 (235) (35) (384)
Income taxes (benefits) ............................................... (120) 79 (44) (24) (109)
Equity in net income of unconsolidated affiliates ..................... 4 46 10 1 61
Minorities' interests in earnings of subsidiaries ..................... (11) (12) (10) (10) (43)
-------- -------- -------- -------- --------
Net (Loss) Income ..................................................... $ (248) $ 202 $ (191) $ (20) $ (257)
======== ======== ======== ======== ========
Basic (Loss) Earnings per Share ....................................... $ (0.39) $ 0.29 $ (0.30) $ (0.04) $ (0.44)
======== ======== ======== ======== ========
Diluted (Loss) Earnings per Share/(2)/ ................................ $ (0.39) $ 0.27 $ (0.30) $ (0.04) $ (0.44)
======== ======== ======== ======== ========
/(1)/ 2001 fourth quarter and full year were announced in a press release dated
January 28, 2002. First, second and third quarters were included in form
10-Q's filed with the SEC.
/(2)/ The sum of quarterly diluted (loss) earnings per share differ from the
full-year amounts because securities that are anti-dilutive in certain
quarters are not anti-dilutive on a full-year basis.
88
FIVE YEARS IN REVIEW
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Restated Restated Restated Restated
(Dollars in millions, except per-share data)
Per-Share Data
(Loss) earnings from continuing operations
Basic ..................................................... $ (0.12) $ (0.48) $ 1.20 $ (0.32) $ 1.30
Diluted ................................................... (0.12) (0.48) 1.17 (0.32) 1.24
Dividends declared ............................................ 0.05 0.65 0.80 0.72 0.64
Operations
Revenues ...................................................... $ 17,008 $ 18,751 $ 18,995 $ 18,777 $ 17,457
Sales ................................................... 7,443 8,839 8,967 8,996 8,303
Service, outsourcing, and rentals 8,436 8,750 8,853 8,742 8,192
Finance Income .......................................... 1,129 1,162 1,175 1,039 962
Research and development expenses ............................. 997 1,064 1,020 1,045 1,080
Selling, administrative and general expenses .................. 4,728 5,518 5,204 5,314 5,196
(Loss) income from continuing operations ...................... (71) (273) 844 23 893
Net (loss) income ............................................. (71) (273) 844 (167) 893
Financial Position
Cash and cash equivalents ..................................... $ 3,990 $ 1,750 $ 132 $ 79 $ 75
Accounts and finance receivables, net ......................... 11,574 13,067 13,487 13,272 11,548
Inventories ................................................... 1,364 1,983 2,344 2,554 2,094
Equipment on operating leases, net ............................ 804 1,266 1,423 1,650 1,517
Land, buildings and equipment, net ............................ 1,999 2,527 2,458 2,366 2,373
Investment in discontinued operations ......................... 749 534 1,130 1,669 2,819
Total assets .................................................. 27,689 28,253 27,803 27,775 26,064
Consolidated capitalization
Short-term debt ........................................... 6,637 3,080 4,626 4,221 3,796
Long-term debt ............................................ 10,128 15,557 11,521 11,104 9,074
--------- -------- -------- ------ --------
Total debt ........................................... 16,765 18,637 16,147 15,325 12,870
Deferred ESOP benefits .................................... (135) (221) (299) (370) (434)
Minorities' interests in equity of subsidiaries ........... 73 87 75 81 88
Obligation for equity put options ......................... -- 32 -- -- --
Company-obligated, mandatorily redeemable preferred
securities of subsidiary trusts holding solely
subordinated debentures of the Company
securities of subsidiary trusts holding solely
subordinated debentures of the Company .................. 1,687 684 681 679 676
Preferred stock ........................................... 605 647 669 687 705
Common shareholders' equity ............................... 1,820 1,801 2,953 3,026 3,605
--------- -------- -------- -------- --------
Total capitalization/(1)/ ................................. 20,815 21,667 20,226 19,428 17,510
--------- -------- -------- -------- --------
Selected Data and Ratios
Common shareholders of record at year-end ..................... 59,830 59,879 55,766 52,001 54,687
Book value per common share ................................... $ 2.51 $ 2.68 $ 4.42 $ 4.59 $ 5.51
Year-end common stock market price ............................ $ 10.42 $ 4.63 $ 22.69 $ 59.00 $ 36.94
Employees at year-end ......................................... 78,900 92,500 94,600 92,700 91,500
Gross margin .................................................. 38.2% 37.4% 42.3% 44.3% 44.8%
Sales gross margin ...................................... 30.5% 31.2% 37.2% 40.5% 39.5%
Service, outsourcing, and rentals gross margin .......... 42.2% 41.1% 44.7% 46.6% 48.4%
Finance gross margin .................................... 59.5% 57.1% 63.0% 58.2% 58.6%
Working capital ............................................... $ 2,340 $ 4,928 $ 2,965 $ 2,959 $ 2,444
Current ratio ................................................. 1.2 1.8 1.3 1.3 1.3
Cost of additions to land, buildings and equipment ............ $ 219 $ 452 $ 594 $ 566 $ 520
Depreciation on buildings and equipment ....................... $ 402 $ 417 $ 416 $ 362 $ 400
/(1)/ Total capitalization is comprised of total debt, deferred ESOP benefits,
minorities' interests in equity of subsidiaries, obligation for equity put
options, Company-obligated, mandatorily redeemable preferred securities of
subsidiary trusts holding solely subordinated debentures of the Company,
preferred stock, and common shareholders' equity.
89
Officers
- --------
Anne M. Mulcahy Guilherme M.N. Bettencourt James J. Miller
Chairman and Vice President Vice President
Chief Executive Officer Presidente, Xerox do Brasil, Ltda. President, Office Printing
Developing Markets Operations Business Group
Allan E. Dugan
Executive Vice President, Richard F. Cerrone Patricia M. Nazemetz
Corporate Business Ethics and Compliance Vice President Vice President
Senior Vice President and General Human Resources
Carlos Pascual Manger
Executive Vice President North American Agent Operations Russell Y. Okasako
President, Developing Markets Operations Vice President
Christina E. Clayton Taxes
Ursula M. Burns Vice President and General
Senior Vice President Counsel Ronald E. Rider
President, Document Systems and Solutions Vice President
Group Patricia A. Cusick Center Manager, Digital
Vice President and Chief Imaging Technology Center
Thomas J. Dolan Information Officer Xerox Innovation Group
Senior Vice President Corporate Operations Group
President, Xerox Global Services Frank D. Steenburgh
J. Michael Farren Vice President
James A. Firestone Vice President Senior Vice President,
Senior Vice President External Affairs DocuColor iGen3 Business
President, Corporate Operations Group Document Systems and
Anthony M. Federico Solutions Group
Herve J. Gallaire Vice President
Senior Vice President Development Gregory B. Tayler
President, Xerox Innovation Group and Document Systems and Solutions Vice President and Treasurer
Chief Technology Officer Group
Leslie F. Varon
Anshoo S. Gupta Emerson U. Fullwood Vice President and Secretary
Senior Vice President Vice President
President, Production Systems Group Executive Chief Staff Officer Armando Zagalo de Lima
Document Systems and Solutions Group Developing Markets Operations Vice President
Senior Vice President and Chief
Gilbert J. Hatch James H. Lesko Operating Officer
Senior Vice President Vice President European Solutions Group
President, Office Systems Group President, e-Business and TeleWeb
Corporate Operations Group Lance H. Davis
Michael C. Mac Donald Assistant Treasurer and Director,
Senior Vice President Rafik O. Loutfy Global Risk Management
President, North American Solutions Group Vice President
Center Manager, Xerox Research Gary R. Kabureck
Centre of Canada Assistant Controller and Chief
Hector J. Motroni Xerox Innovation Group Accounting Officer
Senior Vice President and Chief Staff
Officer Jean-Noel Machon Timothy J. MacCarrick
Vice President Assistant Treasurer
Brian E. Stern President, European Solutions
Senior Vice President Group Richard Ragazzo
President, Xerox Supplies Business Group Assistant Controller
Document Systems and Solutions Group Diane E. McGarry
Vice President Martin S. Wagner
Lawrence A. Zimmerman Chief Marketing Officer, Corporate Assistant Secretary
Senior Vice President and Chief Financial Marketing and Communications Associate General Counsel,
Officer Corporate Operations Group Corporate Finance and Ventures
90
Directors
- ---------
Antonia Ax:son Johnson 2, 3 Martha R. Seger 2, 4
Chairman Financial Economist and
Axel Johnson Group Former Member Federal Reserve Board
Stockholm, Sweden Ann Arbor, Michigan
Vernon E. Jordan, Jr. 1, 4, 5 Thomas C. Theobald 2, 3
Senior Managing Director Managing Director
Lazard Freres & Co., LLC William Blair Capital Partners, LLC
New York, New York Chicago, Illinois
Of Counsel
Akin, Gump, Strauss, Hauer & Feld, LLP
Attorneys-at-Law, Washington, DC
Yotaro Kobayashi /1/ Member of the Executive Committee
Chairman of the Board /2/ Member of the Audit Committee
Fuji Xerox Co., Ltd. /3/ Member of the Executive Compensation and
Tokyo, Japan Benefits Committee
/4/ Member of the Finance Committee
Hilmar Kopper 2, 5 /5/ Member of the Nominating Committee
Former Chairman of the Supervisory Board
Deutsche Bank AG
Frankfurt, Germany
Ralph S. Larsen 1, 3, 5
Former Chairman and Chief Executive Officer
Johnson & Johnson
New Brunswick, New Jersey
George J. Mitchell 4, 5
Chairman
Verner, Liipfert, Bernhard, McPherson & Hand
Washington, DC
Anne M. Mulcahy 1
Chairman and Chief Executive Officer
Xerox Corporation
Stamford, Connecticut
N. J. Nicholas, Jr. 2, 4
Investor
New York, New York
John E. Pepper 2, 3
Chairman, Executive Committee of the Board
The Procter & Gamble Company
Cincinnati, Ohio
91
How to Reach Us
Xerox Corporation Fuji Xerox Co., Ltd.
800 Long Ridge Road 2-17-22 Akasaka
P.O. Box 1600 Minato-ku, Tokyo 107
Stamford, CT 06904 Japan
203 968-3000 81 3 3585-3211
Xerox Europe
Riverview
Oxford Road
Uxbridge
Middlesex
United Kingdom
UB8 1HS
44 1895 251133
Products and Services
www.xerox.com or by phone:
... 800 ASK-XEROX (800 275-9376) for any product or service
... 585 347-9922 for technical support for small office or home office product
... 877 362-6567 for information on the full line of Xerox office printers
Additional Information
The Xerox Foundation and CommunityInvolvement Program: 203 968-3333
Xerox diversity programs and EEO-1 reports: 716 423-6157
Environmental, Health and Safety Progress Report: 800 828-6571
Questions from Students and Educators:
E-mail: Nancy.Dempsey@usa.xerox.com
Independent Accountants
PricewaterhouseCoopers LLP
300 Atlantic Street
Stamford, CT 06901
203 539-3000
Dividends Paid to Shareholders
At its July 9, 2001 meeting, the Company's Board of Directors eliminated the
dividend on the common stock. Previously, at its October 9, 2000 and February 5,
2001 meetings, the Board declared a dividend of $0.05 per share payable on
January 1, 2001 and April 1, 2001. At its July 9, 2001 meeting, the Board of
Directors also decided to suspend the quarterly dividend on the preferred stock,
which had previously been $1.5625 per share. The Series B Convertible Preferred
stock was issued in July 1989 in connection with the formation of a Xerox
Employee Stock Ownership Plan.
Xerox Common Stock Prices and Dividends
New York Stock Exchange composite prices
First Second Third Fourth
2001 Quarter Quarter Quarter Quarter
High $ 8.43 $ 11.35 $9.58 $10.42
Low 5.03 4.95 6.72 6.58
Dividends Paid $ 0.05 $ 0.05 $0.00 $ 0.00
First Second Third Fourth
2000 Quarter Quarter Quarter Quarter
High $28.19 $ 28.13 $20.38 $15.31
Low 20.13 19.19 14.81 4.44
Dividends Paid $ 0.20 $ 0.20 $ 0.20 $ 0.20
Stock Listed and Traded
Xerox common stock (XRX) is listed on the New York Stock Exchange and the
Chicago Stock Exchange. It is also traded on the Boston, Cincinnati, Pacific
Coast, Philadelphia, London and Switzerland exchanges.
Shareholder Information
For Investor Information, including comprehensive earnings releases:
www.xerox.com/investor or www.xerox.com and select "investor information."
Earnings releases also available by mail: 800-828-6396
For shareholder services, call 800-828-6396 (TDD: 800-368-0328) or 781-575-3222,
or write to EquiServe Trust Company, N.A., P.O. Box 43010, Providence, RI
02940-3010 or use email available at www.equiserve.com.
Investment professionals may contact:
James A. Ramsey, Director, Investor Relations
James.Ramsey@usa.xerox.com
Cindy Johnston, Manager, Investor Relations
Cindy.Johnston@usa.xerox.com
92