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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2002
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OR
( ) Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from : to
Commission file number: 1-8133
XEROX CREDIT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 06-1024525
- -------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 First Stamford Place, Stamford, Connecticut 06904
(Address of principal executive offices) (Zip Code)
(203) 325-6600
--------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
7.20% Notes due 2012 New York Stock Exchange
- -------------------- -----------------------
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes: X No:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of the latest practicable date.
Class Outstanding as of July 31, 2002
----- -------------------------------
Common Stock 2,000
THIS DOCUMENT CONSISTS OF 41 PAGES
Forward-Looking Statements
- --------------------------
From time to time we and our representatives may provide information, whether
orally or in writing, including certain statements in this Quarterly Report on
Form 10-Q which are forward-looking. These forward-looking statements and other
information are based on our beliefs as well as assumptions made by us using
information currently available.
The words "anticipate," "believe," "estimate," "expect," "intend," "will," and
similar expressions, as they relate to us, are intended to identify forward-
looking statements. Such statements reflect our current views with respect to
future events and are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those described herein as anticipated, believed, estimated, intended or
expected. We do not intend to update these forward-looking statements.
We are making investors aware that such forward-looking statements, because they
relate to future events, are by their very nature subject to many important
factors which could cause actual results to differ materially from those
contained in the forward-looking statements. Such factors include, but are not
limited to, our liquidity.
Our liquidity is dependent upon the liquidity of our ultimate parent, Xerox
Corporation ("XC", and together with its subsidiaries, "Xerox"). Accordingly,
certain disclosures contained herein relate to events and transactions that
affect the liquidity of Xerox, even if they do not directly affect our
liquidity.
In October 2000, Xerox announced a turnaround program which Xerox believed would
help ensure liquidity, re-establish profitability and build a solid foundation
for future growth. The Turnaround Program encompassed four major components: (i)
asset sales of $2-$4 billion; (ii) cost reductions designed to reduce spending
by at least $1 billion annually; (iii) the transition of equipment financing to
third party vendors and (iv) a focus on core business of providing document
processing systems, solutions and services to customers. The sales of assets are
completed. The success of the remainder of the turnaround program is dependent
upon successful and timely restructuring of the cost base, placement of greater
operational focus on the core business, and completion of the transfer of the
financing of customer equipment purchases to third parties. Cost base
restructuring is dependent upon effectively and timely reducing the number of
employees, closing and consolidating facilities, outsourcing certain
manufacturing and logistics operations, reducing operational expenses and
successfully implementing process and systems changes.
Xerox's liquidity is currently provided through its own cash generation from
operations and various financing strategies including the monetization of
receivables. Xerox is currently funding its customer financing activities from
available sources of liquidity including cash on hand, unregistered capital
markets offerings and receivables monetizations. There is no assurance that
Xerox will be able to continue to fund its customer financing activities at
present levels. Xerox continues to negotiate and implement third-party vendor
financing programs and to actively pursue alternative forms of financing
including receivables monetizations. These initiatives are expected to
significantly improve Xerox's liquidity going forward. Xerox's ability to
continue to offer customer financing and be successful in the placement of its
equipment with customers is largely dependent upon successful implementation of
its third party financing initiatives.
2
In September 2001, XC entered into framework agreements with General Electric
Capital Corporation (GE Capital) under which GE Capital will manage Xerox's
customer administrative functions, provide secured financing for XC's existing
portfolio of finance receivables and become the primary equipment financing
provider for Xerox customers in the U.S. In anticipation of GE Capital becoming
primary equipment financing provider for Xerox customers in the U.S., we stopped
purchasing new contracts receivable from XC effective July 1, 2001 and our
existing portfolio will ultimately run-off. Further, pursuant to the New Credit
Facility (discussed below), we are precluded from purchasing any new contracts
receivable from XC in the future. Xerox is considering monetizing portions of
its existing U.S. finance receivables portfolio as it pursues alternative forms
of financing, which could further reduce our portfolio.
XC has completed the renegotiation of its $7 billion Revolving Credit Agreement
(the "Old Revolver"). Of the original $7 billion in loans outstanding under the
Old Revolver, $2.8 billion (including the entire $1.0 billion we had borrowed)
has been repaid. The remaining $4.2 billion has been refinanced under the terms
of a new Amended and Restated Credit Agreement (the "New Credit Facility"),
which is more fully discussed in Note 7 of this Report on Form 10-Q. We cannot
borrow under the New Credit Facility, and we are also precluded from purchasing
new contracts from XC. Subject to certain limits, all obligations under the New
Credit Facility are secured by liens on substantially all domestic assets of XC
and by liens on the assets of substantially all of its U.S. subsidiaries
(excluding us) and are guaranteed by substantially all of its U.S. subsidiaries
(including us). Our guaranty of obligations under the New Credit Facility,
however, is subordinated to all of our capital markets debt outstanding as of
June 21, 2002. In connection with the New Credit Facility, substantially all of
XC's U.S. subsidiaries (including us) also guaranteed XC's $600 million of
9-3/4% Senior Notes and Euro 225 million of 9-3/4% Senior Notes due 2009
(collectively, the "Senior Notes").
The New Credit Facility contains affirmative and negative covenants of XC
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; inter-company loans and certain restricted payments; and a
requirement to transfer excess foreign cash, and excess cash of ours, as
defined, to XC in certain circumstances. It also contains additional financial
covenants, including minimum EBITDA, as defined, and net worth levels, maximum
leverage (total adjusted debt divided by EBIDTA), and maximum capital
expenditures limits. The Senior Notes contain several similar, though generally
less restrictive, affirmative and negative covenants of Xerox.
Any failure of XC to be in compliance with any material provision of the New
Credit Facility or the Senior Notes could have a material adverse effect on
XC's liquidity and operations and, because we are dependent upon XC for our
liquidity and have guaranteed the obligations of XC under the New Credit
Facility and the Senior Notes, such failure by XC to be in compliance could also
have a material adverse effect on our liquidity and operations.
3
XEROX CREDIT CORPORATION
Form 10-Q
June 30, 2002
Table of Contents
Page
----
Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets 6
Condensed Consolidated Statements of Income 7
Condensed Consolidated Statements of Cash Flows 8
Notes to Condensed Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Results of Operations 15
Capital Resources and Liquidity 16
Xerox Corporation Discussion 18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 38
Part II - Other Information
Item 1. Legal Proceedings 39
Item 2. Changes in Securities 39
Item 3. Defaults Upon Senior Securities 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 39
Signature 41
Exhibits
Exhibit 4(d)(5) Second Supplemental Indenture dated as of July 30,2002
between Xerox Corporation ("Xerox"),the Guarantors named
therein and Wells Fargo Bank Minnesota, National Association
("Wells Fargo "),as Trustee, to the Indenture dated as of
January 17, 2002 among Xerox and Wells Fargo, as trustee, as
supplemented by the First Supplemental Indenture, dated as of
June 21, 2002 between Xerox, the Guarantors named therein and
Wells Fargo, as trustee, relating to Xerox's 9-3/4% Senior
Notes due 2009 (denominated in U.S. Dollars).
4
Exhibit 4(d)(6) Second Supplemental Indenture dated as of July 30,2002
between Xerox, the Guarantors named therein and Wells Fargo, as
Trustee, to the Indenture dated as of January 17,2002 among
Xerox and Wells Fargo, as trustee, as supplemented by the First
Supplemental Indenture, dated as of June 21,2002 between Xerox,
the Guarantors named therein and Wells Fargo, as trustee,
relating to Xerox's 9-3/4% Senior Notes due 2009 (denominated
in Euros).
Exhibit 99.1 Chief Executive Officer and Chief Financial Officer
Certification Pursuant to Section 906 of Sarbanes-Oxley Act of
2002.
5
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
- ------- -------------------------------------------
XEROX CREDIT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions)
ASSETS
June 30, December 31,
2002 2001
---- ----
(UNAUDITED)
Cash and cash equivalents $ - $ -
Investments:
Contracts receivable 2,051 3,244
Unearned income (190) (331)
Allowance for losses (63) (78)
------- -------
Total investments 1,798 2,835
Notes receivable - Xerox and affiliates 1,390 1,377
Derivative and other assets 94 76
------- -------
Total assets $ 3,282 $ 4,288
======= =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Notes payable within one year:
Commercial paper $ - $ -
Current portion of notes payable after one year 791 1,630
Current portion of secured borrowing 72 130
Notes payable after one year 1,643 1,743
Secured borrowing due after one year - 24
Due to Xerox Corporation, net 43 40
Accounts payable and accrued liabilities 8 10
Derivative liabilities 5 53
------- -------
Total liabilities 2,562 3,630
------- -------
Shareholder's Equity:
Common stock, no par value, 2,000 shares
authorized, issued, and outstanding 23 23
Additional paid-in capital 219 219
Retained earnings 481 424
Accumulated other comprehensive income (3) (8)
------- -------
Total shareholder's equity 720 658
------- -------
Total liabilities and shareholder's equity $ 3,282 $ 4,288
======= =======
See accompanying notes.
6
XEROX CREDIT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In Millions)
Three Months Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001*
---- ---- ---- ----
Earned income:
Contracts receivable $ 50 $ 121 $ 111 $ 247
Xerox note receivable 31 - 56 -
--- --- --- ---
Total earned income 81 121 167 247
--- --- --- ---
Expenses:
Interest 39 84 69 161
Derivative fair value
adjustments, net (2) 8 1 7
General and administrative 1 3 4 6
--- --- --- ---
Total expenses 38 95 74 174
--- --- --- ---
Income before income taxes 43 26 93 73
Provision for income taxes 17 10 36 28
--- --- --- ---
Net income before cumulative
effect of change in accounting
principle 26 16 57 45
Cumulative effect of change in
accounting principle (less income
tax benefit of $1) - - - (3)
--- --- --- ---
Net income $ 26 $ 16 $ 57 $ 42
=== === === ===
See accompanying notes.
*As Restated, see Note 2.
7
XEROX CREDIT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In Millions)
Six Months Ended
June 30,
--------
2002 2001*
---- ----
Cash Flows from Operating Activities
Net income $ 57 $ 42
Adjustments to reconcile net income to net cash
provided by operating activities:
Net loss (gain) on derivative instruments 1 7
Net change in other operating assets and liabilities (3) (6)
Derivative collateralization payment (15) -
Change in due to Xerox Corporation, net 11 10
------ ------
Net cash provided by operating activities 51 53
------ ------
Cash Flows from Investing Activities
Purchases of investments - (912)
Proceeds from investments 774 998
Receipts from Xerox, net 74 -
Proceeds from sales of contracts receivable 253 -
Proceeds from sale of other assets - 23
------ ------
Net cash provided by investing activities 1,101 109
------ ------
Cash Flows from Financing Activities
Change in commercial paper, net - (32)
Payments on notes with Xerox and affiliates, net - (4)
Principal payments on long-term debt (1,152) (126)
------ ------
Net cash used in financing activities (1,152) (162)
------ ------
Increase in cash and cash equivalents - -
Cash and cash equivalents, beginning of period - -
------ ------
Cash and cash equivalents, end of period $ - $ -
====== ======
See accompanying notes.
* As restated, see Note 2.
8
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation:
The unaudited condensed consolidated interim financial statements presented
herein have been prepared by Xerox Credit Corporation (referred to below as
"us", "we" or "our") in accordance with the accounting policies described in
our 2001 Annual Report on Form 10-K (the 2001 Annual Report) and the interim
period reporting requirements of Form 10-Q. Accordingly, certain information and
note disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. You should read the unaudited condensed consolidated financial
statements in conjunction with such 2001 Annual Report notes thereto.
In our opinion, all adjustments (including normal recurring adjustments) which
are necessary for a fair presentation for the interim periods presented have
been made. Interim results of operations are not necessarily indicative of the
results for the full year.
The prior year's unaudited condensed consolidated financial statements as of and
for the three months ended March 31, 2001 have been restated (See Note 2).
We and Xerox Corporation ("XC") engage in extensive intercompany transactions
and we receive all of our operational and administrative support from XC. By
their nature, transactions involving related parties cannot be presumed to be
carried out on the same basis as transactions among wholly-unrelated parties.
Liquidity - Our liquidity is dependent upon the liquidity of our ultimate
parent, Xerox Corporation ("XC", and together with its subsidiaries, "Xerox").
Accordingly, the following is a disclosure regarding the liquidity of both XC
and us.
Historically, XC's 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 Xerox equipment, and for working capital
requirements, capital expenditures and business acquisitions. Xerox-specific
business challenges, which were discussed in the 2001 Annual Report, coupled
with significant competitive and industry changes and adverse economic
conditions, began to negatively affect XC's operations and liquidity in 2000.
These challenges, which were exacerbated by significant technology and
acquisition spending, impacted Xerox's and our cash availability and created
marketplace concerns regarding XC's liquidity, which led to credit rating
downgrades and restricted access to capital markets.
XC's and our access to many of the aforementioned sources is currently limited
due to the below investment grade rating on XC's and our debt. XC's and our debt
ratings have been reduced several times since October 2000. These rating
downgrades have had a number of significant negative impacts on XC and us,
including the unavailability of uncommitted bank lines, very limited ability to
utilize derivative instruments to hedge foreign currency and interest rate
exposures, thereby increasing volatility to changes in exchange rates, and
higher interest rates on borrowings. Additionally, as more fully disclosed
below, XC is 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 XC's balance sheet.
On June 21, 2002, XC permanently repaid $2.8 billion on the Old Revolver. The
$4.2 billion New Credit Facility replaced the Old Revolver. However, XC
currently has no incremental borrowing capacity under the New Credit Facility
9
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
as the entire $4.2 billion is outstanding. Of the $2.8 billion payment, $1.0
billion represented a repayment of all of our borrowings under the Old Revolver.
We are not and cannot borrow under the New Credit Facility. In addition,
pursuant to the New Credit Facility, we are prohibited from purchasing any new
contracts receivable from XC.
The New Credit Facility is discussed in more detail in Note 7. The New Credit
Facility contains more stringent financial covenants than the Old Revolver,
including the following:
o Minimum EBITDA, as defined, (based on rolling four quarters);
o Maximum leverage (total adjusted debt divided by EBITDA);
o Maximum capital expenditures (annual test);
o Minimum consolidated net worth, as defined (quarterly test)
Any failure of XC to be in compliance with any material provision of the New
Credit Facility or the Senior Notes (see Note 7) could have a material adverse
effect on XC's liquidity and operations and, because we are dependent upon XC
for our liquidity and we have guaranteed XC's obligations under the New Credit
Facility and the Senior Notes, such failure by XC to be in compliance could also
have a material adverse effect on our liquidity and operations.
In addition, as part of XC's Turnaround Plan, XC has taken significant steps to
improve its 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, XC has been restructuring its
cost base. It has implemented a series of plans to resize its workforce and
reduce its cost structure through such restructuring initiatives. Key factors
influencing Xerox's liquidity include its ability to generate cash flow from an
appropriate combination of operating improvements as anticipated in the
Turnaround Plan and continued execution of the initiatives described above. XC
believes its liquidity is sufficient to meet current and anticipated needs,
including all scheduled debt maturities through at least the next twelve months.
However, Xerox's ability to maintain sufficient liquidity going forward 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 Xerox's liquidity and operations, and could
require Xerox 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. While XC believes it can successfully complete the alternative plans, if
necessary, there can be no assurance that such alternatives would be available
or that XC would be successful in implementing them.
(2) Correction of Error in Comparative Financial Statements:
Our 2001 first quarter and year-to-date unaudited condensed consolidated
financial statements have been restated to reflect a correction to interest
expense resulting from an error in calculating accrued interest on an interest
rate swap in 2000. The correction was properly reflected in the fourth quarter
and annual 2000 consolidated financial statements, as restated. A summary of the
restated amounts are as follows:
10
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in millions) Year-to-Date Year-to-Date
June 30, 2001 June 30, 2001
As Reported Adjustment Restated
Interest Expense $ 166 5 $ 161
Net Income 39 3* 42
2001 1st Quarter 2001 1st Quarter
As Reported Adjustment Restated
Interest Expense $ 82 5 $ 77
Net Income 23 3* 26
* Net of $2 million of taxes
(3) Xerox Corporation Support Agreement:
The terms of a Support Agreement with XC provide that we will receive income
maintenance payments, to the extent necessary, so that our earnings shall not be
less than 1.25 times our fixed charges. For purposes of this calculation, both
earnings and fixed charges are as formerly defined in Section 1404 Section 81(2)
of the New York Insurance Law. In addition, the agreement requires that XC
retain 100 percent ownership of our voting capital stock. There have been no
payments made under this agreement since 1990.
(4) Accounting Changes:
In 2001, the Financial Accounting Standards Board ("FASB") issued Statements
of Financial Accounting Standards No. 141 "Business Combinations" (SFAS No.
141), No. 142 "Goodwill and Other Intangible Assets" (SFAS No. 142), No. 143
"Accounting for Asset Retirement Obligations" (SFAS No. 143) and No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No.
144). We adopted these standards in 2002. The adoption of these standards is
not expected to have any impact on our financial reporting.
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 any impact on our financial reporting.
On July 29, 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred, rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. Previous
accounting guidance was provided by EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)."
11
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SFAS 146 replaces Issue 94-3 and is required to be applied prospectively to exit
or disposal activities initiated after December 31, 2002. We are currently
evaluating the impacts of this standard.
(5) Sales of Contracts Receivable:
In November 2001, XC entered into an agreement with GE Capital providing for the
sale by XC, from time-to-time, of certain lease contracts in the U.S. to a
special purpose entity (SPE) of XC, against which GE Capital would provide a
series of secured loans, up to a maximum amount of $2.6 billion ("Monetization
Agreement"). In connection with the Monetization Agreement, during the second
quarter and first half of 2002 we sold to XC an aggregate of $215 and $253
million, respectively, of contracts receivable. The sales to XC were accounted
for as sales of contracts receivable at book value, which approximated fair
value. We have no continuing involvement nor retained interests in the
receivables sold and all the risk of loss in such receivables was transferred
back to XC.
(6) Notes Receivable - Xerox and affiliates
We have made in the past, and will continue to make, demand loans to XC of all
proceeds from the sale or collection of our receivables. Such demand loans are
also required by the New Credit Facility. As of June 30, 2002 and December 31,
2001, demand loans to XC totaled $1,390 million and $1,377 million,
respectively. These loans bear interest at a rate equal to two percent plus the
average of the H.15 Two-Year Swap Rate and H.15 Three-Year Swap Rate (each as
defined in the master demand note dated November 20, 2001 ("Master Demand Note")
between XC and us). Consistent with the provisions of the New Credit Facility,
we will demand repayment of these loan amounts from XC to the extent necessary
to repay our maturing debt obligations and fund our operations. A copy of the
Master Demand Note is filed as an exhibit to our Annual Report on Form 10-K for
the Year Ended December 31, 2001.
The H.15 is a Federal Reserve Board Statistical Release (published weekly) which
contains daily interest rates for selected U.S. Treasury, money markets and
capital markets instruments.
(7) Notes Payable
On June 21, 2002, XC entered into the New Credit Facility with a group of
lenders, replacing the $7 billion Old Revolver. At that time, Xerox permanently
repaid $2.8 billion of the Old Revolver, of which we paid all of our $1.0
billion of borrowings under the Old Revolver using proceeds from XC's repayment
to us on the Master Demand Note (see Note 6). We are not and cannot borrow under
the New Credit Facility. In addition, pursuant to the terms of the New Credit
Facility, we are prohibited from purchasing any new contracts receivable from
XC.
Under the New Credit Facility, there are currently loans outstanding totaling
$4.2 billion consisting of three tranches of term loans totaling $2.7 billion
and a $1.5 billion revolving facility. The revolving facility includes a
currently unutilized $200 million letter of credit sub-facility. The three term
loan tranches include a $1.5 billion amortizing "Tranche A" term loan maturing
on April 30, 2005, a $500 million amortizing "Tranche B" term loan maturing on
April 20, 2005 and a $700 million "Tranche C" term loan which matures on
September 15, 2002. XC is the borrower of all of the term loans.
12
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
XC is 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 term loans
contractually mature on April 30, 2005, but XC could be required to repay
portions earlier 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 of 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 XC and by liens on the assets of
substantially all of its U.S. subsidiaries (excluding us) and are guaranteed by
substantially all of its U.S. subsidiaries (including us). Our guaranty of
obligations under the New Credit Facility, however, is subordinated to all of
our capital markets debt outstanding as of June 21, 2002.
Under the terms of certain of XC's 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) XC and (ii) XC's non-
financing subsidiaries that have a consolidated net worth of at least $100
million, without triggering a requirement to also secure those indentures, is
limited to the excess of (a) 20% of XC's consolidated net worth (as defined in
XC's 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") will vary from time to time with
changes in XC's 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 New Credit Facility loans generally bear interest at LIBOR plus 4.50%,
except that the Tranche B loan bears interest at LIBOR plus a spread that varies
between 4.00% and 4.50% depending on the Restricted Asset Security Amount in
effect from time to time. Specified percentages of any net proceeds XC receives
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, then
either (1) 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 or (2) 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. Notwithstanding the foregoing description,
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, inter-company loans and certain restricted payments, and a
requirement to transfer excess foreign cash, as defined, and our excess cash
13
XEROX CREDIT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
to Xerox in certain circumstances. Despite a general limitation on the creation
of liens, the New Credit Facility permits the creation of liens from time to
time in connection with the monetization or other financing of discrete pools of
receivables, leases and other financial assets by XC and its subsidiaries. Thus,
the New Credit Facility does not affect XC's or our ability to continue to
monetize receivables, including, in the case of XC, under the agreements with
GECC and others. In addition to other defaults customary for facilities of this
type, defaults on debt of, or bankruptcy of, XC or certain of its 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, as defined (rolling four quarters)
* Maximum Leverage (total adjusted debt divided by EBITDA)
* Maximum Capital Expenditures (annual test)
* Minimum Consolidated Net Worth, as defined (quarterly test)
In connection with the New Credit Facility, substantially all of XC's U.S.
subsidiaries, including us, guaranteed XC's obligations under $600 million of
9-3/4% Senior Notes and Euro 225 million of 9-3/4% Senior Notes due 2009
(collectively the "Senior Notes"). The Senior Notes contain several similar,
though generally less restrictive, affirmative and negative covenants.
Any failure of XC to be in compliance with any material provision of the New
Credit Facility of the Senior Notes could have a material adverse effect on XC's
liquidity and operations and, because we are dependent upon XC for our liquidity
and have guaranteed the obligations of XC under the New Credit Facility and the
Senior Notes, such failure by XC to be in compliance could also have a material
adverse effect on our liquidity and operations.
Copies of the New Credit Facility and certain related agreements and copies of
the indentures and related supplemental indentures for the Senior Notes (which
contain our guaranty), are incorporated by reference as exhibits to our 2001
Annual Report.
(8) Joint Venture
On May 1, 2002, Xerox Capital Services, LLC (XCS), XC's U.S. venture with GECC,
became operational. XCS, a consolidated entity of XC, manages Xerox's customer
administration and leasing activities in the U.S. including credit approval,
order processing, billing and collections. Upon commencement of the XCS joint
venture, XCS replaced XC as the provider of billing, collection and other
administrative services to us. Accordingly, subsequent to May 2002, we pay a fee
to XCS rather than to XC for these services. The rate paid per contract is
expected to be equal to the rate we formerly paid to XC.
14
Item 2. Management's Discussion and Analysis of Results of Operations and
- ---------------------------------------------------------------------------
Financial Condition
- ---------------------
Due to the fact that our liquidity is dependent upon the liquidity of XC, our
ultimate parent, Item 2 includes both our Management's Discussion and Analysis
of Financial Condition and Results of Operations (MD&A) and portions of XC's
MD&A. Each MD&A, or portion thereof, is separately presented. Certain matters
discussed in XC's MD&A will relate to events and transactions that do not
directly affect our liquidity.
RESULTS OF OPERATIONS - XEROX CREDIT CORPORATION
Until July 2001, our sole business was to purchase non-cancelable contracts
receivable arising from installment sales and lease contracts originated by the
domestic marketing operations of XC. Substantially all commercial, federal
government and taxable state and local government transactions originated by XC
were sold to us. However, in anticipation of the agreements between XC and GE
Capital, and GE Capital becoming the primary equipment financing provider for
Xerox customers in the U.S., we stopped purchasing new contracts receivable from
XC effective July 1, 2001. Our existing portfolio of contracts receivable will
ultimately run-off as amounts are collected or contracts are sold back to XC as
part of its continued monetization of the existing receivables portfolio.
Contracts receivable income represents income earned under an agreement with XC
pursuant to which we undertook the purchases noted above. The receivables arose
primarily from XC equipment being sold under non-cancellable installment sales
and lease contracts. Income from the Xerox note receivable represents amounts
earned on funds advanced to XC under the Master Demand Note.
Total earned income was $81 million and $121 million for the second quarter of
2002 and 2001, respectively, and $167 million and $247 million for the first
half of 2002 and 2001, respectively. Contracts receivable income declined by $71
million and $136 million for the second quarter and first half of 2002,
respectively, compared to the second quarter and first half of 2001 reflecting
the decrease in the portfolio of contracts receivable as a result of our
decision to discontinue purchasing receivables from XC in July 2001 as well as
the sales of receivables back to XC in 2001 and the first and second quarters of
2002. Offsetting the decline was earned income of $31 and $56 million in the
second quarter and first half of 2002, respectively, on the XC Master Demand
Note.
Interest expense was $39 million and $84 million for the second quarter of 2002
and 2001, respectively, and $69 million and $161 million for the first half of
2002 and 2001, respectively. The decrease reflects lower debt levels as a result
of the discontinuance of new purchases of contracts receivable and collections
on existing receivables being used to pay down debt in 2001. In addition, as a
result of most of our match funding swaps (pay fixed/receive variable) either
maturing or terminating in 2001, the majority of our debt bears interest at
variable rates and therefore we benefited from the lower interest rates in the
second quarter and first half of 2002 as compared to the second quarter and
first half of 2001. During the second quarter 2002, $1,020 million of debt was
repaid as part of XC's negotiation of a new credit facility. See Note 7.
The mark-to-market valuation of our interest rate derivatives resulted in a net
gain of $2 million for the second quarter and a net loss of $1 million in the
first half of 2002 as compared to a net loss of $8 million and $7 million in the
second quarter and first half of 2001, respectively. The year-to-date loss in
2002 primarily reflects the accretion of the loss booked at the adoption of SFAS
No. 133 in Accumulated Other Comprehensive Income for our match funding (pay
fixed/receive variable) swaps. This was partially offset by net gains on our
cross-currency interest rate swaps associated with our Yen
denominated borrowings. While all of our derivative instruments are intended to
economically hedge currency and interest rate risk, differences between the
15
contract terms of our derivatives and the underlying related debt result in our
inability to obtain hedge accounting treatment in accordance with SFAS No. 133.
This results in mark-to-market valuation of these derivatives directly through
earnings, which increases volatility in our earnings.
Operating and administrative expenses were $1 million and $3 million for the
second quarters of 2002 and 2001, respectively, and $4 million and $6 million
for the first half of 2002 and 2001, respectively. These expenses are primarily
incurred to administer the contracts receivable purchased from XC. The decline
reflects the lower level of receivables as compared to the prior year.
The effective income tax rate for the second quarter of 2002 was 38.9%, which is
unchanged from the second quarter and full year of 2001.
CAPITAL RESOURCES AND LIQUIDITY - XEROX CREDIT CORPORATION
XC manages our cash and liquidity resources as part of its U.S. cash management
system. Accordingly, any cash we generate is remitted to XC, and we do not
maintain cash balances. Our liquidity is dependent on the continued liquidity of
XC. Due to our cessation of receivables purchases from XC in 2001 and our
decision to run-off or sell our existing portfolio of contracts receivable,
funds collected since mid-2001 have been loaned to XC under an interest bearing
Master Demand Note. We have in the past and will continue to make demand loans
to XC of all proceeds from the sale or collection of our receivables and we are
required to continue to lend such amounts to XC by the terms of the New Credit
Facility discussed below. We will continue to demand repayment of these loan
amounts by XC as and to the extent necessary to repay our maturing debt
obligations and fund our operations.
Net cash provided by operating activities was $51 million in the first half of
2002 as compared to $53 million in the first half of 2001. The add back for the
net change in the Due to Xerox Corporation account of $11 million in the first
half of 2002 and $10 million in the first half of 2001 is the result of timing
of income tax accruals due to Xerox versus payments made. Operating cash usage
in 2002 also reflects additional collateralization payments of $15 million
associated with certain derivative contracts.
Net cash provided by investing activities was $1,101 million in the first half
of 2002 as compared to $109 million in the first half of 2001. The 2002 amount
reflects the decision to discontinue purchasing new receivables from XC after
July 1, 2001 resulting in net collections from investments of $774 million,
compared to $86 million in 2001. The 2001 amount reflects reduced XC equipment
sale activity, as new contract purchases were exceeded by collections. 2002 also
reflects proceeds of $253 million from the sale of receivables back to XC as
described in Note 5 to the Condensed Consolidated Financial Statements. In
addition to contract collections and proceeds from the sale of receivables were
net receipts of $74 million from XC under the Master Demand Note. This net
amount reflects receipts from XC of $1,020 million for use in the repayment of
our revolver debt, which was repaid in connection with XC's negotiation of a new
credit facility as described in Note 7 to the Condensed Consolidated Financial
Statements. Partially offsetting this receipt were net advances to Xerox of
proceeds received from the collection and sale of contracts receivable. 2001
includes $23 million associated with the sale of certain assets.
The changes in operating and investing cash flows resulted in net cash used in
financing activities of $1,152 million in the first half of 2002 compared to
$162 million in the first half of 2001. 2002 reflects principal payments on
long-term debt, primarily the $1,020 million repayment of our revolver debt,
as no proceeds from new debt were received. 2001 reflects principal payments
on long-term debt and commercial paper of $126 million and $32 million,
respectively.
16
As of June 30, 2002, we had approximately $2.5 billion of debt outstanding of
which approximately $.6 billion is expected to be paid in the second half of
2002. We believe that the funds collected from our existing portfolio of
contracts receivable as well as amounts due under the Master Demand Note with XC
will be sufficient to meet our remaining maturing obligations.
On June 21, 2002, XC entered into an Amended and Restated Credit Agreement (the
"New Credit Facility") with a group of lenders, replacing the $7 Billion
Revolving Credit Agreement (the "Old Revolver") dated October 22, 1997. On June
21, 2002 we repaid the entire $1.0 billion we owed under the Old Revolver as
part of XC's total permanent repayment of $2.8 billion under the Old Revolver.
We are not, and will not become, a borrower under the New Credit Facility. In
addition, pursuant to the New Credit Facility, we are prohibited from purchasing
any new contracts receivable from XC. In connection with the aforementioned $1.0
billion repayment, XC paid us $1.0 billion of the then outstanding balance on
the Master Demand Note.
In connection with XC's Monetization Agreement with GE Capital, during 2002, we
sold back to XC an aggregate of $253 million of contracts receivable. The sales
to XC were accounted for as sales of contracts receivable at book value, which
approximated fair value. We have no continuing involvement or retained interests
in the receivables sold and all the risk of loss in such receivables was
transferred back to XC. XC continues to pursue alternative forms of financing
including monetization of portions of its U.S. finance receivables portfolio,
which underlies our contracts receivable. Any such future monetizations by XC
could further reduce our portfolio if we sell contracts receivable back to XC.
Any funds received on such sales will be loaned to XC under the interest bearing
Master Demand Note.
Financial Risk Management
- -------------------------
We are exposed to market risk from changes in interest rates and foreign
currency exchange rates that could affect our results of operations and
financial condition. We have historically entered into certain derivative
contracts, including interest rate swap agreements and foreign currency swap
agreements, to manage interest rate and foreign currency exposures. However, the
recent downgrades of our and XC's indebtedness have effectively eliminated our
ability to manage this exposure as our ability to currently enter into new
derivative contracts is severely constrained. Furthermore, 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 described below. For this reason, we anticipate volatility in our
results of operations due to market changes in interest rates and foreign
currency rates. Therefore, while our overall risk management strategy is as
explained below, our ability to employ that strategy effectively has been
severely limited. Any further downgrades of XC's or our debt could further limit
our ability to execute this risk management strategy effectively.
To assist in managing our interest rate exposure and match funding our principal
assets, we routinely use certain financial instruments, primarily interest rate
swap agreements. 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. 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
17
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. We do not enter into derivative
instrument transactions for trading purposes and employ long- standing policies
prescribing that derivative instruments are only to be used to achieve a set of
very limited match funding and liquidity objectives.
Since our liquidity is heavily dependent upon the liquidity of our ultimate
parent, XC, we are including the following excerpts from Management's Discussion
and Analysis of Financial Statements and Results of Operations, including
Capital Resources and Liquidity, as reported in the Xerox Corporation Quarterly
Report on Form 10-Q for the Quarter Ended June 30, 2002.
READER'S NOTE: THE FOLLOWING DISCUSSION HAS BEEN EXCERPTED DIRECTLY FROM XEROX
CORPORATION'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30,
2002.DEFINED TERMS HEREIN MAY NOT NECESSARILY HAVE THE SAME MEANING AS THE SAME
DEFINED TERMS HAVE IN OTHER PARTS OF THIS DOCUMENT. SUCH TERMS SHOULD BE READ IN
THE NARROW CONTEXT IN WHICH THEY ARE DEFINED IN THIS SECTION. REFERENCES TO
"WE", "OUR", AND "US" REFER TO XEROX CORPORATION. ADDITIONALLY, AMOUNTS AND
EXPLANATIONS CONTAINED IN THIS SECTION ARE MEANT TO GIVE THE READER ONLY A
GENERAL SENSE OF XC'S OPERATIONS, CAPITAL RESOURCES AND LIQUIDITY. ACCORDINGLY,
THESE EXCERPTS SHOULD BE READ IN THE CONTEXT OF THE XC CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS, WHICH ARE INCLUDED IN XEROX CORPORATION'S QUARTERLY REPORT
ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002 FILED SEPARATELY WITH THE SEC.
Summary
Revenue
- -------
Total second quarter 2002 revenues of $4.0 billion declined 8 percent from $4.3
billion in the second quarter of 2001 reflecting continued economic weakness and
marketplace competition. Approximately two percentage points of the decline were
due to our second half 2001 exit from the Small Office/Home Office (SOHO)
business and declines in our Developing Markets Operations (DMO) as we continue
to prioritize liquidity and profitable revenue. Monochrome revenues declined as
Document Centre digital multifunction revenue growth, reflecting continued
customer transition to connected office devices, was more than offset by light
lens and production printing and publishing declines. Second quarter 2002
results included improved gross margins and reduced selling, administrative and
general expenses reflecting the benefits from our cost saving initiatives.
During the second quarter 2002 we were profitable in all geographies: North
America, Europe and DMO.
Total revenues of $7.8 billion declined 9 percent from $8.6 billion in the first
half of 2002. Approximately one quarter of the year-to-date decline was due to
declines in SOHO and DMO. The remaining decline occurred in all operating
segments reflecting the effects of lower equipment population in all
geographies, competitive pressures, a weak economic environment and our focus on
more profitable revenue.
Net Income (Loss)
- -----------------
Second quarter 2002 net income of $93 million, or $0.12 cents per diluted share,
included after-tax restructuring charges of $41 million ($53 million pre-tax),
and net after-tax losses from unhedged foreign currency exposures of $24 million
($33 million pre-tax). The second quarter 2001 net loss of $101 million, or
$0.14 cents per share, included after-tax restructuring charges of $222 million
($295 million pre-tax), net after-tax losses from unhedged
18
foreign currency exposures of $10 million ($13 million pre-tax), after-tax
goodwill amortization of $15 million ($16 million pre-tax) and an after-tax gain
of $18 million ($30 million pre-tax) reflecting the early extinguishment of
debt. The gain from debt extinguishment was previously classified as an
extraordinary item; this classification has changed due to the adoption of
Statement of Financial Accounting Standards ("SFAS") No.145 issued in April 2002
and discussed in the "Other expenses, net" section of this Management's
Discussion and Analysis.
Net income for the six months ended June 30, 2002 was $47 million, or $0.06
cents per diluted share compared with $126 million or $0.15 cents per diluted
share for the same period in the prior year. Net income for the first half of
2002 included after-tax restructuring charges of $142 million ($199 pre-tax), an
after-tax charge of $44 million ($72 million pre-tax) for permanently impaired
capitalized software and net after-tax losses from unhedged foreign currency
exposures of $46 million ($57 million pre-tax). Net income for the six months
ended June 30, 2001 included the following items: a $300 million after-tax gain
($769 pre-tax) on the sale of half our interest in Fuji Xerox, after-tax
restructuring charges of $303 million ($424 million pre-tax), net after-tax
gains from unhedged foreign currency exposures of $34 million ($51 million
pre-tax), after-tax goodwill amortization of $31 million ($33 million pre-tax)
and an after-tax gain of $35 million ($58 million pre-tax) reflecting the early
extinguishment of debt.
Pre-Currency Amounts
To understand the trends in our business, we believe that it is helpful to
adjust revenue and expense amounts (except for ratios) to exclude the impact of
changes in the translation of European and Canadian currencies into U.S.
dollars. We refer to these adjusted amounts as "pre-currency." Latin American
currencies are shown at actual exchange rates for both pre-currency and
post-currency reporting, since these countries generally have volatile currency
and inflationary environments.
A substantial portion of our consolidated revenues is derived from operations
outside of the United States where the U.S. dollar is not the functional
currency. When compared with the average of the major European and Canadian
currencies on a revenue-weighted basis, the U.S. dollar was approximately 3
percent weaker and 4 percent stronger in the second quarter and first quarter of
2002, respectively, than it was in the comparable periods of the prior year. As
a result, foreign currency translation favorably impacted revenue by
approximately one percentage point in the second quarter 2002 and was flat in
the first half of 2002.
Revenues by Type
Year-over-year post currency percent changes by type of revenue on a quarterly
basis were as follows:
2001 2002
------------------------------------------------------ --------------------
First Second Third Fourth First Second
Quarter Quarter Quarter Quarter Full Year Quarter Quarter
-------- --------- -------- -------- --------- ------- --------
Equipment sales (1) (10)% (20)% (19)% (21)% (18)% (19)% (15)%
Post sale and other revenue (1) (5)% (7)% (6)% (8)% (6)% (7)% (5)%
Finance Income 1 % (1)% (7)% (5)% (3)% (10)% (13)%
Total Revenue (6)% (10)% (9)% (12)% (9)% (10)% (8)%
(1) Total sales revenue in the Condensed Consolidated Statement of Income
includes equipment sales noted above, as well as, supplies, paper and other
revenue that is included in "Post Sale and Other Revenue" in the above
table.
19
Year-over-year post currency percent changes by type of revenue on a quarterly
basis were as follows:
Six Months Ended
-----------------------------
June 30, 2002 June 30, 2001
------------- -------------
Equipment sales (1) (17%) (15%)
Post sale and other revenue(1) (6%) (6%)
Finance Income (11%) -
Total Revenue (9%) (8%)
(1) Total sales revenue in the Condensed Consolidated Statement of Income
includes equipment sales noted above, as well as, supplies, paper and other
revenue that is included in "Post Sale and Other Revenue" in the above
table.
Equipment sales typically represent approximately 20-25 percent of total
revenue. Equipment sales in the second quarter 2002 declined 15 percent from the
second quarter 2001 with approximately three percentage points of the decline
due to our exit from the SOHO business. While office color printer growth was
excellent, continued competitive pressures and economic weakness adversely
impacted equipment sales in most other areas.
Equipment sales in the first half of 2002 declined 17 percent from the first
half of 2001 reflecting competitive pressures, continued weakness in the economy
and our focus on profitable revenue. Approximately 4 percentage points of the
decline was due to our previously discussed exit from SOHO.
Post sale and other revenues include service, document outsourcing, rentals,
supplies and paper, which represent the revenue streams that follow equipment
placement, as well as revenue not associated with equipment placement, such as
royalties. Second quarter and year-to-date 2002 post sale and other revenues
declined 5 percent and 6 percent from the 2001 second quarter and first half of
2001, respectively, reflecting lower equipment populations due to reduced
placements in earlier periods and lower page print volumes.
Document outsourcing revenues are split between equipment sales and post sale
and other revenue. Where document outsourcing contracts include revenue
accounted for as equipment sales, this revenue is included in equipment sales,
and all other document outsourcing revenues, including service, equipment
rental, supplies, paper, and labor are included in post sale and other revenues.
2002 second quarter document outsourcing revenue declined 8 percent (9 percent
pre-currency) from the 2001 second quarter as revenue growth in Europe was more
than offset by declines in North America. Document outsourcing revenue for the
first half of 2002 declined approximately 9 percent from the first half of 2001.
In the 2002 second quarter, the estimated value of future document outsourcing
revenue from existing contracts declined 11 percent to approximately $6.8
billion from approximately $7.6 billion in the 2001 second quarter. These values
are determined as the estimated services to be provided under committed
contracts as of a point in time. We expect total document outsourcing revenue to
continue to decline as we focus on more profitable service contracts. This will
be partially offset by our intensified focus on customers who are seeking a
bundled value added solution.
Finance Income declined 13 percent in the second quarter 2002 from the second
quarter 2001 and 11 percent in the first half of 2002 from the first half of
2001. Declines reflect continued equipment sale declines and the initial effects
of our transition to third party financing, primarily in Europe. Third party
financing arrangements were in place for the second quarter in the Nordic
countries, Italy and the Netherlands. During the second quarter 2002, we
transitioned certain equipment financing to third parties in Germany, Mexico and
Brazil.
20
Key Ratios and Expenses
The key ratios for 2002 and 2001 were as follows:
2001 2002
---------------------------------------------------- -------------------
Second
First -------- Third Fourth Full First Second
Quarter Quarter Quarter Quarter Year Quarter Quarter
------- ------- ------- ------- ------- ------- --------
Gross Margin 34.8% 39.1% 37.6% 41.4% 38.2% 41.0% 42.5%
Research and development expenses (1) 5.8% 6.0% 6.3% 5.3% 5.9% 6.0% 6.1%
Selling, administrative and general expenses(1) 26.8% 28.5% 29.0% 27.0% 27.8% 30.3% 28.1%
(1) As a percentage of Total Revenue
The key ratios for 2002 and 2001 were as follows:
Six Months Ended
June 30, June 30,
2002 2001
------------- --------------
Gross Margin 41.8% 36.9%
Research and development expenses (1) 6.0% 5.9%
Selling, administrative and general expenses (1) 29.2% 27.6%
(1) As a percentage of Total Revenue
Second quarter 2002 gross margin of 42.5 percent improved 3.4 percentage points
from 39.1 percent in the second quarter 2001. Approximately two percentage
points of the increase reflect the prior liquidation of equipment inventory
associated with our SOHO exit. In addition, improved manufacturing and service
productivity more than offset the adverse impact of competitive price pressures.
Gross margin for the first half of 2002 of 41.8 percent improved 4.9 percentage
points from 36.9 percent in the first half of 2001. Improved manufacturing and
service productivity, favorable product mix, our SOHO exit and lower cost of
borrowings for our finance businesses more than offset the adverse impact of
competitive price pressures.
Research and development (R&D) expense of $240 million was $17 million lower in
the 2002 second quarter than the second quarter 2001. First half 2002 R&D
spending of $470 million was $38 million lower than in the first half of 2001.
The R&D expense reduction primarily reflects our SOHO exit, helped further by
benefits from cost restructuring actions. R&D spending in the 2002 second
quarter and first half of 2002 represented approximately 6 percent of revenue as
we continue to invest in technological development, particularly color, to
maintain our position in the rapidly changing document processing market. We
expect 2002 R&D spending will represent approximately 5-6 percent of revenue, a
level that we believe is adequate to remain technologically competitive. Xerox
R&D remains strategically coordinated with Fuji Xerox.
Selling, administrative and general (SAG) expenses declined by $110 million or 9
percent in the 2002 second quarter to $1,110 million. The decrease reflects
benefits from our Turnaround Program, partially offset by increased advertising
spending and higher professional fees associated with the SEC settlement,
restatement and related activities. Second quarter 2002 bad debt expense of $68
million was $25 million lower than 2001 primarily due to lower provisions in
North America due to reduced receivables associated with lower sales as well as
improved aging and historical write-off trends for both accounts and finance
receivables. First half 2002 SAG expense of $2,279 million declined $90 million
or 4 percent from the 2001 first half. The reduction reflects benefits from our
Turnaround Program, partially offset by a write-off of $72 million for
permanently impaired capitalized software. First half 2002 bad debt expense of
$171 million was only slightly lower than 2001 bad debt expense of $177 million
as the improvements in North America were partially offset by higher provisions
in Europe and DMO.
21
During the fourth quarter of 2000, we announced a Turnaround Program in which we
outlined a wide-ranging plan to sell assets, cut costs and strengthen our
strategic core business. In 2001 we exceeded our target by implementing actions
which are expected to reduce annualized costs by at least $1.1 billion. We have
continued to initiate additional actions in the first half of 2002 that are
expected to further reduce annualized costs by approximately $175 million, $70
million of which were initiated in the second quarter. As part of these
cost-cutting measures, we continue to record additional charges for initiatives
under the Turnaround Program. The recognition of such charges is based on having
a formal and committed plan, in accordance with existing accounting rules. As a
result of these actions and changes in estimates related to previously
established reserves, in the second quarter 2002, we provided an incremental $53
million, net of reversals of $9 million, primarily for new initiatives under the
Turnaround Program. We have provided $193 million, net of reversals of $19
million on a year-to-date basis during 2002. We expect additional provisions
will be required in 2002 as additional plans are finalized and are committed to.
The restructuring reserve balance at June 30, 2002 for the Turnaround Program
was $222 million.
Worldwide employment declined by approximately 2,200 in the 2002 second quarter
and approximately 6,500 in the 2002 first half to approximately 72,400 largely
as a result of employees leaving under our restructuring programs.
Other expenses, net for the three and six months ended June 30, 2002 and 2001
were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
($ in millions) 2002 2001 2002 2001
- --------------- ---- ---- ---- ----
Non-financing interest expense ........................... $ 60 $ 141 $ 141 $ 296
Currency losses (gains), net ............................. 33 13 57 (51)
Amortization of goodwill (2001 only) and intangible
assets.................................................... 9 22 19 45
Interest income .......................................... (22) (23) (43) (47)
Gain on early extinguishment of debt ..................... -- (30) -- (58)
SEC Civil Penalty ........................................ -- -- 10 --
Losses (gains) on sale of businesses and assets........... 12 5 (7) 6
All other, net ........................................... 15 16 20 11
----- ----- ----- ------
Total ............................................... $ 107 $ 144 $ 197 $ 202
===== ===== ===== ======
For the second quarter 2002, significantly lower non-financing interest expense
reflected lower debt levels and reduced borrowing costs, as the terms of the
higher interest rate new bank facility were only effective for a few days of the
quarter. In addition, the second quarter of 2002 includes $22 million of
mark-to-market gains related to interest rate swaps compared to $4 million in
the second quarter of 2001. Non-financing interest expense was $141 million in
the 2002 first half compared to $296 million in the same period of the prior
year due to lower 2002 debt levels and reduced borrowing costs. The proportion
of our debt that is subject to variable rates has increased significantly from
2001 which, coupled with the significant reduction in market interest rates has
resulted in a significant reduction in interest expense as compared to prior
year periods. However, the increased variable rate debt leaves us exposed to
higher interest expense if interest rates rise.
Net currency losses of $33 million in the 2002 second quarter primarily reflect
$24 million of exchange losses in Brazil and other DMO countries and a $9
million loss reflecting the impact of marking to market hedges on our underlying
trade exposures. The second quarter 2001 included losses of $13 million
primarily related to losses on Yen denominated debt. These currency exposures
are the result of net unhedged positions largely caused by our restricted access
to the derivatives markets. Although we have been able to re-enter the
derivatives market on a limited basis in 2002 to hedge certain balance sheet
exposures, we continue to remain largely unhedged in certain of
22
our DMO affiliates. Accordingly, we may continue to experience volatility in
this area in the future. Currency losses in the first half of 2002 were $57
million compared to gains of $51 in the first half of 2001. Net currency losses
for the first half of 2002 primarily reflect the Brazilian exchange losses
incurred in the second quarter and the devaluation of the Argentine Peso
compared to net exchange gains in 2001 primarily related to Yen denominated
debt.
Effective January 1, 2002, we adopted the provisions of SFAS No. 142 "Goodwill
and Other Intangible Assets." Accordingly, the amortization of goodwill was
discontinued in 2002 under SFAS No. 142. The second quarter 2001 included $16
million of goodwill amortization and the first half of 2001 included $33 million
of goodwill amortization.
Interest income is primarily derived from our invested cash balances. We expect
interest income will decline as a result of our lower cash balances following
our recent debt repayments, which included a partial pay-down on the Old
Revolver.
Effective April 1, 2002 we adopted the provisions of SFAS No. 145 "Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." Accordingly, we have reclassified the extraordinary gain
on extinguishment of debt, which was previously reported in the Consolidated
Statements of Income as an extraordinary item to Other expenses, net. The effect
of this reclassification was a decrease in Other expenses, net of $30 and $58
for the three and six months ended June 30, 2001.
In the second quarter 2002 we sold our Italian leasing subsidiary to a third
party for $200 million cash plus the assumption of $20 million of debt. The loss
on this transaction totaled $11 million, primarily related to recognition of
cumulative translation adjustment losses. In addition, in the first half of
2002, the sale of Prudential Insurance Company common stock associated with that
company's demutualization generated a $19 million gain. The $10 million civil
penalty is associated with our April 2002 settlement with the SEC.
Income Taxes, Equity in Net Income of Unconsolidated Affiliates and
Minorities' Interests in Earnings of Subsidiaries
The following table summarizes our consolidated Income taxes (benefits) and the
related effective tax rate for each respective period:
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
Pre-tax income (loss) $170 $(242) $117 $432
Income taxes (benefits) 67 (120) 47 321
Effective Tax Rate 39.4% 49.6% 40.2% 74.3%
The difference between the 2002 second quarter effective tax rate and the U.S.
statutory tax rate primarily related to losses in certain jurisdictions where we
are not providing tax benefits. Losses in such jurisdictions also represented
the primary difference between the 2002 year-to-date effective tax rate and the
U.S. statutory tax rate.
The 2001 second quarter effective tax rate was higher than the U.S. statutory
tax rate, which resulted in additional tax benefits, primarily due to the
favorable resolution of certain tax audit issues, partially offset by losses in
low tax jurisdictions or jurisdictions where we are not providing tax benefits.
On a year-to-date basis through June 30, 2001 the effective tax rate was higher
than the U.S. statutory tax rate, which resulted in an additional tax provision,
primarily due to the taxes incurred in connection with the sale of one-half of
our ownership interest in Fuji Xerox as well as losses in low tax jurisdictions
or jurisdictions where we are not providing
23
tax benefits, partially offset by the favorable resolution of certain tax audit
issues.
Our effective tax rate will change based on nonrecurring events (such as new
restructuring initiatives) as well as recurring factors including the
geographical mix of income before taxes and the related tax rates in those
jurisdictions. We expect that our consolidated 2002 effective tax rate will be
in the mid 50 percent range. Before restructuring charges, 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 consisted of our 25 percent
share of Fuji Xerox income as well as income from other smaller equity
investments. Lower equity in net income for the second quarter and first half of
2002 primarily reflects the reduction of Fuji Xerox net income due to weak
economic conditions in Japan and our reduced equity interest in Fuji Xerox
effective April 2001.
Minorities interest in earnings of subsidiaries increased by $15 million to $25
million in the second quarter 2002 and by $32 million to $49 million in the
first half of 2002 primarily due to the quarterly distribution on the
Convertible Trust Preferred Securities issued in November 2001.
Business Performance by Operating Segment
The following table summarizes our business performance by operating segment.
Revenue and year-over-year revenue percentage changes by operating segment were
as follows (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ----------------------------------------
2002 2001 Change 2002 2001 Change
-------- -------- ------- ---------- --------- -------
Production $ 1,370 $ 1,484 (8)% $ 2,688 $ 2,933 (8)%
Office 1,655 1,732 (4)% 3,293 3,473 (5)%
DMO 462 512 (10)% 910 1,016 (10)%
SOHO 56 96 (42)% 126 219 (42)%
Other 409 459 (11)% 793 933 (15)%
------- ------- ------- -------
Total $ 3,952 $ 4,283 (8)% $ 7,810 $ 8,574 (9)%
======= ======= ======= =======
Memo: Color $ 693 $ 687 1 % $ 1,312 $ 1,363 (4)%
Operating segment profit (loss) and margins were as follows (in millions):
Operating Segment Profit (Loss)
------------------------------------------------------------------------ Segment Margin
2001 2002 -----------------------
------------------------------------------------ ------------------- Second Second
First Second Third Fourth Full First Second Quarter Quarter
Quarter * Quarter* Quarter Quarter Year Quarter* Quarter* 2002 2001
------- ------- ------- ------ ----- ------- -------- ------ -----------
Production $112 $101 $ 73 $180 $466 $105 $125 9.1% 6.8%
Office 47 98 63 157 365 91 138 8.3% 5.7%
DMO (70) 5 (12) (48) (125) (5) 7 1.5% 1.0%
SOHO (79) (84) (54) 22 (195) 27 15 26.8% (87.5%)
Other (1) (42) (101) 35 (109) (112) (47) (11.5%) (9.2%)
----- ----- ----- ---- ----- ------ -----
Total $ 9 $ 78 $(31) $346 $402 $106 $238 6.0% 1.8%
----- ----- ----- ---- ----- ------ -----
* See reconciliation to total Company pre-tax profit (loss) for the
three and six months ended June 30, 2002 and 2001 included in Note 8 to the
condensed consolidated financial statements.
Note: For purposes of comparability, 2001 segment information has been
adjusted to reflect a change in measurement of segment profit or loss that
was implemented in 2002. The nature of the changes related primarily to
corporate expense and other allocations associated with internal
reorganizations made in 2002, as well as decisions concerning direct
applicability of certain overhead expenses to the segments. The adjustments
increased (decreased) full year 2001 revenues as follows: Production ($16),
Office ($16), DMO ($1), SOHO $3 and Other $30. The full year 2001 segment
profit was increased (decreased) as follows: Production $12, Office $24,
DMO $32, SOHO $2 and Other ($70).
24
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 in the second quarter of 2002 declined 8 percent (9
percent pre-currency) from the 2001 second quarter and declined 8 percent in the
first half of 2002 compared to the same period in the prior year. Production
monochrome declines reflect customer transition from light lens to digital
offerings and the continued movement to distributed printing and electronic
substitutes. Second quarter 2002 color production revenues were stable from the
2001 second quarter as accelerated growth in the DocuColor 2000 family and
modest DocuColor 12 growth was offset by declines in prior generation color
products reflecting continued marketplace competition. Color production revenues
decreased in the first half 2002 from the 2001 first half, as growth from
DocuColor 2000 products, was more than offset by declines in prior generation
color products reflecting continued marketplace competition and the weak
economy, particularly in the graphic arts market. In June 2002 we launched the
DocuColor 2240 and 1632 Printers/Copiers, which deliver affordability and speed,
with a benchmark cost for color pages of less than 10 cents a page. Improvements
in operating costs are supported by a new emulsion aggregation (EA) color toner,
which delivers superior quality and improved efficiency. Production revenues
represented approximately 35 percent of total revenue in both the second
quarters and first halves of 2002 and 2001.
Second quarter 2002 production segment profit increased by $24 million to $125
million and the segment margin improved by 2.3 percentage points to 9.1 percent.
2002 first half segment profit of $230 million increased by $17 million and the
margin improved by 1.3 percentage points to 8.6 percent. Improvements reflect
cost and expense benefits from our cost saving initiatives partially offset by
increased R&D spending.
Office revenues include our family of Document Centre digital multifunction
products, color laser, solid ink and monochrome laser 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. Second
quarter 2002 revenues declined 4 percent (5 percent pre-currency) from the 2001
second quarter reflecting accelerating reductions in light lens revenues,
particularly in North America, and reduced participation in very aggressively
priced competitive bids and tenders in Europe. Monochrome revenues declined as
growth in digital was insufficient to offset light lens declines. In June 2002
we launched the Document Centre 500 Series digital multifunction systems, which
bring unparalleled productivity and features to small and mid-sized workgroups
at significantly lower manufacturing costs. Digital devices now represent over
98 percent of our combined office light lens and digital equipment revenues.
Strong office color revenue growth reflects excellent activity from our Phaser
6200 laser and Phaser 8200 solid ink color printers launched in May 2002. They
are designed to fuel the migration to color in the office by offering cost and
print quality advantages that make it practical to replace black-and-white
printers. First half 2002 Office revenues declined 5 percent from the 2001 first
half. Office revenues represented 42 percent of total revenue in the second
quarter and first half of 2002 and 40 and 41 percent in the second quarter and
first half of 2001, respectively.
Second quarter 2002 office segment profit increased by $40 million to $138
million and the segment margin improved by 2.6 percentage points to 8.3 percent.
Segment profit increased by $84 million to $229 million in the first half of
2002 from the first half of 2001 and segment margin improved by 2.8 percentage
points to 7.0 percent. Improvements reflect expense benefits from our cost
saving initiatives and improved gross margins driven by our focus on more
profitable revenue and improved manufacturing and service productivity.
DMO includes operations in Latin America, the Middle East, India, Eurasia,
Russia and Africa. DMO revenue declined 10 percent (8 percent pre currency) in
the 2002 second quarter and 10% in the first half of 2002 compared to the same
period in the prior year. Approximately half the decline was due to major
25
economic disruptions in Argentina and Venezuela. In addition, revenue in Brazil
declined due to the weak economy and our continued focus on liquidity and
profitable revenue.
Second quarter 2002 DMO segment profit increased by $2 million to $7 million and
the segment margin improved by 0.5 percentage points to 1.5 percent, despite
increased unhedged currency losses of $26 million. Segment profit in the first
half 2002 improved by $67 million to $2 million compared to the same period in
the prior year. The improvements reflect significantly lower SAG spending
resulting from our cost saving initiatives and lower second quarter bad debt
provisions, offset by increased currency losses.
We announced our disengagement from our worldwide SOHO business in June 2001.
SOHO revenues now consist primarily of consumables for the inkjet printers and
personal copiers previously sold through indirect channels in North America and
Europe. Second quarter and first half 2002 SOHO revenues declined 42 percent
from 2001, primarily due to the absence of equipment revenue. Second quarter and
first half 2002 profitability reflects continued sales of high margin
consumables for the existing equipment population. We expect sales of these
supplies to continue over the next few years, but will decline over time as the
existing population of equipment is replaced.
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 and other non-allocated costs. 2002 second
quarter revenue declined 11 percent (13 percent pre currency) principally due to
higher inter-segment revenue eliminations which are recognized in the Other
operating segment (see Note 8 to the condensed consolidated financial
statements). The increased loss in the second quarter of 2002 reflects higher
advertising expense, higher professional fees related to the restatement and SEC
settlement, partially offset by lower non-financing interest expense. Revenue
declined 15 percent in the first half of 2002 compared to the first half of 2001
due to lower paper revenue and lower Xerox Connect revenues. The increased loss
for the first half 2002 reflects a write-off of $72 million of impaired
capitalized software in the first quarter of 2002, as well as higher advertising
expense, unfavorable currency impacts and the SEC civil penalty, partially
offset by lower non-financing interest expense and the gain on the Prudential
demutualization.
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 Xerox-specific business
challenges, which have been discussed in the Notes to the Consolidated Financial
Statements included in our 2001 Annual Report on Form 10-K. 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 SEC investigation since June 2000
and the accounting issues raised by the SEC, the SEC Staff advised us that we
could not make any publicly registered securities offerings. This additional
constraint had the effect of limiting our means of raising funds to those of
26
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:
o Since October 2000, uncommitted bank lines of credit and the unsecured
public capital markets have been largely unavailable to us.
o 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.
o 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.
o 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.
o 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.
o 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 our existing $290 million U.S. trade
receivable securitization facility, which we are currently
renegotiating with the counterparty, as described more fully below.
o 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 August 8, 2002, our senior and short-term debt ratings and outlooks were
as follows:
Senior
Debt Short Term
Rating Debt Rating Outlook
------ ----------- -------
Moody's B1 Not Prime Negative
S&P* BB-/B+* B* Negative*
Fitch BB- B Negative
* 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 our Corporate credit and senior
secured debt ratings 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
27
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 $7 billion
Revolving Credit Agreement (the "Old Revolver"). At that time, we permanently
repaid $2.8 billion of 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") 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
28
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 defaults under the New Credit Facility.
The New Credit Facility also contains financial covenants which the Old Revolver
did not contain, including:
o Minimum EBITDA, as defined (based on rolling four quarters)
o Maximum leverage (total adjusted debt divided by EBITDA)
o Maximum capital expenditures (annual test)
o Minimum consolidated net worth, as defined (quarterly test)
Failure to be in compliance with any material provision or covenant of the New
Credit Facility could have a material adverse effect on our liquidity and
operations.
We incurred total fees and expenses in connection with the New Credit Facility
of approximately $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.
29
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 June 30, 2002, and since that time, we have made
significant progress toward these objectives.
With respect to asset sale initiatives:
o 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.
o In March 2001, we sold half of our interest in Fuji Xerox to Fuji
Photo Film Co., Ltd. for $1,283 million in cash (we paid $346 million
in taxes in March 2002 related to this sale).
o 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 $53 million related to the sales of additional facilities
under that agreement.
o In July 2002, we sold all of our equity investment in Katun
Corporation for approximately $67 million of cash.
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:
o 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.
o 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.
o 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.
o In July 2002, we retired $32 million of long-term debt through the
exchange of 4 million shares of our common stock, which increased our
net worth by a nominal amount.
30
In connection with vendor financing and related initiatives:
o In 2001, we received $885 million in financing from GE Capital,
secured by portions of our finance receivable portfolios in the United
Kingdom, and in May 2002, we received an additional loan from GE
Capital of $106 million secured by portions of our finance receivable
portfolio in the U.K. At June 30, 2002, the remaining balances of
these loans totaled $438 million.
o 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.
o 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 June 30,
2002, the remaining debt totaled $261 million.
o 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.
o 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. 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. At June 30, 2002, the remaining balances of these loans totaled
$1,669 million.
o 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 receivables in Canada. Cash proceeds of $281
million were net of $8 million of escrow requirements and $2 million
of fees. At June 30, 2002, the remaining balance of this loan was $266
million.
o In the first quarter 2002, we formed a joint venture with De Lage
Landen International BV (DLL) which manages equipment financing,
billing and collections for our customers' equipment orders in the
Netherlands. This joint venture 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.
o 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.
31
o 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.
o In April 2002, we sold our leasing business in Italy to a third party
for $200 million in cash plus the assumption of $20 million of debt.
This sale is part of an agreement under which the third-party will
provide on-going, exclusive equipment financing to our customers in
Italy.
o 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. At June 30,
2002, the remaining balance of this loan was $68 million.
Cash and Debt Positions:
The following represents our aggregate debt maturity schedules by quarter for
the remainder of 2002 and all of 2003 (in billions):
2002 2003
----- -----
First Quarter $ 0.6
Second Quarter 1.2
Third Quarter $ 1.1 0.5
Fourth Quarter 1.0 1.4
----- -----
Full Year $ 2.1 $ 3.7
===== =====
With $1.9 billion of cash and cash equivalents on hand at June 30, 2002, we
believe our liquidity (including operating and other cash flows we will
generate) will be sufficient to meet operating cash flow requirements as they
occur and to satisfy all scheduled debt maturities for at least the next twelve
months. Additionally, as discussed throughout this Quarterly Report on Form
10-Q, 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.
We believe our liquidity is sufficient to meet current and anticipated needs,
including all scheduled debt maturities through at least the next twelve months.
Our ability to maintain sufficient liquidity going forward 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 profitability
growth and operating cash generation and (2) continued progress on our vendor
financing initiatives. Until such 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.
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. and Canadian loans from GE
Capital discussed above, which utilized SPEs as part of their structures, as of
June 30, 2002, we have entered into the following similar transactions which
were accounted for as debt on our balance sheets:
o 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 June 30, 2002, the remaining debt
under this facility totaled approximately $72 million.
o In 1999, XCC securitized certain finance receivables in the United
States, generating gross proceeds of $1,150 million. At June 30, 2002,
the remaining obligations in this facility had been substantially
repaid.
We have also entered into the following SPE transactions which were accounted
for as sales of receivables:
33
o 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 reduced the
size of its $315 million U.S. facility to a maximum of $290 million,
of which $229 million was utilized at June 30, 2002. 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 was subsequently fully repaid.
o In 1999, XCL securitized certain finance receivables, generating gross
proceeds of $345 million. At June 30, 2002, the remaining obligations
in this facility totaled $65 million, and we expect them to be fully
paid in 2002. This is the only outstanding SPE transaction with
recourse provisions that could be asserted against us.
In summary, at June 30, 2002, amounts owed by these receivable-related SPEs to
their investors totaled $2,568 million, of which $294 million represented
transactions we treated as asset sales, and the remaining $2,274 million is
reported as Debt in our Condensed Consolidated Balance Sheet. A detailed
discussion of the terms of these transactions, including descriptions of our
retained interests, is included in Note 6 to the Consolidated Financial
Statements of our 2001 Annual Report. We also utilized SPEs in our Trust
Preferred Securities transactions. Refer to Note 17 to the Consolidated
Financial Statements in our 2001 Annual Report for a detailed description of
these transactions.
Secured Debt - Summary:
The following table summarizes our secured and unsecured debt as of June 30,
2002 (in millions):
June 30, 2002
-------------
New Credit Facility - debt secured under the 20% net worth limitation $ 925(1)
New Credit Facility - debt secured outside the 20% limitation 905
New Credit Facility - unsecured 2,370(1)
Debt secured by finance receivables 2,780(2)
Capital leases 25
Debt secured by other assets 47
Senior Notes 790
Subordinated debt 614
Other Debt 5,802
-----
Total Debt $14,258
=======
(1) The amount of New Credit Facility debt secured under the 20% Consolidated
Net Worth limitation represents an estimate based on Consolidated Net Worth at
June 30, 2002 and an estimate of the amount of other debt, as defined, secured
under the 20% limitation. Any change to the amount indicated would
correspondingly change the amount of the unsecured portion of the New Credit
Facility.
(2) Of this amount, $2,274 is secured by assets owned by SPEs.
34
Equity Put Options:
During 1999, we sold 0.8 million equity put options for proceeds of $0.4
million. 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. There were no put options outstanding as
of June 30, 2002.
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 June 30, 2002 and 2001, cash and cash equivalents on hand totaled $1,891
million and $2,176 million, respectively, and total debt was $14,258 million and
$16,581 million, respectively. Total debt net of cash (Net Debt) decreased by
$408 million in the first half of 2002 and decreased by $2,482 million in the
first half of 2001. The consolidated ratio of total debt to common and preferred
equity was 5.5:1 and 6.4:1 as of June 30, 2002, and 2001, respectively. The
decrease in this ratio in 2002 reflects the partial paydown of the Old Revolver
in June 2002, offset partially by net losses and incremental borrowings during
that twelve-month period, the proceeds of which were used to accumulate cash
rather than being used to repay other debt.
The following summarizes our cash flows for the first six months of 2002 and
2001 as reported in our Condensed Statement of Cash Flows in the accompanying
Condensed Consolidated Financial Statements:
2001
2002 Restated
---- --------
Operating Cash Flows ....................................... $ 631 $ 733
Investing Cash Flows ....................................... 175 1,258
Financing Cash Usage ....................................... (2,945) (1,514)
Effect of exchange rate changes on cash and cash equivalents 40 (51)
------- -------
(Decrease) Increase in cash and cash equivalents ........... (2,099) 426
Cash and cash equivalents at beginning of period ........... 3,990 1,750
------- -------
Cash and cash equivalents at end of period ................. $ 1,891 $ 2,176
======= =======
Excluding a 2002 tax payment of $346 million related to the 2001 sale of
one-half of our interest in Fuji Xerox, operating cash flows for the six months
ended June 30, 2002 improved compared to the prior year period. The resultant
increase in operating cash flows was primarily the result of improvements in our
management of working capital. Our performance related to finance and accounts
receivable, accounts payable and other liabilities improved versus the prior
year by over $400 million. This was partially offset by funding of operating
restricted cash balances during 2002 of almost $150 million. Such funding did
not exist in the prior year.
Investing cash flows for the six months ended June 30, 2002 largely consisted of
proceeds from sales of our Italian leasing business of $200 and certain
manufacturing locations to Flextronics of $53, partially offset by our capital
spending and certain restricted cash requirements. Investing cash flows from the
prior year period largely consisted of the $1,635 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 partially offset by our
capital spending as well as $255 million related to our funding of trusts to
replace Ridge Reinsurance letters of credit.
35
Financing activities for the six months ended June 30, 2002 largely consisted of
the $2.8 billion repayment under the renegotiated New Credit Facility, as well
as other payments of maturing debt, offset by proceeds from the 9 3/4 Senior
Notes offering and new secured borrowings from GE Capital. Financing activities
for the 2001 period largely consisted of debt repayments as well as dividends on
our common and preferred stock (which were suspended in the third quarter of
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 first quarter 2002 compared to 2001.
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, excluding Finance income and 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 that we employ,
as presented herein, may be different than definitions of EBITDA used by other
companies.
EBITDA and the related cash flows presentation for the six months ended June 30,
2002 and 2001 (in millions):
2002 2001
---- Restated
--------
Non-financing revenues .................................................. $ 7,296 $ 7,996
Non-financing cost of sales ............................................. 4,355 5,153
------- -------
Non-financing gross profit ...................................... 2,941 2,843
Research and development expenses ....................................... (470) (508)
Selling, administrative and general expenses ............................ (2,279) (2,369)
Depreciation and amortization expense, excluding goodwill
and intangibles 540 635
------- -------
EBITDA .......................................................... 732 601
Working capital and other changes ....................................... (79) 217
Increase in on-lease equipment .......................................... (91) (181)
Cost of additions to land, buildings and equipment ...................... (71) (121)
Cash payments for restructurings ........................................ (183) (264)
Interest payments ....................................................... (334) (606)
Equipment financing ..................................................... 1,013 702
Debt repayments, net .................................................... (2,949) (1,419)
Dividends and other non-operating items ................................. (45) (138)
Proceeds from divestitures .............................................. (92)** 1,635
------- -------
Net (decrease) increase in cash and cash equivalents ............ $(2,099) $ 426
======= =======
** Amount includes the tax payments associated with the Fuji Xerox sale
explained below. Such amount is included in operating activities in our GAAP
Condensed Consolidated Statement of Cash Flows.
EBITDA improved in the first six months in 2002 over the same period in 2001
driven by lower costs resulting from our productivity actions, partially offset
by lower revenues. The decline in capital spending was due primarily to
significant spending constraints. The decline in on-lease equipment spending
reflected declining rental placement activity and populations, particularly in
our older-generation light lens products. The investments in working capital
were driven largely by an increase in restricted cash in 2002 related to secured
borrowings, a slower pace of inventory reductions versus
36
prior year, lower income tax refunds and a lower level of non-cash inventory and
accounts receivable provisions versus the prior year.
Significantly lower interest payments in first half of 2002 reflected reductions
of our debt levels together with lower market interest rates.
The increase in cash flow from Equipment financing in 2002 was driven by a
continuing decrease of our finance receivable portfolio, resulting in greater
net cash collections, as continuing lower equipment sales levels continue to
result in a lower level of new finance receivable originations. Further, as the
portfolio continues to decrease, we are generating lower levels of Finance
income.
The net repayment of $2.9 billion of debt in the first half of 2002 includes the
$2.8 billion payment we made to our group of banks in connection with the
completion of the New Credit Facility.
Dividends and other non-operating items used $45 million of cash in 2002,
compared to usage of $138 million in 2001. This improvement was due to cash
savings resulting from our elimination and suspension of our common and Series B
Preferred dividends, respectively, which we announced in July 2001. In 2002, we
used $92 million of cash related to the sales of businesses, primarily due to
the first quarter 2002 payment of taxes due on the 2001 sale of half our
interest in Fuji Xerox, partially offset by the proceeds received from the
second quarter 2002 sale of our leasing business in Italy. Cash restructuring
payments were $183 million and $264 million in first half of 2002 and 2001,
respectively. The status of the restructuring reserves is discussed in Note 5 to
the Condensed 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 interest
rate swaps are often used in place of more expensive fixed-rate
37
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.
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.
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.
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. 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 continued volatility in our results of
operations due to market changes in interest rates and foreign currency rates.
READER'S NOTE: THIS CONCLUDES THE DISCUSSION EXCERPTED DIRECTLY FROM XEROX
CORPORATION'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------- ----------------------------------------------------------
The information set forth under the caption "Capital Resources and Liquidity" in
Item 2 above is hereby incorporated by reference in response to this Item.
38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
- ------- -----------------
None.
Item 2. Changes in Securities
- ------- ---------------------
None.
Item 3. Defaults Upon Senior Securities
- ------- -------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
None.
Item 5. Other Information
- ------- -----------------
None.
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) Exhibits
Exhibit 3(a) Articles of Incorporation of Registrant
filed with the Secretary of State of
Delaware on June 23, 1980, as amended by
Certificates of Amendment thereto filed with
the Secretary of State of Delaware on
September 12, 1980 and September 19, 1988,
as further amended by Certificate of Change
of Registered Agent filed with the Secretary
of State of Delaware on October 7, 1986.
Incorporated by reference to Exhibit 3(a) to
Registrant's Annual Report on Form 10-K for the
Year ended December 31, 1999.
(b) By-Laws of Registrant, as amended through
September 1, 1992.
Incorporated by reference to Exhibit 3(b) to
Registrant's Annual Report on Form 10-K for the
Year Ended December 31, 2001.
Exhibit 4(d)(5) Second Supplemental Indenture dated as
of July 30,2002 between Xerox Corporation
("Xerox"),the Guarantors named therein and Wells
Fargo Bank Minnesota, National Association
("Wells Fargo "),as Trustee, to the Indenture
dated as of January 17, 2002 among Xerox and
Wells Fargo, as trustee, as supplemented by the
First Supplemental Indenture, dated as of June
21, 2002 between Xerox, the Guarantors named
therein and Wells Fargo, as trustee, relating to
Xerox's 9-3/4% Senior Notes due 2009
(denominated in U.S. Dollars).
Exhibit 4(d)(6) Second Supplemental Indenture dated as
of July 30,2002 between Xerox, the Guarantors
named therein and Wells Fargo, as Trustee, to
the Indenture dated as of January 17,2002 among
Xerox and Wells Fargo, as trustee, as
supplemented by the First Supplemental
Indenture, dated as of June 21,2002 between
Xerox, the Guarantors
39
named therein and Wells Fargo, as trustee,
relating to Xerox's 9-3/4% Senior Notes due 2009
(denominated in Euros).
Exhibit 99.1 Chief Executive Officer and Chief Financial
Officer Certification Pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
Current Reports on Form 8-K dated April 1, 2002, April 11, 2002
and June 21, 2002 reporting Item 5 "Other Events" were filed
during the quarter for which this Quarterly Report is filed.
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
XEROX CREDIT CORPORATION
August 13, 2002 BY: /S/ John F. Rivera
--------------------
John F. Rivera
Vice President, Treasurer and
Chief Financial Officer
41