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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
( X ) Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended: December 31, 2001
OR
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from: to
Commission file number: 1-8133
XEROX CREDIT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 06-1024525
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(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
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(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
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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 by check mark if disclosure of delinquent filers pursuant to Item 405
of regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. Not Applicable
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 May 31, 2002
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Common Stock 2,000
THIS DOCUMENT CONSISTS OF 71 PAGES
1
Forward - Looking Statements
From time to time we and our representatives may provide information, whether
orally or in writing, including certain statements in this Annual Report on Form
10-K which are forward-looking. These forward-looking statements and other
information are based on our beliefs as well as assumptions made by us based on
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 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 designed to 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 largely
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.
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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's discussions to consider monetizing
portions of its existing U.S. finance receivables portfolio as it pursues
alternative forms of financing 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 the Capital Resources and Liquidity section of
this 10-K Report. 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 the $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 and net worth levels, maximum leverage
(total adjusted debt divided by EBIDTA, as defined), 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 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, such failure by
XC to be in compliance could also have a material adverse effect on our
liquidity and operations.
3
PART I
ITEM 1. Business
Xerox Credit Corporation, a Delaware corporation (together with its subsidiaries
herein called the "Company", or "us" or "we" or "our" unless the context
otherwise requires), was organized on June 23, 1980. All of our outstanding
capital stock is owned by Xerox Financial Services, Inc. (XFSI), a holding
company, which is wholly-owned by Xerox Corporation (XC and together with its
subsidiaries Xerox unless the context otherwise requires).
We are primarily a funding entity, engaged until July 2001 in purchasing
long-term non-cancelable contracts receivable from XC which arise from
installment sales and lease contracts originated by the domestic marketing
operations of XC, and we raised debt in the capital markets to fund purchases of
these receivables.
Prior to July 2001, the financing of Xerox equipment was generally carried out
by us in the United States, and internationally by certain of XC's foreign
financing subsidiaries and divisions in most countries where Xerox operates. As
part of Xerox's Turnaround Plan (see Capital Resources and Liquidity), Xerox is
in the process of transitioning equipment financing to third parties whenever
practicable.
In September 2001, Xerox entered into framework agreements with General Electric
Capital Corporation (GE Capital) under which GE Capital (or an affiliate
thereof) (GECC) 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 GECC 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 and our existing portfolio of contracts will
ultimately run-off as amounts are collected or contracts are sold back to XC as
part of its efforts to monetize existing receivables. 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.
We have no international operations and do not purchase receivables from
international customers. Terms on our purchased contracts receivable range
primarily from three to five years. These purchases and the subsequent
administration of the receivables by XC have historically been undertaken
pursuant to the Amended and Restated Operating Agreement between XC and us (the
Operating Agreement). Under the Operating Agreement, XC transferred to us
whatever security interest it had in the receivables and equipment.
As noted, historically, XC provided billing, collection and other services
related to the administration of the receivables that we purchased from XC. We
paid a fee to XC for these services. Since XC provided these services, we
maintained minimal facilities and had no separate infrastructure or employees.
On May 1, 2002, Xerox Capital Services (XCS), XC's U.S. venture with GECC,
became operational. XCS now manages Xerox's customer administration and leasing
activities in the U.S. including credit approval, order processing, billing and
collections. Accordingly, subsequent to May 1, 2002, we now pay a fee to XCS
rather than to XC, for these services. The fees we pay to XCS are expected to be
equal to the fees paid to XC. XCS is accounted for in XC's financial statements
as a fully consolidated entity. XCS collects the receivables on our behalf.
Amounts due to us from receivable collections are
4
currently being retained by XC and result in an increase in our demand loan
receivable from XC; net of any amounts we owe XC for administrative fees.
Pursuant to a Support Agreement between XC and us, XC has agreed to retain 100%
ownership of our voting capital stock and make periodic payments to us to the
extent necessary to ensure that our annual pre-tax earnings available for fixed
charges equal at least 1.25 times our fixed charges. The Support Agreement
specifically provides that XC is not directly or indirectly guaranteeing any of
our indebtedness, liabilities or obligations. The Support Agreement may not be
terminated or modified while any of our debt for money borrowed is outstanding.
Historically, we have paid dividends to XFSI to the extent appropriate to ensure
the maintenance of a target debt-to-equity ratio. It was our intent to maintain
a target debt-to-equity ratio of 8 to 1. However, due to our cessation of
receivables purchases from XC and our decision to run-off or sell the existing
portfolio, we will no longer maintain a specific debt-to-equity ratio, and we
have no current intention to pay any dividends. We will continue to loan to XC,
on a demand basis, all proceeds from the sale or collection of our receivables.
In addition, we will demand repayment of these loan amounts from XC as and to
the extent necessary to repay our maturing debt obligations, fund our
operations, or for such other purposes that we determine appropriate.
ITEM 2. Properties
We do not directly own any facilities. Our principal executive offices in
Stamford, Connecticut are leased facilities of approximately 500 square feet of
office space. Xerox's North American Solutions Group, located in Rochester, New
York, uses less than 1,000 square feet of office space to house the support
personnel. These facilities are deemed adequate by management.
ITEM 3. Legal Proceedings
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
5
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Because we are a wholly owned subsidiary, there is no market for our common
shares. Dividends declared during the five years ended December 31 were as
follows (in millions):
1997 - $41; 1998 - None; 1999 - $170; 2000 - None; and 2001 - None.
ITEM 6. Selected Financial Data
5 Years in Review
(Dollars in millions, except per-share data) 2001 2000* 1999 1998 1997
---- ----- ---- ---- ----
Operations:
Earned income: Contracts receivable $ 400 $ 441 $ 435 $ 388 $ 351
Income from continuing operations 91 137 180 137 123
Net income 53 83 110 82 73
Financial position
Contracts receivable 3,244 6,355 5,653 5,789 4,796
Total assets 4,288 5,494 4,940 5,039 4,158
Consolidated capitalization
Short-term debt 1,760 880 2,902 3,720 2,384
Long-term debt 1,767 3,856 1,330 647 1,191
Total debt 3,527 4,736 4,232 4,367 3,575
Common shareholder's equity 658 613 530 590 508
Selected Data and Ratios
Common shareholders of record at year-end 1 1 1 1 1
* As Restated, see Note 2 to the Consolidated Financial Statements included in
Item 8
6
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Due to the fact that our liquidity is dependent upon the liquidity of XC, our
ultimate parent, Item 7 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 GECC
(see Note 3 to the Consolidated Financial Statements included in Item 8), and
GECC 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 its continued
monetization of the existing receivables portfolio.
Earned income on contracts receivable represents income earned under the
Operating Agreement. In 2001, we purchased contracts from XC totaling $908
million compared to $2,496 million and $2,911 million in 2000 and 1999,
respectively. The decrease in receivable purchases in 2001 was due to the
cessation of purchases from XC effective July 1, 2001, as described above, plus
a decrease in XC's volume of business. The decrease in receivables purchased in
2001 and 2000 as compared to 1999 was due to decreased equipment sales/leases in
the United States resulting from Xerox-specific issues as well as industry
conditions.
In July 2001, a special purpose entity (SPE) owned by XC completed the offering
of $513 million of floating rate asset backed notes and received cash proceeds
of $480 million net of $3 million paid for fees and expenses. As part of the
transaction, we sold back to XC $643 million of contracts receivable, which in
turn sold such receivables to the SPE as security for the asset backed notes.
Our transaction was accounted for as a sale of contracts receivable at book
value, which approximated fair value.
During 2001, XC entered into an agreement with GE Capital providing for the sale
by XC, from time to time, of certain lease contracts to a SPE of XC, against
which GE Capital would provide a series of secured loans (Monetization
Agreement). In connection with the Monetization Agreement, during the fourth
quarter of 2001 we sold to XC an aggregate of $949 million of existing contracts
receivable and during the first half of 2002 we sold to XC an aggregate $253
million additional contracts receivable. The sales to XC were accounted for as
sales of contracts receivable at book value, which approximated fair value.
Total earned income was $400 million, $441 million and $435 million for the
years ending December 31, 2001, 2000 and 1999, respectively. The decrease in
2001 reflects the sale of contracts receivable to XC as well as the run-off of
our portfolio resulting from the cessation of contracts receivable purchases
from XC effective July 2001. Although the year-end balance of contracts
receivable was reduced by over 50% in 2001 as compared to 2000, the decline in
earned income for the full year was less than expected, reflecting only an 11
percent decrease in the average level of receivables in 2001 as compared to
7
2000. This is because the majority of the sales of contracts receivable back to
XC did not occur until the fourth quarter. The 2000 increase over 1999 was
mainly due to a larger average portfolio of contracts receivable together with
higher interest rates.
Interest expense was $261 million, $292 million and $243 million for the years
ended December 31, 2001, 2000 and 1999, respectively. The 2001 decrease reflects
lower debt levels resulting from a reduction in the portfolio size. As noted
above, although the portfolio was significantly reduced by year-end, the
majority of the decrease did not occur until the fourth quarter, thereby
mitigating the decline in interest expense. The increase in 2000 as compared to
1999 was primarily due to a larger average portfolio of contracts receivable and
higher interest rates, which resulted in higher cost of borrowing for both XC
and us.
Prior to the fourth quarter of 2000, Xerox and we had employed a match funding
policy for financing assets and related liabilities. Under this policy, the
interest and currency characteristics of the indebtedness were, in most cases,
matched to the interest and currency characteristics of the contracts
receivable, and short-term debt was classified on our balance sheets as
long-term if we had the intent and ability to extend the maturities of that
debt. The recent credit rating downgrades of our debt significantly changed the
characteristics of our indebtedness and precluded us from maintaining our
historical match funding policy. We now expect to pay down our outstanding
obligations as they contractually mature, and our debt has been classified in
our consolidated balance sheets accordingly.
Operating and administrative expenses were $11 million in 2001 compared to $12
million in 2000 and 1999. These expenses primarily include payments to XC to
administer our contracts receivable that we purchased from XC.
The effective income tax rate was 38.9 percent in 2001, 2000, and 1999.
Effective January 1, 2001, we adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS No. 133) which requires companies to recognize all derivatives
as assets or liabilities measured at their fair value regardless of the purpose
or intent of holding them. Gains or losses resulting from changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, depending on whether a derivative is
designated as a part of a hedge transaction. Changes in fair value for
derivatives not designated as hedging instruments and the ineffective portions
of hedges are recognized in earnings in the current period. The adoption of SFAS
No. 133, resulted in a net cumulative after-tax loss of $3 million in the
statement of operations and a net cumulative after-tax loss of $20 million in
Accumulated Other Comprehensive Income. Further, as a result of recognizing all
derivatives at fair value, including the differences between the carrying values
of related hedged assets, liabilities and firm commitments, we recognize a $10
million increase in assets and a $33 million increase in liabilities.
The adoption of SFAS No. 133 has increased the potential future volatility of
our reported earnings and other comprehensive income. In general, the amount of
volatility will vary with the level of derivative and hedging activities and the
market volatility during any period. However, as more fully described in
management's discussion of capital resources and liquidity, our and XC's ability
to enter into new derivative contracts is severely constrained.
While our remaining portfolio of derivative instruments is intended to
economically hedge interest rate risks to the extent possible, differences
8
between the contract terms of our derivatives and the underlying related debt
reduce our ability to obtain hedge accounting in accordance with SFAS No. 133.
This results in mark-to-market valuation of the majority of our derivatives
directly through earnings, which accordingly leads to increased earnings
volatility. During 2001, in accordance with SFAS No. 133, we recorded a net loss
of $37 million on our derivative contracts. The majority of the loss was the
recognition of the change in fair value on our derivative contracts directly
through earnings as a result of our inability to obtain hedge accounting in
accordance with SFAS No. 133.
Application of Critical Accounting Policies
In preparing the financial statements and accounting for the underlying
transactions and balances, we apply our financial policies as disclosed in our
Notes to the Consolidated Financial Statements. The application of our
accounting policies generally does not involve significant estimates or demands
on management's judgement.
However, from time-to-time, in the normal course of business, we may securitize
or sell contracts receivable with or without recourse and/or discounts. The
receivables are removed from the Consolidated Balance Sheet at the time they are
sold and the risk of loss has transferred to the purchaser. However, we maintain
risk of loss on any retained interest in such receivables. Sales and transfers
that do not meet the criteria for surrender of control or were sold to a
consolidated special purpose entity (non-qualified special purpose entity)under
SFAS No. 140 are accounted for as secured borrowings. These transactions are
often complex, involve highly structured contracts between us and the buyer or
transferee and involve strict accounting rules application. The key distinction
in the application of the accounting rules to the structured contracts and
similar transactions (sale versus a secured borrowing) is the inclusion or
exclusion of the related receivables and or associated obligations that would or
would not be included in our Consolidated Balance Sheet, as well as any gain or
loss that would result in a sale transaction. In order for a transaction to
qualify as a sale, several accounting requirements must be met including the
surrender of control over the receivables and the existence of a bankruptcy
remote contract structure. Transactions not meeting these requirements must be
accounting for as a secured borrowings.
When we sell receivables, the value assigned to the retained interests in
securitized contracts receivable is based on the relative fair values of the
retained interest and sold in the securitization. We estimate fair value based
on the present value of future expected cash flows using management's best
estimates of the key assumptions, consisting of receivable amounts, anticipated
credit losses and discount rates commensurate with the risks involved. Gains or
losses on the sale of the receivables depend in part on the previous carrying
amount of the financial assets involved in the transfer, allocated between the
assets sold and the retained interests based on their relative fair value at the
date of transfer.
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 also dependent on the continual
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 demand note. We 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 under the terms of the New Credit Facility
described below. We will continue to demand these loan amounts from
9
XC to the extent necessary to repay our maturing debt obligations, fund our
operations, or for such other purposes that we determine appropriate.
Net cash used in operating activities was $6 million in 2001 compared with net
cash provided of $74 million in 2000 and $107 million in 1999. Adding back the
net losses on derivative instruments of $23 million in 2001, net income was
slightly lower in 2001 reflecting the decline in contracts receivable during
2001. The net change in operating assets and liabilities, reflecting a $35
million use of cash, is the result of lower tax and interest accruals primarily
due to lower income and debt levels, respectively. Operating cash usage also
reflects collateralization payments of $47 million associated with certain
derivative contracts. The 2000 decrease versus 1999 was due to lower net income
and lower accrued interest due to the timing of interest payments.
Net cash provided by investing activities was $1,236 million in 2001 compared to
a $622 million usage in 2000 and $129 million provided in 1999. The 2001 amount
reflects the decision to discontinue purchasing new receivables from XC after
July 1, 2001 resulting in net collections from investments of $998 million in
2001, compared to net purchases of investments of $622 million in 2000 and
$1,021 million in 1999. The decline in net purchases between 2000 and 1999
reflects decreased contract purchases as a result of XC's declining equipment
sales in the United States. 2001 also reflects proceeds of $1,592 million from
the sale of receivables back to XC as described in Note 3 to Consolidated
Financial Statements as well as $23 million associated with the sale of certain
assets as described in Note 6 of the Consolidated Financial Statements.
Offsetting these receipts were advances of $1,377 million to Xerox under the
Master Demand Note. The 1999 results include proceeds of $1,150 million from the
sale of receivables.
The changes in operating and investing cash flows resulted in net cash used in
financing activities of $1,230 million in 2001, compared to $548 million
provided by financing activities in 2000 and $236 million used in 1999. The
majority of the net cash provided from investments, either through collections
or sale of receivables, was used to pay down the amounts due to Xerox. Principal
payments on long-term debt amounted to $555 million in 2001 and no proceeds from
new debt were received in 2001. The change between 2000 and 1999 was primarily
due to the increase in term funding of $963 million which more than offset the
reduction of commercial paper and payments of notes payable to XC and
affiliates. The term funding increase includes the proceeds received from the
secured borrowing associated with the transfer of finance receivables as
described in Note 3 of the Consolidated Financial Statements. Also contributing
to the increase in 2000 was the absence of $170 million of dividend payments to
XC made in 1999 to maintain the debt-to-equity ratio at 8.0 to 1 in that year.
As of December 31, 2001, we had approximately $3.5 billion of debt outstanding
of which approximately $1.8 billion is expected to mature in 2002. This includes
$1.0 billion due under the Old Revolver (as defined below) which was repaid on
June 21, 2002 (see below). We believe that the funds collected from our existing
portfolio of contracts receivable as well as amounts due under the demand note
with XC will be sufficient to meet 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 Xerox'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 contracts receivable from XC. In connection with the
aforementioned $1.0
10
billion repayment, XC paid us $1.0 billion of the then, outstanding balance on
the demand note.
In connection with XC's Monetization Agreement with GE Capital, in March and May
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 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 increased 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 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
11
prescribing that derivative instruments are only to be used to achieve a set of
very limited match funding and liquidity objectives.
Many of the financial instruments we use are sensitive to changes in interest
rates. Interest rate changes result in fair value gains or losses on our term
debt and interest rate swaps, due to differences between current market interest
rates and the stated interest rates within the instrument. The loss in fair
value at December 31, 2001, from a 10% change in market interest rates would be
approximately $54 million for our interest rate sensitive financial instruments.
Our currency and interest rate hedging activity are typically unaffected by
changes in market conditions as forward contracts, options and swaps are
normally, when possible, held to maturity consistent with our objective to lock
in currency rates and interest rate spreads on the underlying transactions.
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 2001
Annual Report on Form 10-K.
READER'S NOTE: THE FOLLOWING DISCUSSION HAS BEEN EXCERPTED DIRECTLY FROM XEROX
CORPORATION'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001.
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 CONSOLIDATED FINANCIAL
STATEMENTS, WHICH ARE INCLUDED IN XEROX CORPORATION'S 2001 ANNUAL REPORT ON FORM
10-K FILED SEPARATELY WITH THE SEC.
Summary of Total Company Results
To understand the trends in our business, we believe that it is helpful to
adjust revenue and expense (except for ratios) to exclude the impact of changes
in the translation of European and Canadian currencies into U.S. dollars. We
refer to this adjustment as "pre-currency."
A substantial portion of our consolidated revenues is derived from operations
outside of the United States where the U.S. dollar is not the functional
currency. We generally do not hedge the translation effect of revenues
denominated in currencies where the local currency is the functional currency.
When compared with the average of the major European and Canadian currencies on
a revenue-weighted basis, the U.S. dollar in 2001 was approximately 3 percent
stronger than in 2000. The U.S. dollar was approximately 10 percent stronger in
2000 than in 1999. As a result, foreign currency translation unfavorably
impacted revenue growth by approximately one percentage point in 2001 and 3
percentage points in 2000.
Latin American currencies are shown at actual exchange rates for both
pre-currency and post-currency reporting, since these countries generally have
volatile currency and inflationary environments. In 2001, currency devaluations
in Brazil continued to impact our results, as the Brazilian Real devalued 22
percent against the U.S. dollar. The devaluation was 2 percent in 2000 and 35
percent in 1999.
Total revenues of $17.0 billion in 2001 declined 9 percent (8 percent
pre-currency) from 2000. Approximately 25 percent of the decline reflected the
12
loss in revenues resulting from the 2000 sale of our China operations and our
exit from the SOHO business in the second half of 2001. The remaining revenue
decline occurred in all operating segments, but was most pronounced in the
Developing Markets segment, which declined by $330 million or 14 percent from
2000 and the Production segment which declined by $433 million or 7 percent from
2000. Revenues in all geographies were impacted by marketplace competition,
further weakening of the worldwide economy and our reduced participation in
aggressively priced bids and tenders as we focus on improved profitability. We
expect total revenues to decline in 2002, reflecting the effects of our exit
from the SOHO business, lower equipment population in all geographies,
competitive pressures and the weak economic environment, partially offset by the
benefit of new product launches in the second half 2002. We expect finance
income will decline over time as we transition equipment financing to third
parties.
In 2000, revenues of $18.8 billion declined one percent (grew 2 percent
pre-currency) from 1999. 2000 revenues declined 5 percent (one percent
pre-currency) excluding the beneficial impact of the January 1, 2000 acquisition
of the Tektronix, Inc. Color Printing and Imaging Division (CPID). CPID is
discussed in Note 4 to the consolidated financial statements. Revenues in 2000
were impacted by a combination of the previously mentioned company specific
issues, increased competitive environment and some weaker European and Latin
American economies toward the latter part of the year.
Revenues by Type. Revenues and year-over-year changes by type of revenues were
as follows:
Revenues % Change
-------- --------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Restated Restated
($ in billions)
Equipment Sales ..................... $ 4.3 $ 5.3 $ 5.7 (18)% (9)%
Post Sale and Other Revenue ......... 11.6 12.3 12.1 (6) 2
Financing Income .................... 1.1 1.2 1.2 (3) (1)
----- ----- ----- --- ---
Total Revenues ................... $17.0 $18.8 $19.0 (9)% (1)%
===== ===== ===== === ===
Note 1: Post sale and other revenue include service, document outsourcing,
rentals, supplies and paper, which represent the revenue streams that follow
equipment placement, as well as other revenue not associated with equipment
placements, such as royalties.
Note 2: Revenue from document outsourcing arrangements of $3.7, $3.8 and $3.2
billion in 2001, 2000 and 1999, respectively, are included in all revenue
categories.
Note 3: Total Sales revenue in the Consolidated Statement of Operations includes
equipment sales noted above as well as $3.1, $3.5 and $3.3 billion of supplies
and paper and other revenue for 2001, 2000 and 1999, respectively.
2001 equipment sales declined 18 percent (17 percent pre-currency) from 2000.
Over one third of the decline was due to our exit from the SOHO business and the
sale of our China operations. Equipment sales in North America and Europe
declined 5 percent and 21 percent respectively from 2000, reflecting increased
marketplace competition, continued economic weakness and pricing pressures in
many major market segments. In Europe equipment sales also declined due to our
decision to reduce participation in aggressively priced bids and tenders as we
reorient our focus from market share to profitable revenue.
2000 equipment sales declined 9 percent (5 percent pre-currency) from 1999 due
to the combination of company specific business challenges, including sales
force disruption and turnover, increased competition and some weaker economies.
Excluding the beneficial impact of the CPID acquisition, 2000 equipment sales
declined 12 percent (9 percent pre-currency).
13
2001 post sale and other revenue declined 6 percent (5 percent pre-currency) or
5 percent (4 percent pre-currency) excluding the impact of the 2000 sale of our
China operations. Post sale and other revenue grew 2 percent (5 percent
pre-currency) in 2000 including the beneficial impact of the CPID acquisition.
Post sale and other revenues have been adversely affected by reduced equipment
populations and lower page print volumes.
Financing income declined 3 percent (2 percent pre-currency) in 2001 reflecting
lower equipment sales and the initial effects of our transition to third party
finance providers. Financing income declined one percent (grew 2 percent
pre-currency) in 2000. Financing income is determined by the discount rate that
is implicit in the lease agreements with our customers, after determination of
the fair value of the services and equipment included in a bundled lease
agreement with multiple deliverable elements. Refer to a discussion of our
leasing policies above in the Application of Critical Accounting Policies
section for more information. Financing income will generally be dependent on
the amount of new equipment leases that we enter. We expect finance income will
decline over time as we transition equipment financing to third parties.
Total document outsourcing revenues of $3.7 billion declined 2 percent (one
percent pre-currency) in 2001 and grew 19 percent in 2000. The backlog of future
estimated document outsourcing revenues was approximately $7.6 billion at the
end of 2001, a reduction of 7 percent from the end of 2000 and in line with
trends experienced elsewhere in our business. Our backlog is determined as the
estimated post-sale services and financing to be provided under committed
contracts as of a point in time.
Gross Margin
The trend in gross margin was as follows:
2001 2000 1999
---- ---- ----
Total Gross Margin/(1)/ ................... 38.2% 37.4% 42.3%
Gross Margin by revenue stream:
Sales/(2)/ ................................ 30.5 31.2 37.2
Service, Outsourcing/(2)/, and Rentals .... 42.2 41.1 44.7
Finance Income ............................ 59.5 57.1 63.0
/(1)/ Includes inventory charges of $42 million and $84 million associated with
2001 and 2000 restructuring actions. These changes impacted 2001 and 2000
total gross margin by 0.2 points and 0.4 points, respectively and sales
gross margin by 0.6 points and 1.0 point, respectively.
/(2)/ The equipment sales gross margin for document outsourcing is included in
the sales gross margin.
The 2001 gross margin of 38.2 percent increased by 0.8 percentage points from
2000, as improved manufacturing and service productivity more than offset
unfavorable mix and competitive price pressures, particularly in the production
monochrome business. Gross margin improved during 2001 from 34.7 percent in the
first quarter to 40.8 percent in the fourth quarter reflecting the benefits of
our cost base restructuring and exit from the SOHO business. We expect the 2002
gross margin will approximate 40 percent, reflecting the beneficial impacts of
continuing cost base restructuring, and our SOHO exit, partially offset by
competitive price pressures.
14
2000 gross margin of 37.4 percent was 4.9 percentage points below 1999.
Approximately half the decline was the result of production monochrome weakness
reflecting initial competitive product entry during a time when our sales force
was weakened as we realigned from a geographic to an industry structure. Higher
revenue growth in the lower margin document outsourcing business and SOHO inkjet
investments to build equipment population also contributed to the decline.
Finally, gross margin was also adversely impacted by competitive price pressure,
unfavorable transaction currency and temporary pricing actions implemented to
reduce inventory on certain products in the latter part of the year.
Manufacturing and other productivity improvements only partially offset the
above items.
Finance margins reflect interest expense related to our financing operations
based on our overall cost of funds, applied against the level of debt required
to support the Company's financed receivables.
Research and Development. 2001 Research and development (R&D) spending of $997
million declined 6 percent from 2000 primarily due to the SOHO disengagement.
2001 R&D spending represented approximately 6 percent of total revenues as we
continued to invest in technological development, particularly color, to
maintain our position in the rapidly changing document processing market.
Including CPID, R&D expense grew 4 percent in 2000 reflecting increased program
spending primarily for solid ink, solutions and the DocuColor iGen3, a
next-generation digital printing press technology which is scheduled to launch
in the second half 2002. We believe our R&D remains technologically competitive
and is strategically coordinated with Fuji Xerox, which invested $548 million in
R&D in 2001, for a combined total of $1,545 million. We are planning to launch
five new platforms this year, compared with two per year during the last several
years. We expect 2002 R&D spending will represent approximately 5 to 6 percent
of revenue, a level that we believe is adequate to remain technologically
competitive.
Selling, Administrative and General Expenses.
Selling, administrative and general (SAG) expenses as a percent of revenue were
as follows:
2001 2000 1999
---- ---- ----
SAG % Revenue ............................ 27.8% 29.4% 27.4%
SAG declined $790 million or 14 percent (13 percent pre-currency) in 2001 to
$4,728 million reflecting significantly lower labor costs and other benefits
derived from our Turnaround Program, temporarily lower advertising and marketing
communications spending and reduced SOHO spending, partially offset by increased
professional costs related to litigation, SEC issues and related matters. In
2001, SAG represented 27.8 percent of revenue, a 1.6 percentage point
improvement from 2000. We expect a mid-single digit decline in 2002 SAG spending
as we continue to implement cost cutting actions.
In 2000, SAG increased $314 million or 6 percent (9 percent pre-currency) to
$5,518 million. Excluding the CPID acquisition, SAG grew 3 percent (6 percent
pre-currency) reflecting increased sales force payscale and incentive
compensation, significant transition costs associated with implementation of the
European shared services organization, continued effects of the U.S. customer
administration issues and significant marketing, advertising and promotional
investments for our SOHO inkjet printer initiative.
Bad debt expense, which is included in SAG, was $438 million, $473 million and
$386 million in 2001, 2000 and 1999, respectively. Reduced 2001 provisions
15
reflect lower equipment sales partially offset by some reserve increases due to
the weakened worldwide economy. Provisions increased in 2000 due to continued
resolution of aged billing and receivables issues in the U.S. and Europe
resulting from the consolidation of our customer administration centers and
infrastructure changes and unsettled business and economic conditions in many
Latin American countries. Bad debt provisions as a percent of total revenue were
2.6 percent, 2.5 percent, and 2.0 percent for 2001, 2000 and 1999, respectively.
The agreements with GE Capital in the U.S. and Canada include new approaches to
managing most of our customer administrative functions. On May 1, 2002, XCS, our
U.S. venture with GE Capital Vendor Financial Services, became operational. XCS
manages our customer administration and leasing activities, including financing
administration, credit approval, order processing, billing and collections. We
will consolidate the operations of XCS in our financial statements and include
the XCS headcount with our employee statistics. We are completing the
negotiation of definitive agreements with GE Capital for the implementation of
the Canadian joint venture which is expected in the second half of 2002. Over
time we expect these arrangements will facilitate reduced back office and
infrastructure expenses and improve collection discipline. We expect this will
improve sales force productivity and customer satisfaction through improved
billing practices as well as reduce bad debt expense.
Restructuring Programs. Since early 2000, we have been restructuring our cost
base. We have implemented a series of plans to resize our workforce and reduce
our cost structure through three restructuring initiatives: the October 2000
Turnaround Program, the June 2001 SOHO disengagement and the March 2000
restructuring action. The execution of these actions and payment of obligations
continued through December 31, 2001, with each initiative in various stages of
completion. In total, we recorded restructuring provisions of $715 million in
2001 and $475 million in 2000, including $205 million and $64 million of asset
impairment charges in 2001 and 2000, respectively. As management continues to
evaluate the business, there may be supplemental charges for new plan
initiatives as well as changes in estimates to amounts previously recorded as
payments are made or actions are completed. We expect to complete the
initiatives associated with the programs in 2002 and will have new initiatives
going forward under the Turnaround Program. The restructuring programs are
discussed below and in Note 3 to the consolidated financial statements.
Turnaround Program: In October 2000, we announced our Turnaround Program and
recorded a restructuring provision of $105 million in connection with finalized
initiatives. This charge included estimated costs of $71 million for severance
associated with the worldwide resizing of our work force and $34 million
associated with the disposition of a non-core business. Over half of these
charges related to our Production segment with the remainder related to our
Office, DMO and Other segments. In 2001, we provided an incremental $403
million, net of reversals, for initiatives for which we had a formal and
committed plan. This provision included $339 million for severance and other
employee separation costs associated with the resizing of our work force
worldwide, $36 million for lease cancellation and other exit costs and $28
million for asset impairments. The aggregate severance and other employee
separation costs in 2001 and 2000 of $410 million were for the elimination of
approximately 7,800 positions worldwide. The majority of these charges related
to our Production and Office segments. The Turnaround Program restructuring
reserve balance at December 31, 2001 was $223 million.
SOHO Disengagement: In June 2001, we announced our disengagement from our
worldwide SOHO business. In connection with exiting this business, during 2001
we recorded a net charge of $239 million. The charge included provisions for the
elimination of approximately 1,200 positions worldwide, the closing of
facilities and the write-down of certain assets to net realizable value. The
16
charge consisted of $164 million of asset impairments, $49 million for lease
cancellation and other exit costs and $26 million in severance and related
costs. During the fourth quarter 2001, we sold our remaining inventory of
personal inkjet and xerographic printers, copiers, facsimile machines and
multi-function devices which were distributed primarily through retail channels
to small offices, home offices and personal users (consumers). We will continue
to provide current SOHO customers with service, support and supplies, including
the manufacturing of such supplies, during a phase-down period to meet customer
commitments, which will result in a declining revenue base over the next few
years. The SOHO disengagement restructuring reserve balance at December 31, 2001
was $23 million.
March 2000 and 1998 Restructurings: In March 2000, we recorded a provision of
$489 million as part of a worldwide restructuring program including asset
impairments of $30 million. During 2001 and 2000, we recorded net changes in
estimates for both the March 2000 and the 1998 restructuring programs which
reduced restructuring expense by $25 million and $125 million, respectively. As
of December 31, 2001, these programs had been substantially completed.
As a direct result of the various restructuring actions, we determined that
certain products were not likely to be sold in their product life cycle. For
this reason, in 2001 we recorded a $42 million charge to write-down excess and
obsolete inventory, $34 million of which resulted from the disengagement from
our SOHO operations. In 2000, we recorded a charge of $84 million primarily as a
result of the consolidation of distribution centers and warehouses and the exit
from certain product lines. These charges are included in Cost of sales in the
Consolidated Statement of Operations.
Worldwide employment declined by approximately 13,600 in 2001 to approximately
78,900, largely as a result of our restructuring programs and the transfer of
approximately 2,500 employees to Flextronics as part of our office manufacturing
outsourcing. Worldwide employment was approximately 92,500 and 94,600 at
December 31, 2000 and 1999, respectively.
Other Expenses, Net. Other expenses, net for the three years ended December 31,
2001 were as follows:
2001 2000 1999
---- ---- ----
Restated Restated
(in millions)
Non-financing interest expense ................................................ $446 $592 $407
Currency gains, net ........................................................... (29) (103) (7)
Amortization of goodwill and intangibles ...................................... 94 86 50
Business divestiture and asset sale (gains)losses ............................. 10 (67) (78)
Interest income ............................................................... (101) (77) (20)
Year 2000 costs ............................................................... -- 2 47
All other, net ................................................................ 53 91 108
---- ---- ----
Total ...................................................................... $473 $524 $507
==== ==== ====
In 2001, non-financing interest expense was $146 million lower than 2000,
reflecting lower interest rates and lower debt levels. Non-financing interest
expense in 2001 included net gains of $32 million from the mark-to-market of our
remaining interest rate swaps required to be recorded as a result of applying
SFAS No. 133. Differences between the contract terms of our interest rate swaps
and the underlying related debt restricts hedge accounting treatment in
accordance with SFAS No. 133, which requires us to record the mark-to-market
valuation of these derivatives directly to earnings. Non-financing interest
17
expense was $185 million higher in 2000 than in 1999 as a result of the CPID
acquisition, which resulted in incremental borrowings of $852 million, generally
higher debt levels and increased interest rates.
Net currency (gains) losses result from the re-measurement of unhedged foreign
currency-denominated assets and liabilities. In 2001, exchange gains on yen debt
of $107 million more than offset losses on euro loans of $36 million, a $17
million exchange loss resulting from the peso devaluation in Argentina and other
currency exchange losses of $25 million. In 2000, large gains on both the yen
and euro loans in the fourth quarter contributed to the $103 million gain. These
currency exposures are the result of net unhedged positions largely caused by
our restricted access to the derivatives markets since the fourth quarter 2000.
Due to the inherent volatility in the interest rate and foreign currency
markets, we are unable to predict the amount of the above noted re-measurement
and mark-to-market gains or losses in future periods. Such gains or losses could
be material to the financial statements in any reporting period.
Goodwill and other intangible asset amortization relates primarily to our
acquisitions of the remaining minority interest in Xerox Limited in 1995 and
1997, XL Connect in 1998 and CPID in 2000. Effective January 1, 2002 and in
connection with the adoption of SFAS No. 142, we will no longer record
amortization of goodwill. However, in lieu of amortization, goodwill will be
tested at least annually for impairment using a fair value methodology.
Intangible assets will continue to be amortized. Further discussion is provided
in Note 1 to the consolidated financial statements.
(Gains) losses on business divestitures and asset sales include the sales of our
Nordic leasing business in 2001, the North American paper business and a 25
percent interest in ContentGuard in 2000, and various Xerox Technology
Enterprise businesses in 1999, as well as miscellaneous land, buildings and
equipment in all years. Further discussion of our divestitures follows and is
also contained in Note 5 to the consolidated financial statements.
Interest income is derived primarily from our significant invested cash balances
since the latter part of 2000 and from tax audit refunds. 2001 interest income
was $24 million higher than 2000 due to higher investment interest resulting
from a full year of invested cash balances in 2001, partially offset by lower
interest from tax audit refunds. The increases in our invested cash balances
reflect our decision, beginning in the second half of 2000, to accumulate cash
to maintain financial flexibility rather than continue our historical practice
of paying down debt with available cash.
All other, net includes many additional items, none of which are individually
significant.
Gain on Affiliate's Sale of Stock. In 2001 and 2000, gain on affiliate's sale of
stock of $4 million and $21 million, respectively, reflects our proportionate
share of the increase in equity of ScanSoft Inc. (NASDAQ: SSFT) resulting from
ScanSoft's issuance of stock in connection with acquisitions. The 2000 gain was
partially offset by a $5 million charge reflecting our share of ScanSoft's
write-off of in-process research and development associated with one of the
acquisitions, which is included in equity in net income of unconsolidated
affiliates. ScanSoft, an equity affiliate, is a developer of digital imaging
software that enables users to leverage the power of their scanners, digital
cameras, and other electronic devices.
Income Taxes and Equity in Net Income of Unconsolidated Affiliates. The
effective tax rates were 132.9 percent in 2001, 19.1 percent in 2000 and 34.6
percent in 1999. The difference between the 2001 effective tax rate of 132.9
percent and the U.S. federal statutory income tax rate of 35 percent relates
primarily to the recognition of deferred tax asset valuation allowances
18
resulting from our recoverability assessments, the taxes incurred in connection
with the sale of our partial interest in Fuji Xerox and continued losses in low
tax jurisdictions. The gain for tax purposes on the sale of Fuji Xerox was
disproportionate to the gain for book purposes as a result of a lower tax basis
in the investment. Other items favorably impacting the tax rate included a tax
audit resolution of approximately $140 million and additional tax benefits
arising from prior period restructuring provisions. On a loss basis, the
difference between the 2000 effective tax rate of 19.1 percent and the U.S.
federal statutory income tax rate of 35 percent relates primarily to continued
losses in low tax jurisdictions, the recognition of deferred tax asset valuation
allowances resulting from our recoverability assessments and additional tax
benefits arising from the favorable resolution of tax audits of approximately
$125 million. The 1999 effective tax rate benefited from increases in foreign
tax credits as well as a shift in the mix of our worldwide profits, partially
offset by the recognition of deferred tax asset valuation allowances. Please
refer to Note 15 to the consolidated financial statements for further
information. Our effective tax rate will change year to year based on
nonrecurring events (such as new Turnaround Program initiatives) as well as
recurring factors including the geographical mix of income before taxes. In the
normal course of business, we expect that our 2002 effective tax rate will be in
the low to mid 40 percent range.
Equity in net income of unconsolidated affiliates is principally related to our
25 percent share of Fuji Xerox income. Equity income was $53 million in 2001,
$66 million in 2000 and $48 million in 1999. The 2001 reduction primarily
reflects our reduced ownership in Fuji Xerox. The 2000 improvement reflected
improved Fuji Xerox operating results and the absence in 2000 of a prior year
$21 million unfavorable tax adjustment relating to an increase in Fuji Xerox tax
rates. These favorable items were partially offset by our $37 million share of a
2000 Fuji Xerox restructuring charge and reductions in income from several
smaller equity investments.
Manufacturing Outsourcing. In October 2001, we announced a manufacturing
agreement with Flextronics, a global electronics manufacturing services company.
The agreement provides for a five-year supply contract for Flextronics to
manufacture certain office equipment and components; the purchase of inventory,
property and equipment at a premium over book value; and the assumption of
certain liabilities. The premium will be amortized over the life of the
five-year supply contract, as we will continue to benefit from the property
transferred to Flextronics. Inventory purchased from us by Flextronics
remains on our balance sheet until it is sold to an end user with a
corresponding liability recognized for the proceeds received. This inventory and
the corresponding liability was approximately $27 million at December 31, 2001.
In total, the agreement with Flextronics represents approximately 50 percent of
our overall worldwide manufacturing operations. In the 2001 fourth quarter, we
completed the sales of our plants in Toronto, Canada; Aguascalientes, Mexico and
Penang, Malaysia to Flextronics for approximately $118 million, plus the
assumption of certain liabilities. The sale is subject to certain closing
adjustments. Approximately 2,500 Xerox employees in these operations transferred
to Flextronics upon closing. In January 2002, we completed the sale our office
manufacturing operations in Venray, the Netherlands and Resende, Brazil for $29
million plus the assumption of certain liabilities. Approximately 1,600 Xerox
employees in these operations transferred to Flextronics upon closing. By the
end of the third quarter 2002, we anticipate all production at our printed
circuit board factories in El Segundo, California and Mitcheldean, England and
our customer replaceable unit plant in Utica, New York will be fully transferred
to Flextronics' facilities which will complete the plans that we announced in
October. Included in the 2001 Turnaround Program are restructuring charges of
$24 million related to the closing of these facilities.
19
Divestitures. In December 2001, we sold Delphax Systems and Delphax Systems,
Inc. (Delphax) to Check Technology Corporation for $14 million in cash, subject
to purchase price adjustments. Delphax designs, manufactures and supplies
high-speed electron beam imaging digital printing systems and related parts,
supplies and maintenance services. There was no gain or loss recorded related to
this sale.
In April 2001, we sold our leasing businesses in the four Nordic countries to
Resonia Leasing AB (Resonia) for proceeds of approximately $370 million, which
approximated book value. The assets sold included the leasing portfolios in the
respective countries, title to the underlying equipment included in the lease
portfolios and the transfer of certain employees and systems used in the
operations of the businesses. Under terms of the agreement, Resonia will provide
on-going exclusive equipment financing to Xerox customers in those countries.
In March 2001, we sold half our ownership interest in Fuji Xerox to FujiFilm for
$1,283 million in cash. The sale resulted in a pre-tax gain of $773 million.
Income taxes of approximately $350 million related to this transaction were paid
in the first quarter 2002. Under the agreement, FujiFilm's ownership interest in
Fuji Xerox increased from 50 percent to 75 percent. While Xerox's ownership
interest decreased to 25 percent, we retain significant rights as a minority
shareholder. All product and technology agreements between Fuji Xerox and us
continue, ensuring that the two companies retain uninterrupted access to each
other's portfolio of patents, technology and products. With its business scope
focused on document processing activities, Fuji Xerox will continue to provide
office products to us and collaborate with us on research and development. We
maintain our agreement with Fuji Xerox to provide them production publishing and
solid ink technology.
In December 2000, we completed the sale of our China operations to Fuji Xerox
for $550 million cash and the assumption of $118 million of debt for which we
recorded a $200 million pre-tax gain. Revenues from our China operations were
$262 million in 2000.
In June 2000, we entered into an agreement to sell our U.S. and Canadian
commodity paper product line and customer list, for $40 million. We also entered
into an exclusive license agreement for the Xerox brand name.
Additionally, we earn commissions on Xerox originated sales of commodity paper
as an agent for Georgia Pacific.
In April 2000, we sold a 25 percent ownership interest in our wholly owned
subsidiary, ContentGuard, to Microsoft, Inc. for $50 million and recognized a
gain of $23 million. An additional gain of $27 million was deferred pending the
achievement of certain performance criteria. In May 2002, we paid Microsoft $25
million as the performance criteria had not been achieved. In connection with
the sale, ContentGuard also received $40 million from Microsoft for a
non-exclusive license of its patents and other intellectual property and a $25
million advance against future royalty income from Microsoft on sales of
products incorporating ContentGuard's technology. The license payment is being
amortized over the ten year life of the license agreement and the royalty
advance will be recognized in income as earned.
Acquisition of the Color Printing and Imaging Division of Tektronix, Inc. In
January 2000, we acquired the Color Printing and Imaging Division of Tektronix,
Inc. (CPID) for $925 million in cash including $73 million paid by Fuji Xerox
for the Asia/Pacific operations of CPID. CPID manufactures and sells color
printers, ink and related products and supplies. The acquisition accelerated us
to the number two market position in office color printing, improved our
reseller and dealer distribution network and provided us with scalable solid
20
ink technology. The acquisition also enabled significant product development and
expense synergies with our monochrome printer organization.
Business Performance by Segment. In 2001, we realigned our reportable segments
to be consistent with how we manage the business and to reflect the markets we
serve. Our business segments are as follows: Production, Office, DMO, SOHO, and
Other. The table below summarizes our business performance by segment for the
three-year period ended December 31, 2001. Revenues and associated percentage
changes, along with operating profits and margins by segment are included.
Segment operating profit (loss) excludes certain non-segment items, such as
restructuring and gains on sales from businesses, as further described in Note
10 to the consolidated financial statements.
Business Segment Performance
Business Segment Performance
% Change
--------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Restated Restated
-------- --------
(In millions)
Total Revenue
Production ...................................... $5,899 $6,332 $6,933 (7)% (9)%
Office .......................................... 6,926 7,060 6,853 (2) 3
DMO ............................................. 2,027 2,619 2,450 (23) 7
SOHO ............................................ 407 599 575 (32) 4
Other ........................................... 1,749 2,141 2,184 (18) (2)
Total ........................................... $17,008 $18,751 $18,995 (9)% (1)%
------- ------- -------
Memo: Color/(1)/ ................................... $ 2,762 $ 2,612 $ 1,619 6 % 61 %
Segment Operating Profit Loss/(2)/
Production ...................................... $ 454 $ 463 $ 1,236
Office .......................................... 341 (180) 49
DMO ............................................. (157) (93) 48
SOHO ............................................ (197) (293) (188)
Other ........................................... (39) 225 203
Total ........................................... $ 402 $ 122 $ 1,348
------- ------- -------
Operating Margin
Production ...................................... 7.7 % 7.3% 17.8%
Office .......................................... 4.9 (2.5) 0.7
DMO ............................................. (7.7) (3.6) 2.0
SOHO ............................................ (48.4) (48.9) (32.7)
Other ........................................... (2.2) 10.5 9.3
Total ........................................... 2.4 % 0.7% 7.1 %
------- ------ ------
/(1)/ Color revenue is included in all segments except Other.
/(2)/ Segment operating profit (loss) includes allocation of certain corporate
expenses such as research, finance, business strategy, marketing, legal, and
human resources. The "Other" segment includes certain expenses which have not
been allocated to the businesses such as non-financing interest expense.
Production: Production revenues include production publishing, production
printing, color products for the production and graphic arts markets and
light-lens copiers over 90 pages per minute sold predominantly through direct
sales channels in North America and Europe. Revenues declined 7 percent (6
percent pre-currency) in 2001 and 9 percent (6 percent pre-currency) in 2000.
The monochrome production revenue decline reflected competitive product
introductions, movement to distributed printing and electronic substitutes, and
weakness in the worldwide economy. Revenue from our DocuTech production
publishing family, which had been continually refreshed and expanded since its
1990 launch, declined in both 2001 and 2000 reflecting the 1999 introduction of
a competitive product. While Xerox remained the market leader, our production
21
publishing market share declined in 2000, but improved significantly in the U.S.
in 2001. In production printing, Xerox maintained its strong market leadership
in both 2001 and 2000, however, revenue decreased reflecting declines in the
transaction printing market.
2001 production color revenues grew 2 percent from 2000 including continued
strong DocuColor 2000 series growth, partially offset by declines in older
products reflecting introduction of competitive offerings and the effects of the
weakened economy in the second half of the year. The DocuColor 2000 series,
launched in 2000, at speeds of 45 and 60 pages per minute established an
industry standard by producing near-offset quality, full color prints including
customized one-to-one printing at a variable cost of less than 10 cents per
page. Production color revenues grew significantly in 2000 largely due to the
very successful launch of the DocuColor 2000 series. Production revenues
represented 35 percent of 2001 revenues compared with 34 percent in 2000.
2001 Production operating profit continued to decline, but significantly less
than the rate of decline experienced in 2000. Lower 2001 revenue combined with
reduced monochrome gross margin reflecting competitive pressures were only
partially offset by a substantial improvement in SAG expenses generated by our
Turnaround Program. 2000 operating profit was significantly below 1999 due to
lower revenue and gross margin, reflecting increased competition. Expenses
increased due to the earlier sales realignment and administrative transition and
higher DocuColor iGen3 R&D investments.
Office: Office revenues include our family of Document Centre digital
multifunction products, color laser, solid ink and monochrome laser desktop
printers, digital and light-lens copiers under 90 pages per minute, and
facsimile products sold through direct and indirect sales channels in North
America and Europe. 2001 revenues declined 2 percent (one percent pre-currency)
from 2000 as strong office color revenue growth was not sufficient to offset
monochrome declines. Color revenue growth was driven by the Document Centre
Color Series 50 and strong color printer equipment sales including the Phaser
860 solid ink and Phaser 7700 laser printers which use single pass color
technology. 2001 monochrome revenues declined as growth in digital multifunction
was more than offset by declines in light lens as the market
continues to transition to digital technology. This decline was exacerbated
further by our reduced participation in very aggressively priced competitive
customer bids and tenders in Europe, as we reorient our focus from market share
to profitable revenue. These declines were only slightly offset by the very
successful North American launch of the Document Centre 490 in September 2001.
In 2001, digital multifunction equipment sales represented approximately 91
percent of our monochrome copier equipment sales compared with 82 percent in
2000.
2000 revenues increased 3 percent from 1999 including the January 2000
acquisition of CPID. Excluding CPID, revenues declined 6 percent. Office
revenues represented 41 percent of 2001 revenues compared with 38 percent in
2000.
Operating profit in the Office segment increased significantly in 2001
reflecting lower SAG spending, benefiting from our Turnaround Program and
improved gross margins. Gross margin improvement includes the benefit of our
reduced participation in very aggressively priced European bids and tenders,
significantly improved document outsourcing margins, improving Document Centre
margins facilitated by favorable mix due to the Document Centre 480 and 490
launches, improved manufacturing and service productivity, and favorable
currency. 2000 operating profit was significantly lower than 1999 reflecting
lower gross margins, higher R&D spending associated with the CPID acquisition
and increased SAG expenses due to the sales realignment, administrative
transition and CPID spending.
22
DMO: DMO includes operations in Latin America, the Middle East, India, Eurasia,
Russia and Africa. DMO included our China operation, which generated revenues of
$262 million in 2000, prior to the December 2000 sale. In Latin America most
equipment transactions are recorded as operating leases. 2001 DMO revenue
declined 23 percent from 2000, with approximately 45 percent of the decline due
to the sale of our China operation. The balance of the decline was due to lower
equipment populations, implementation of a new business model that places
greater emphasis on liquidity and profitable revenue rather than market share as
well as general economic weakness in many of the countries. Revenues in Brazil,
which represented approximately 5 percent of our total revenues in 2001,
declined 18 percent from 2000 primarily as a result of an average 22 percent
currency devaluation of the Brazilian Real and implementation of the new
business model. In 2001, DMO incurred a $157 million loss reflecting lower
revenue and gross margins only partially offset by initial cost restructuring
benefits. In addition, results were adversely impacted by higher aggregate
exchange losses including the Argentinean devaluation.
2000 revenues grew 7 percent reflecting growth in Brazil and most countries
outside Latin America. Revenues in Brazil grew 5 percent as an improved economic
environment was partially offset by increased competitive activity and lower
prices during the latter half of the year as the operation focused on reducing
inventory. DMO incurred an $93 million loss in 2000 compared to a profit of $48
in 1999 reflecting lower margins and an increase in SAG expenses, including
higher bad debt provisions.
SOHO: We announced our disengagement from our worldwide SOHO business in June
2001 and sold our remaining equipment inventory by the end of the year. SOHO
revenues now consist primarily of profitable consumables for the inkjet printers
and personal copiers previously sold through indirect channels in North America
and Europe. SOHO revenues represented 2 percent of 2001 revenues compared with 3
percent in 2000, and declined 32 percent in 2001 from 2000. Despite a gross
margin decline, significant SAG and R&D reductions following our June 2001
disengagement resulted in substantially lower operating losses in
2001 and a return to profitability in the fourth quarter. We expect profits to
continue in 2002 as we sell high-margin consumables for the existing equipment
population. We also expect SOHO revenues and profits to decline over time as the
existing equipment population is replaced.
Other: Other includes revenues and costs associated with paper sales, Xerox
Engineering Systems (XES), Xerox Connect, Xerox Technology Enterprises (XTE),
our investment in Fuji Xerox, consulting and other services. Other also includes
corporate items such as non-financing interest expense and other non-allocated
central costs.
2001 revenue declined 18 percent from 2000 and operating losses increased
principally reflecting lower paper, XES, Xerox Connect, and XTE revenues, and
lower income related to our reduced investment in Fuji Xerox, partially offset
by lower net non-financing interest expense. The 2001 operating loss also
reflects the additional ESOP funding necessitated by the elimination of the ESOP
dividend; higher professional fees related to litigation, SEC issues and related
matters; employee retention compensation; and lower pension settlement gains.
2000 results benefited from gains on the sales of our North American paper
business, a 25 percent interest in ContentGuard, and a gain on our ScanSoft
affiliate's sale of stock.
23
Capital Resources and Liquidity
Liquidity, Financial Flexibility and Funding Plans:
Historically, our primary sources of funding have been cash flows from
operations, borrowings under our commercial paper and term funding programs, and
securitizations of accounts and finance receivables. We used these funds to
finance customers' purchases of our equipment and for working capital
requirements, capital expenditures and business acquisitions. Our operations and
liquidity began to be negatively impacted in 2000 by Company-specific business
challenges, which have been previously discussed. These challenges were
exacerbated by significant competitive and industry changes, adverse economic
conditions, and significant technology and acquisition spending. Together, these
challenges and conditions negatively impacted our cash availability and created
marketplace concerns regarding our liquidity, which led to credit rating
downgrades and restricted our access to capital markets.
In addition to the limited access to capital markets which resulted from our
credit rating downgrades, we have been unable to access the public capital
markets. This is because, as a result of the ongoing SEC investigation since
June 2000 and the accounting issues raised by the SEC, the SEC Staff advised us
that we could not make any public registered securities offerings. This
additional constraint had the effect of limiting our means of raising funds to
those of unregistered capital markets offerings and private lending or equity
sources. Our credit ratings became even more important, since credit rating
agencies often include access to other capital sources in their rating criteria.
During 2000, 2001, and 2002, these rating downgrades, together with the recently
concluded review by the SEC, adversely affected our liquidity and financial
flexibility, as follows:
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
24
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 June 26, 2002, our senior and short-term debt ratings and outlooks were as
follows:
Senior Debt Short Term Debt Outlook
----------- --------------- -------
Rating Rating
------ ------
Moody's B1 Not Prime Negative
S&P* BB-/B+* B* Negative*
Fitch BB B Stable
*Effective June 11, 2002, S&P lowered our Corporate credit rating, and
downgraded our senior debt, to BB- and maintained us on CreditWatch with
Negative implications. Upon receipt of commitments from the banks who are party
to our New Credit Facility, S&P affirmed the Corporate credit rating and our
senior secured debt at BB- with a Negative Outlook, and downgraded our senior
unsecured debt to B+.
We expect our limited access to unsecured credit sources to result in higher
borrowing costs going forward, and to potentially result in Xerox Corporation
having to increase its level of intercompany lending to affiliates and/or to
guarantee portions of their debt.
Actions Taken to Address Liquidity Issues:
In the fourth quarter of 2000, as a result of the various factors described
above, we began accumulating cash in an effort to maintain financial
flexibility, rather than continuing our historical practice of using available
cash to voluntarily pay down debt. To the extent possible, and except as
otherwise prohibited under the New Credit Facility described below, we expect to
continue this practice of accumulating cash for the foreseeable future.
New Credit Facility:
On June 21, 2002, we entered into an Amended and Restated Credit Agreement (the
"New Credit Facility") with a group of lenders, replacing the Old Revolver. At
that time, we permanently repaid $2.8 billion of the $7 billion Revolving Credit
Agreement (the "Old Revolver"). Accordingly, there is currently $4.2 billion
outstanding under the New Credit Facility, consisting of three tranches of term
loans totaling $2.7 billion and a $1.5 billion revolving facility that includes
a $200 million letter of credit sub-facility. The three term loan tranches
include a $1.5 billion amortizing "Tranche A" term loan, a $500 million "Tranche
B" term loan, and a $700 million "Tranche C" term loan maturing on September 15,
2002. Xerox Corporation is currently, and will remain, the borrower of all of
the term loans. The revolving loans are available, without sub-limit, to Xerox
Corporation, Xerox Canada Capital Limited (XCCL), Xerox Capital Europe plc (XCE)
and other foreign subsidiaries, as requested by us from time to time, that meet
certain qualifications. We are required to repay a total of $400 million of the
Tranche A loan and $5 million of the Tranche B loan in semi-annual installments
in 2003, and a total of $600 million of the Tranche A loan and $5 million of the
Tranche B loan in semi-annual installments in 2004. The remaining portions of
the Tranche A and Tranche B term loans and the revolving facility contractually
mature on April 30, 2005. We could be required to repay portions of the loans
earlier than their scheduled maturities upon the occurrence of certain events,
as described below. In addition, all loans under the New Credit Facility mature
upon the occurrence of a change in control.
25
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 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
26
Xerox Credit Corporation to Xerox Corporation in certain circumstances. The New
Credit Facility does not affect our ability to continue to monetize receivables
under the agreements with GE Capital and others, which are discussed below. No
cash dividends can be paid on our Common Stock for the term of the New Credit
Facility. Cash dividends may be paid on preferred stock provided there is then
no event of default. In addition to other defaults customary for facilities of
this type, defaults on debt of, or bankruptcy of, Xerox Corporation or certain
subsidiaries would constitute a default under the New Credit Facility.
The New Credit Facility also contains financial covenants which the Old Revolver
did not contain, including:
o Minimum EBITDA (rolling four quarters, as defined)
o Maximum Leverage (total adjusted debt divided by EBITDA, as defined)
o Maximum Capital Expenditures (annual test)
o Minimum Consolidated Net Worth (quarterly test, as defined)
Failure to be in compliance with any material provision of the New Credit
Facility could have a material adverse effect on our liquidity, financial
position and results of operations.
We expect total fees and expenses incurred in connection with the New Credit
Facility to approximate $125 million, the majority of which was paid at closing.
These amounts will be deferred and amortized over the three year term of the New
Credit Facility.
Turnaround Program:
In 2000 we announced a global Turnaround Program which included initiatives to
sell certain assets, improve operations and liquidity, and reduce annual costs
by at least $1 billion. Through December 31, 2001, and since that time, we have
made significant progress toward these objectives.
With respect to asset sale initiatives:
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.
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 $29
million related to the sales of additional facilities under that agreement.
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
27
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 3/4percent Senior Notes
and(euro)225 million of 9 3/4percent Senior Notes, for cash proceeds
totaling $746 million, which is net of fees and original-issue discount.
These notes mature on January 15, 2009, and contain several affirmative and
negative covenants which are similar to those in the New Credit Facility.
Taken as a whole, the Senior Notes covenants are less restrictive than the
covenants contained in the New Credit Facility. In addition, our Senior
Notes do not contain any financial maintenance covenants or scheduled
amortization payments. The Senior Notes covenants (1) restrict certain
transactions, including new borrowings, investments and the payment of
dividends, unless we meet certain financial measurements and ratios, as
defined, and (2) restrict our use of proceeds from certain other
transactions including asset sales. In connection with the June 21, 2002
closing of the New Credit Facility, substantially all of our U.S.
subsidiaries guaranteed these notes. In order to reduce the immediate cost
of this borrowing, we entered into derivative agreements to swap the cash
interest obligations under the dollar portion of these notes to LIBOR plus
4.44 percent. We will be required to collateralize any out-of-the-money
positions on these swaps.
In connection with vendor financing and related initiatives:
o In 2001, we received $885 million in financing from GE Capital, secured by
portions of our finance receivable portfolios in the United Kingdom. At
December 31, 2001, the remaining balances of these loans totaled $521
million.
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 December 31, 2001, the remaining debt totaled
$395 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. At December 31, 2001, the
remaining balances of these loans totaled $1,149 million. In March 2002, we
received our third secured loan from GE Capital totaling $266 million. Cash
proceeds of $229 million were net of $35 million of escrow requirements and
$2 million of fees. In May 2002, we received our fourth secured loan from GE
Capital, totaling $499 million. Cash proceeds of $496 million were net of $3
million of fees. Through June 26, 2002 approximately $1.9 billion of loans
have been funded under this agreement.
28
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.
o In December 2001, we announced that we would be forming a joint venture with
De Lage Landen International BV (DLL) to manage equipment financing, billing
and collections for our customers' financed equipment orders in the
Netherlands. This joint venture was formed and began funding in the first
quarter of 2002. DLL owns 51 percent of the venture and provides the funding
to support new customer leases, and we own the remaining 49 percent of this
unconsolidated venture.
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.
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
$207 million in cash plus the assumption of $20 million of debt. We can also
receive retained interests up to approximately $30 million, based on the
occurrence of certain future events. This sale is part of an agreement under
which the third-party will provide on-going, exclusive equipment financing
to our customers in Italy.
o In May 2002, we received an additional loan from GE Capital of $106 million
secured by portions of our lease receivable portfolio in the U.K.
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.
Cash and Debt Positions:
With $4.0 billion of cash and cash equivalents on hand at December 31, 2001,
(and approximately $1.8 billion on hand as of June 26, 2002, after giving effect
to the refinancing under the New Credit Facility) we believe our liquidity is
sufficient to meet current operating cash flow requirements and to satisfy all
scheduled debt maturities through December 31, 2002.
As a result of the New Credit Facility discussed above, our debt maturities have
changed. Significantly less debt will now mature in 2002 and 2003 than would
have become due had the Old Revolver not been refinanced. In addition, a portion
of our available cash has been used to retire some of the debt under the Old
Revolver. The following represents our aggregate debt maturity schedules by
quarter for 2002 and 2003, and reflects the New Credit Facility and related
principal payments discussed above (in billions):
2002 2003
---- ----
First Quarter $0.7 $0.5
Second Quarter 4.0 1.1
Third Quarter 1.0 0.3
Fourth Quarter 0.9 1.3
---- -----
Full Year $6.6 $3.2
==== ====
29
Additionally, as discussed throughout this Annual Report, we have reached a
settlement with the SEC as to all matters that were under investigation. It is
our expectation that the resolution of these matters will restore our ability to
access the public capital markets and reduce our earlier reliance on other
funding sources including non-public capital markets. Our current plans include
accessing the public capital markets in 2002, however, we are not dependent on
such access to maintain adequate liquidity in 2002.
Plans to Strengthen Liquidity and Financial Flexibility Beyond 2002:
Our ability to maintain sufficient liquidity beyond 2002 is highly dependent on
achieving expected operating results, including capturing the benefits from
restructuring activities, and completing announced vendor financing and other
initiatives. There is no assurance that these initiatives will be successful.
Failure to successfully complete these initiatives could have a material adverse
effect on our liquidity and our operations, and could require us to consider
further measures, including deferring planned capital expenditures, modifying
current restructuring plans, reducing discretionary spending, selling additional
assets and, if necessary, restructuring existing debt.
We also expect that improvements in our debt ratings, and our related ability to
fully access certain unsecured public debt markets, namely the commercial paper
markets, will depend on (1) our ability to demonstrate sustained EBITDA growth
and operating cash generation and (2) continued progress on our vendor financing
initiatives, as discussed above. Until such time, we expect some bank lines to
continue to be unavailable, and we intend to access other segments of the
capital markets as business conditions allow, which could provide significant
sources of additional funds until full access to the unsecured public debt
markets is restored.
Contractual Cash Obligations and Other Commercial Commitments and Contingencies:
At December 31, 2001, we had the following contractual cash obligations and
other commercial commitments and contingencies:
Contractual Cash Obligations:
2002 2003 2004 2005 2006 Thereafter
---- ---- ---- ---- ----
(In millions)
Long term debt ...................................... $6,584 $3,247 $2,567 $3,370 $ 30 $ 914
Minimum operating lease commitments ................. 250 207 165 135 112 359
Total contractual cash obligations ................ $6,834 $3,454 $2,732 $3,505 $142 $1,273
(1) The long-term debt obligations reflect the refinancing of our New Credit
Facility on June 21, 2002.
Cumulative Preferred Securities:
As of December 31, 2001, we have four series of outstanding preferred securities
as summarized below. The redemption requirements and the annual cumulative
dividend requirements on our outstanding preferred stock are as follows:
o Series B Convertible Preferred Stock (ESOP shares): The balance at December
31, 2001 was $605 million, and is o redeemable in shares of common stock or
cash, at our option, as employees with vested shares leave the Company. o
Annual cumulative dividend requirements are $6.25 per share. In 2001, we
suspended these dividends, but the unpaid dividends are cumulative and
amount to approximately $40 million at December 31, 2001.
30
o 7 1/2percent Convertible Trust Preferred Securities: The balance at December
31, 2001 was $1,005 million, and is putable in 2004 in cash or in shares of
common stock at a redemption value of $1,035 million. Annual cumulative
distribution requirements are $3.75 per Preferred Security on 20.7 million
securities. The first three years' dividend requirements were funded at
issuance and are invested in U.S. Treasury securities held by a separate
trust.
o 8 percent Convertible Trust Preferred Securities: The balance at December
31, 2001 was $639 million, and is o redeemable in 2027 at a redemption value
of $650 million. Annual cumulative dividend requirements are $80 per o
security on 650,000 securities.
o Canadian Deferred Preferred Stock: The balance at December 31, 2001 was $43
million, and is redeemable in 2006. o Annual cumulative non-cash dividend
requirements will increase this amount to its 2006 redemption value of o
approximately $56 million.
Other Commercial Commitments and Contingencies:
Flextronics: As previously discussed, in 2001 we outsourced certain
manufacturing activities to Flextronics under a five-year agreement. At December
31, 2001 we anticipate that we will purchase approximately $1 billion of
inventory from Flextronics during 2002 and expect to maintain this level in the
future.
Fuji Xerox: We had product purchases from Fuji Xerox totaling $598 million, $812
million, and $740 million in 2001, 2000 and 1999, respectively. Our purchase
commitments with Fuji Xerox are in the normal course of business and typically
have a lead time of three months.
Other Purchase Commitments: We enter into other purchase commitments with
vendors in the ordinary course of business. Our policy with respect to all
purchase commitments is to record any losses when they are probable and
reasonably estimable.
EDS Contract: We have an information management (IM) contract with Electronic
Data Systems Corp (EDS). We can terminate the contract with six months notice
upon the payment of termination fees, as defined in the contract. Although there
are no minimum payments due under the contract, the IM function is integral to
our operations and at this time, we anticipate making the following payments to
EDS over the next five years (in millions): 2002--$381; 2003--$354; 2004--$351;
2005--$354; 2006--$345.
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
31
agent, in which event the SPEs may engage another servicing agent and we would
cease to receive a servicing fee. Although the debt rating downgrade provisions
have been triggered in some of our securitization agreements, the securitization
investors and/or their agents have not elected to remove us as administrative
servicer as of this time. We are not liable for non-collection of securitized
receivables or otherwise required to make payments to the SPEs except to the
limited extent that the securitized receivables did not meet specified
eligibility criteria at the time we sold the receivables to the SPEs or we fail
to observe agreed-upon credit and collection policies and procedures.
Most of our SPE transactions were accounted for as borrowings, with the debt and
related assets remaining on our balance sheets. Specifically, in addition to the
July 2001 asset-backed notes transaction and the U.S. loans from GE Capital
discussed above, which utilized SPEs as part of their structures, as of December
31, 2001, we have entered into the following similar transactions which were
accounted for as debt on our balance sheets:
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 December 31, 2001, the remaining debt under this
facility totaled approximately $154 million.
o In 1999, XCC securitized certain finance receivables in the United States,
generating gross proceeds of $1,150 million. At December 31, 2001, the
remaining obligations in this facility totaled $94 million, and were
substantially repaid as of June 26, 2002.
We have also entered into the following SPE transactions which were accounted
for as sales of receivables:
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 renegotiated the $315 million U.S. facility,
reducing its size to $290 million. The May 2002 Moody's downgrade
constituted an event of termination under this agreement, which we are
currently renegotiating. Failure to successfully renegotiate the facility
could result in the suspension of its revolving features, whereupon we would
be unable to sell new accounts receivable into the facility, and our
availability would wind down. In February 2002, the size of the Canadian
facility was reduced in order to make certain receivables eligible under the
GE Capital Canadian transaction described above. Also in February 2002, a
downgrade of our Canadian debt by Dominion Bond Rating Service caused the
Canadian counterparty to withdraw its waiver, in turn causing the remaining
Canadian facility at that time to enter into wind-down mode. This facility
has subsequently been fully repaid.
o In 1999, XCL securitized certain finance receivables, generating gross
proceeds of $345 million. At December 31, 2001, the remaining obligations in
this facility totaled $93 million, and we expect them to be fully paid in
2002. At December 31, 2001, this is the only outstanding SPE transaction
with recourse provisions that could be asserted against us.
o In 1999, Xerox Corporation and certain of its subsidiaries securitized
accounts receivable, generating aggregate gross proceeds of $231 million. No
amounts remained outstanding as of December 31, 2001.
In summary, at December 31, 2001, amounts owed by these receivable-related SPEs
to their investors totaled $2,210 million, of which $418 million represented
transactions we treated as asset sales, and the remaining $1,792 million is
reported as Debt in our Consolidated Balance Sheet. A detailed discussion of
32
the terms of these transactions, including descriptions of our retained
interests, is included in Note 5 to the Consolidated Financial Statements. We
also utilized SPEs in our Trust Preferred Securities transactions. Refer to Note
17 to the Consolidated Financial Statements for a detailed description of these
transactions.
Secured Debt - Summary:
As of March 31, 2002, after giving effect to the New Credit Facility, we have
approximately $930 million of debt which is secured by assets that are measured
against the 20 percent consolidated net worth limitation described above. In
addition, we have $3,802 million of debt which is secured by assets that are not
measured against that 20 percent limitation, in most cases because the
applicable borrowing entities are considered financing subsidiaries under the
public indenture definitions.
Equity Put Options:
During 2000 and 1999, we sold 7.5 million and 0.8 million equity put options,
respectively, for proceeds of $24 million and $0.4 million. We did not sell any
such options in 2001. Equity put options give the counterparty the right to sell
our common shares back to us at a specified strike price. In January 2001, we
paid $28 million to settle the put options we issued in 1999, which we funded by
issuing 5.9 million unregistered common shares. In the fourth quarter 2000, we
were required to pay $92 million to settle the put options that we issued in
2000. In 1999, we paid $5 million to settle put options that we issued in 1998.
There were no put options outstanding as of December 31, 2001.
Cash Management:
Xerox and its material subsidiaries and affiliates manage their worldwide cash,
cash equivalents and liquidity resources through internal cash management
systems, which include established policies and procedures. They are subject to
(1) the statutes, regulations and practices of the local jurisdictions in which
the companies operate, (2) the legal requirements of the agreements to which the
companies are parties and (3) the policies and cooperation of the financial
institutions utilized by the companies to maintain such cash management systems.
At December 31, 2001, 2000 and 1999, cash and cash equivalents on hand totaled
$3,990 million, $1,750 million and $132 million, respectively, and total debt
was $16,765 million, $18,637 million, and $16,147 million, respectively. Total
debt net of cash (Net Debt) decreased by $4,112 million in 2001, increased by
$872 million in 2000, and increased by $769 million in 1999. The consolidated
ratio of total debt to common and preferred equity was 6.9:1, 7.6:1 and 4.5:1 as
of December 31, 2001, 2000 and 1999, respectively. The decrease in this ratio in
2001 reflects debt-for-equity exchanges, a curtailment of dividends, and debt
repayments funded by asset sales and working capital improvements, offset
partially by a net loss and the impacts of currency devaluation. The increase in
2000 reflects the 2000 net loss, an increase in debt to fund the CPID
acquisition, cash payments required to settle outstanding put options on our
common stock, cash dividends, and the impact of currency devaluation. The
increases in both 2001 and 2000 compared to 1999 also reflect our decision,
beginning in 2000, to accumulate cash to maintain financial flexibility rather
than continue our historical practice of paying down debt with available cash.
33
The following represents the results of our cash flows for the last three years
included within our Statement of Cash Flows in our consolidated financial
statements (in millions):
2001 2000 1999
---- ---- ----
Operating Cash Flows $1,566 $ 207 $ 551
Investing Cash Flows (Usage) 873 (855) (789)
Financing Cash Flows (Usage) (189) 2,255 300
Foreign Currency Impacts (10) 11 (9)
------ ------ -----
Net Change in Cash Balance 2,240 1,618 53
Cash - Beginning of year 1,750 132 79
------ ------ -----
Cash - End of year $3,990 $1,750 $ 132
====== ====== =====
2001 operating cash flows improved significantly compared to 2000, primarily due
to working capital improvements. Although our sales declined, which normally
leads to a reduction in receivables and payables balances, our collections of
receivables exceeded our payments on accounts payable and other current
liability accounts by approximately $500 million. We further reduced our
inventory balances and spending for on-lease equipment by approximately $480
million. We also had a short-term benefit of approximately $350 million
associated with the timing of taxes due on the gain from our sale of half our
interest of Fuji Xerox, which we did not have to pay until first quarter 2002.
The overall impact of our reported net loss on our operating cash flows, after
considering the impacts of non-cash items associated with restructuring charges,
provisions, tax valuation allowances and gains did not vary significantly
between 2001 and 2000.
Investing cash flows were higher in 2001 primarily due to $1,768 million of cash
received from the sales of businesses, including Fuji Xerox and our leasing
businesses in the Nordic European countries. These cash proceeds were greater
than those received from the sale of businesses in 2000, which resulted in
proceeds of $640 million. In 2001 we also reduced capital spending and
internal-use software spending significantly. Other factors contributing to the
2001 improvement were the acquisition of CPID in 2000, which utilized cash of
$856 million, while in 2001 we were required to fund $628 million of certain
escrow and insurance trusts based on contractual requirements.
Our 2001 financing activities largely consisted of a net repayment of
approximately $1.1 billion of debt, offset by a private placement of $1.0
billion of trust preferred securities. Our suspension of dividends on our common
and preferred stock also had a positive impact on our cash flows in 2001.
Refer to our EBITDA-based cash flows discussion below to understand the way we
look at cash flows from a treasury and cash management perspective, and for
explanations of cash flows for 2000 and 1999.
Historically, we separately managed the capital structures of our non-financing
operations and our captive financing operations. Consistent with our continuing
efforts to exit the customer equipment financing business, we now use EBITDA and
operating cash flow to measure our liquidity, and we no longer distinguish
between financing and non-financing operations in our liquidity management
processes. We define EBITDA as earnings before interest expense, income taxes,
depreciation, amortization, minorities' interests, equity in income of
unconsolidated affiliates, and non-recurring and non-operating items. We believe
that EBITDA provides investors and analysts with a useful measure of liquidity
generated from recurring operations. EBITDA is not intended to represent an
alternative to either operating income or cash flows from operating activities
(as those terms are defined in GAAP). While EBITDA is frequently used to analyze
companies, the definition of EBITDA we employ, as
34
presented herein, may differ from definitions of EBITDA employed by other
companies.
The following is a summary of EBITDA, operating and other cash flows for the
years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
---- ---- ----
Restated Restated
-------- --------
Non-financing revenues $15,879 $17,589 $17,820
Non-financing cost of sales 10,050 11,233 10,529
------- ------- -------
Non-financing gross profit 5,829 6,356 7,291
Research and development expense (997) (1,064) (1,020)
Selling, administrative and general expenses (4,728) (5,518) (5,204)
Depreciation and amortization expense 1,238 1,158 1,040
-------- -------- --------
Adjusted EBITDA 1,342 932 2,107
Working capital and other changes 794 694 (319)
On-Lease equipment spending (271) (506) (387)
Capital spending (219) (452) (594)
Restructuring payments (484) (387) (441)
---------- ---------- -----------
Operating Cash Flow* 1,162 281 366
Interest payments (1,074) (1,050) (848)
Financing payments 1,374 494 292
Debt borrowings (repayments), net (1,242) 2,917 793
Net proceeds from Trust Preferred Securities 775 -- --
Dividends and other non-operating items (541) (808) (508)
Proceeds from sales of business 1,768 640 65
Acquisitions 18 (856) (107)
----------- ---------- ----------
Net Increase in Cash $ 2,240 $ 1,618 $ 53
======= ======= =========
*The primary difference between this amount and the Cash Flows from Operations
reported in our GAAP Statements of Cash Flows, is the inclusion of Capital
Spending in, and the exclusion of Financing Cash Flow and Interest Payments
from, the amount shown above.
2001 EBITDA operating cash flow of $1,162 million increased by $881 million,
from $281 million in the prior year. The improvement was driven by cost
reductions, lower on-lease equipment spending, lower capital spending, and
modest working capital improvements, and was partially offset by higher
restructuring payments and lower revenues. The decline in capital spending was
due primarily to significant spending constraints as well as completion in 2000
of our remaining Ireland projects described below. The decline in on-lease
equipment spending reflected declining rental placement activity and
populations, particularly in our older-generation light lens products.
The increase in EBITDA financing cash flow in 2001 reflected lower finance
receivable originations resulting from lower equipment sales in 2001 compared to
2000. Dividends and other non-operating items used $541 million of cash in 2001,
compared to usage of $808 million in 2000. This improvement was largely due to
cash savings of approximately $500 million resulting from our elimination and
suspension of our common and Series B Preferred dividends, respectively, which
we announced in July 2001, and lower payments required to terminate derivative
contracts, partially offset by a $255 million payment related to our funding of
trusts to replace Ridge Reinsurance letters of credit.
In 2001, we generated $1,768 million of cash from the sales of businesses,
including the sale of half our interest in Fuji Xerox, our leasing businesses
in four European countries, and certain of our manufacturing-related assets to
Flextronics, as discussed below. These asset sales, together with net proceeds
35
of $775 million from the sale of trust preferred securities and the significant
improvements in operating and financing cash flows, funded net repayments of
debt totaling $1,242 million in 2001, compared to incremental borrowings of
$2,917 million in 2000 which included funding for the CPID acquisition.
EBITDA operating cash flow was $281 million in 2000, including $328 million of
accounts receivable securitizations, compared to $366 million in 1999.
Significant improvements in working capital and lower capital spending
essentially offset lower EBITDA, which reflected lower revenues and higher costs
compared to 1999. Capital spending in 2000 included production tooling and our
investments in Ireland, where we consolidated European customer support centers
and invested in inkjet supplies manufacturing. The significant decline in 2000
spending versus 1999 is due primarily to substantial completion of several
aspects of the Ireland projects as well as significant spending constraints.
Investments in on-lease equipment reflected growth in our document outsourcing
business.
The significant increase in interest payments in 2000 largely reflects higher
debt levels.
In 2000, we generated $640 million of cash from the sales of businesses,
including the sale of our China operations to Fuji Xerox for $550 million, and
we used $856 million of cash for the acquisition of the CPID division of
Tektronix. The increased spending in Dividends and other non operating items
reflected cash payments of $68 million to settle put options on our common
stock, plus payments of $108 million to settle out-of-the-money currency and
interest rate derivatives which were cancelled upon one of our debt downgrades
discussed below. Together with increased interest costs, only partially offset
by modest increases in operating and financing cash flows, these cash decreases
required us to borrow an incremental $2,917 million in 2000.
Cash restructuring payments were $484 million, $387 million, and $441 million in
2001, 2000 and 1999, respectively. We expect that substantially all of the
remaining restructuring reserves as of December 31, 2001 of $282 million will be
paid in 2002. The status of the restructuring reserves is discussed in Note 3 to
the Consolidated Financial Statements.
Financial Risk Management:
We are typical of multinational corporations because we are exposed to market
risk from changes in foreign currency exchange rates and interest rates that
could affect our results of operations and financial condition. Accordingly, we
have historically entered into derivative contracts, including interest rate
swap agreements, forward exchange contracts and foreign currency swap
agreements, to manage such interest rate and foreign currency exposures. The
fair market values of all of our derivative contracts change with fluctuations
in interest rates and/or currency rates, and are designed so that any change in
their values is offset by changes in the values of the underlying exposures. Our
derivative instruments are held solely to hedge economic exposures; we do not
enter into such transactions for trading purposes, and we employ long-standing
policies prescribing that derivative instruments are only to be used to achieve
a set of very limited objectives. As described above, our ability to currently
enter into new derivative contracts is severely constrained. Therefore, while
the following paragraphs describe our overall risk management strategy, our
current ability to employ that strategy effectively has been severely limited.
Currency derivatives are primarily arranged to manage the risk of exchange rate
fluctuations associated with assets and liabilities that are denominated in
foreign currencies. Our primary foreign currency market exposures include the
Japanese Yen, Euro, Brazilian Real, British Pound Sterling and Canadian Dollar.
36
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 debt.
Additionally, pay-variable-rate/receive-fixed-rate interest rate swaps are used
from time to time to transform longer-term fixed-rate debt into variable-rate
obligations. The transactions performed within each of these categories enable
more cost-effective management of interest rate exposures by eliminating the
risk of a major change in interest rates. We refer to the effect of these
practices as "match funding" customer financing assets.
Consistent with the nature of economic hedges, unrealized gains or losses from
interest rate and foreign currency derivative contracts are designed to offset
any corresponding changes in the value of the underlying assets, liabilities or
debt.
Assuming a 10 percent appreciation or depreciation in foreign currency exchange
rates from the quoted foreign currency exchange rates at December 31, 2001, the
potential change in the fair value of foreign currency-denominated assets and
liabilities in each entity would aggregate approximately $31 million, and a 10
percent appreciation or depreciation of the U.S. Dollar against all currencies
from the quoted foreign currency exchange rates at December 31, 2001, would have
a $335 million impact on our Cumulative Translation Adjustment portion of
equity. The amount permanently invested in foreign subsidiaries and affiliates
- -- primarily Xerox Limited, Fuji Xerox and Xerox do Brasil -- and translated
into dollars using the year-end exchange rates, was $3.3 billion at December 31,
2001, net of foreign currency-denominated liabilities designated as a hedge of
our net investment.
Pay fixed-rate and receive variable-rate swaps are often used in place of more
expensive fixed-rate debt. Additionally, pay variable-rate and receive
fixed-rate swaps are used from time to time to transform longer-term fixed-rate
debt into variable-rate obligations. The transactions performed within each of
these categories enable more cost-effective management of interest rate
exposures. The potential risk attendant to this strategy is the non-performance
of the swap counterparty. We address this risk by arranging swaps with a diverse
group of strong-credit counterparties, regularly monitoring their credit ratings
and determining the replacement cost, if any, of existing transactions. On a
consolidated basis, including the impact of our hedging activities,
weighted-average interest rates for 2001, 2000 and 1999 approximated 5.5
percent, 6.2 percent and 5.7 percent, respectively.
Many of the financial instruments we use are sensitive to changes in interest
rates. Interest rate changes result in fair value gains or losses on our term
debt and interest rate swaps, due to differences between current market interest
rates and the stated interest rates within the instrument. The loss in fair
value at December 31, 2001, from a 10 percent change in market interest rates
would be approximately $161 million for our interest rate sensitive financial
instruments. Our currency and interest rate hedging are typically
unaffected by changes in market conditions as forward contracts, options and
swaps are normally held to maturity consistent with our objective to lock in
currency rates and interest rate spreads on the underlying transactions.
37
As described above, the downgrades of our debt during 2000, 2001 and 2002,
together with the recently-concluded SEC investigation, significantly reduced
our access to capital markets. Furthermore, several of the debt downgrades
triggered various contractual provisions which required us to collateralize or
repurchase a number of derivative contracts which were then outstanding. While
we have been able to replace some derivatives on a limited basis, our current
debt ratings restrict our ability to utilize derivative agreements to manage the
risks associated with interest rate and some foreign currency fluctuations,
including our ability to continue effectively employing our match funding
strategy. For this reason, we anticipate increased volatility in our results of
operations due to market changes in interest rates and foreign currency rates.
READER'S NOTE: THIS CONCLUDES THE DISCUSSION EXCERPTED DIRECTLY FROM XEROX
CORPORATION'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information set forth in the eighth through tenth paragraphs under the
caption "CAPITAL RESOURCES AND LIQUIDITY - XEROX CREDIT CORPORATION" in Item 7
above is hereby incorporated by reference in answer to this Item.
ITEM 8. Financial Statements and Supplementary Data
Our consolidated financial statements and the notes thereto and the report
thereon of PricewaterhouseCoopers LLP, independent accountants, are set forth on
pages 46 through 66 hereof.
ITEM 9. Disagreements on Accounting and Financial Disclosure
On October 4, 2001, our ultimate parent, XC ended the engagement of KPMG LLP
(KPMG) and retained PricewaterhouseCoopers LLP (PricewaterhouseCoopers) as its
independent auditors. The Audit Committee of XC's Board of Directors and the
Board of Directors of XC approved the decision to change independent
accountants.
Consistent with XC's decision to change its independent accountants, and not
because of any disputes or disagreements between us and KPMG, on October 25,
2001 our Board of Directors likewise approved the decision to change our
independent accountants. Accordingly, effective as of October 4, 2001, we ended
the engagement of KPMG and retained PricewaterhouseCoopers as our independent
accountants for the fiscal year ended December 31, 2001. The reports of KPMG on
our financial statements for each of the fiscal years ended December 31, 2000
and December 31, 1999 contained no adverse opinion or disclaimer of opinion and
were not qualified or modified as to uncertainty, audit scope or accounting
principles. For the fiscal years ended December 31, 2000 and December 31, 1999
and through October 25, 2001, there were no disagreements with KPMG on any
matter of accounting principles or practices, financial statement disclosure or
audit scope or procedure which, if not resolved to the satisfaction of KPMG,
would have caused it to make reference to the subject matter of such
disagreement in its reports on our financial statements for such fiscal years.
Nor were there any reportable events within the meaning of Item 304(a)(1)(v) of
Regulation S-K for the fiscal years ended December 31, 2000 and December 31,
1999 and through October 25, 2001. Our Board of Directors authorized KPMG to
respond fully to inquiries of PricewaterhouseCoopers concerning the matters
addressed in the Current Report on Form 8-K dated October 25, 2001 that we filed
with the SEC.
The Current Report on Form 8-K dated October 25, 2001 that we filed with the SEC
contained the following text taken from Item 4 of a Current Report on Form
38
8-K dated September 28, 2001 that XC filed with the SEC. This information is
provided to give the reader a full understanding of the events and circumstances
that led XC to replace its auditors.
"On October 4, 2001, Xerox Corporation ("Company") determined to change the
Company's independent accountants, and, accordingly, ended the engagement of
KPMG LLP ("KPMG") in that role and retained PricewaterhouseCoopers LLP as its
independent accountants for the fiscal year ending December 31, 2001. The Audit
Committee of the Board of Directors (the "Audit Committee") and the Board of
Directors of the Company approved the decision to change independent
accountants.
The reports of KPMG on the financial statements of the Company for each of the
fiscal years ended December 31, 2000 and December 31, 1999 contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles. Except to the extent
discussed below, for the fiscal years ended December 31, 2000 and December 31,
1999 and through the date of this report, there were no disagreements with KPMG
on any matter of accounting principles or practices, financial statement
disclosure or audit scope or procedure which, if not resolved to the
satisfaction of KPMG, would have caused it to make reference to the subject
matter of such disagreement in its reports on the financial statements for such
fiscal years. Nor, except to the extent discussed below, were there any
reportable events within the meaning of Item 304(a)(1)(v) of Regulation S-K for
the fiscal years ended December 31, 2000 and December 31, 1999 and through the
date of this report. With respect to the matters discussed below, the Audit
Committee discussed them with KPMG and authorized KPMG to respond fully to
inquiries of PricewaterhouseCoopers LLP concerning them.
In March 2001, KPMG informed management and the Audit Committee that it wished
to expand significantly the scope of its audit work in connection with the audit
of the Company's 2000 financial statements. KPMG proposed that certain
additional procedures be performed, including that the Audit Committee appoint
Special Counsel to conduct an inquiry into certain issues, which procedures were
performed in March, April and May 2001.
While the expanded procedures were being performed, KPMG informed the Audit
Committee and management that KPMG was unwilling to rely on representations by
two employees in one of the Company's geographic operating units. Management
removed those employees from responsibility in connection with the Company's
system of financial reporting.
As a result of observations during its 2000 audit, and other information
discussed with the Audit Committee, KPMG reported certain material weaknesses in
the Company's internal control systems and made recommendations concerning
certain components of the Company's business:
- KPMG emphasized the importance for internal control of the tone set by
the Company's top management. KPMG noted that, as a result of its audit
and information reported by Special Counsel, it believed there was
evidence that management was not successful in setting the appropriate
tone with respect to financial reporting. It recommended that the
Company take steps to remediate appropriately those issues. Certain
personnel changes have been made based in part on KPMG views offered to
the Audit Committee and management.
- Customer Business Operations (CBO) in the Company's North American
Solutions Group. KPMG noted issues with regard to CBO's ability to bill
customers accurately for services, and noted that difficulties in that
area had resulted in unfavorable billing adjustments during 2000.
Although KPMG recognized that the Company had initiated several steps
to
39
address this issue, it concluded that it remained unclear when those
changes would result in sustained improvement in reducing non-cash
resolution adjustments of billing differences. It acknowledged that
this weakness did not suggest that the net trade receivable account
balance is unreasonably stated at December 31, 2000, but that proper
reporting required extensive evaluation of billing adjustments during
the fourth quarter. KPMG suggested various business and operational
changes to address this issue.
- Communication of Accounting and Control Policies. KPMG noted that
policy documents need to be updated, among other things to address
issues identified by the Company's worldwide audit function. Special
Counsel and KPMG, recommended that the Company also provide increased
formal training to ensure that its personnel understand the accounting
and control guidance in its policies.
- Consolidation and Corporate-Level Entries. KPMG observed that the
Company's quarterly consolidation process is manually intensive,
requiring numerous adjustments at corporate financial reporting levels.
It recommended that the Company's Consolidated Financial Information
System be augmented to enhance the monitoring and review of
corporate-level and manual entries, and further that the Company ensure
adequate segregation of duties in the preparation and approval of such
entries.
- Appropriateness of the Concessionaire Business Model in Latin American
Countries. KPMG noted that during 2000, analysis by the Company's
worldwide audit function indicated that certain issues existed with
respect to this business model, including that certain concessionaires
may lack economic substance independent of the Company, and that
certain business practices involving concessionaires resulted in
allowances with respect to receivables in 2000. KPMG suggested periodic
assessment of the financial position of prospective and existing
concessionaires, and that the Company monitor its business relationship
with them to ensure that they are substantive independent distributors
of the Company's products.
In addition to those items, KPMG noted that organizational changes, including
the Company's turnaround program and associated reductions in headcount, had and
would continue to stress the Company's internal control structure. KPMG
recommended that the Company take steps to ensure that issues likely to impact
the control environment receive appropriate management attention. KPMG also
recommended improved balance sheet account reconciliation and analysis on a
global basis, in particular with respect to intercompany balances.
The foregoing matters were considered by KPMG in connection with their 2000
audit and did not result in any adverse opinion or disclaimer of opinion or any
qualification or modification as to uncertainty, audit scope or accounting
principles. KPMG's auditor's report dated May 30, 2001 contained a separate
paragraph stating that the Company's 1999 and 1998 consolidated financial
statements had been restated.
The Company commenced actions in fiscal 2000 and expanded actions in fiscal 2001
which, collectively, it believes have addressed the above-discussed matters.
The Company has provided KPMG a copy of this Report and requested KPMG to
furnish it with a letter addressed to the Securities and Exchange Commission
stating whether it agrees with the statements made herein. A copy of such
letter, dated October 4, 2001, is filed as an Exhibit to the Company's Form
8-K."
40
PART III
ITEM 10. Directors and Executive Officers of the Registrant
Directors
Our directors are elected annually by Xerox Financial Services, Inc. (XFSI), our
sole shareholder, to serve for one year until their successors have been elected
and shall have qualified. There are no family relationships between any of the
directors. Our current directors are:
Director Other
Name Age Since Occupation Directorships
Gary R. Kabureck 48 2001 Assistant Corporate None
Controller and Chief
Accounting Officer,
Xerox Corporation
2001 - Present;
Assistant Corporate
Controller, Xerox Corp.
2000-2001; Vice President
and Controller, Financial
Services North American
Solutions Group, Xerox
Corp. 1999-2000; Vice
President and Controller,
Financial Services U.S.
Customer Operations,
Xerox Corp. 1997-1999
John F. Rivera 38 2001 Director, Cash None
Strategies and
Planning, Xerox Corp.
2000-Present; Director,
Corporate Financial
Planning, 2000; Manager,
Financial Reporting and
Analysis, Xerox Corp.
1999-2000; Manager,
Business Arrangements and
Internal Control Programs
Xerox Corp., 1997-1999;
Manager, Accounting Policy
Projects, Xerox Corp.
1995-1997
Peter K. Gallagher 40 2002 Director, Accounting None
Policy and Control, Xerox
Corp., 2000 - Present;
Manager, Accounting
Policy Projects, Xerox
Corp. 1997-2000
41
Executive Officers
Our executive officers are elected annually by our Board of Directors, to hold
office until their successors have been elected and shall have qualified. There
are no family relationships between any of the executive officers. Our current
executive officers are:
Officer
Name Age Since Office
- ---- --- ----- ------
Gary R. Kabureck 48 2000 Chairman, President and Chief Executive
Officer
John F. Rivera 38 2001 Vice President, Treasurer and Chief
Financial Officer
Peter K. Gallagher 40 2002 Controller
Section 16(a) Beneficial Ownership Reporting Compliance
Not applicable because all of our outstanding capital stock is owned by XFSI, a
holding company, which is wholly-owned by XC.
ITEM 11. Executive Compensation
None of our directors or executive officers receive any compensation for
services rendered to us or to our subsidiaries.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
All of our outstanding capital stock is owned by XFSI, a holding company, which
is wholly-owned by XC. None of our directors or executive officers hold, or
possess any rights to acquire, any of our capital stock.
ITEM 13. Certain Relationships and Related Transactions
In the past, we frequently and routinely enter into material transactions with
our ultimate parent, XC, pursuant to the Operating Agreement between XC and us,
and otherwise in the ordinary course of business. Although we have discontinued
purchases of contracts receivable from XC under the Operating Agreement (and,
pursuant to the New Credit Facility, are precluded from purchasing any new
contracts receivable from XC), we nonetheless continue to enter into material
transactions with XC. These transactions and other business relationships
between us and XC are disclosed in the responses to: Part I, Item 1 "Business";
Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations"; Part II, Item 8 "Financial Statements and Supplementary
Data" and Part IV, Item 14 "Exhibits, Financial Statement Schedules and Reports
on Form 8-K", Exhibits 10(a) "Amended and Restated Operating Agreement", 10(b)
"Support Agreement" and 10(c) "Tax Allocation Agreement"; of this Annual Report
on Form 10-K. All of our directors and executive officers are employees, and in
some cases officers, of XC, but do not have any direct or indirect material
interest in such transactions.
All amounts collected on our contracts receivable and all proceeds from the sale
of contracts receivable back to XC, are currently loaned directly back to XC
under an interest bearing demand note agreement (Demand Note). The Demand Note
agreement is included as Exhibit 10 (d) to this Annual Report on Form 10-K. The
Demand Note earns interest at a rate equal to the result of adding the H.15
Two-Year Swap Rate and H.15 Three-Year Swap Rate (each as defined in the Master
Note) and dividing by two (2) and then adding 2.00% (200 basis points).
We will demand repayment of these loan amounts from XC as and to the extent
42
necessary to repay our maturing debt obligations, fund our operations, or for
such other purposes that we determine appropriate.
Subject to certain limitations, all XC and other obligations under the New
Credit Facility are guaranteed by substantially all of XC's 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 New Credit Facility, all of our cash in excess of the
amounts required to make principal and interest payments on our debt and/or
required to meet our ordinary course expenses, in each case for the then next
succeeding fiscal quarter, is transferred to XC on a regular basis. In
connection with the New Credit Facility, substantially all of XC's U.S.
subsidiaries, including us, have also 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").
43
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Index to Financial Statements and financial statements schedules,
filed as part of this report:
Report of Independent Accountants
Consolidated balance sheets at December 31, 2001 and 2000
Consolidated statements of income for each of the years in the
three-year period ended December 31, 2001
Consolidated statements of shareholder's equity for each of the
years in the three-year period ended December 31, 2001
Consolidated statements of cash flows for each of the years in the
three-year period ended December 31, 2001
Notes to consolidated financial statements
All schedules are omitted as they are not applicable or the
Information required is included in the consolidated financial
statements or notes thereto.
(2) Supplemental Data:
Quarterly Results of Operations
(3) The exhibits filed herewith are set forth in the Exhibit Index
included herein.
(b) A Current Report on Form 8-K dated October 25, 2001 reporting Item 4
"Changes in Registrant's Certifying Accountant" and Item 7 "Financial
Statements, Pro Forma Financial Information and Exhibits" was filed during
the last quarter of the period covered by this Report.
44
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
XEROX CREDIT CORPORATION
/s/ John F. Rivera
------------------------------------
(NAME AND TITLE) John F. Rivera, Vice President,
Treasurer and Chief Financial Officer
June 28, 2002
Pursuant to the requirement of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Registrant and in
the capacities and on the date indicated.
June 28, 2002
Principal Executive Officer:
Gary R. Kabureck /s/ Gary R. Kabureck
------------------------------------
Chairman, President, Chief Executive
Officer and Director
Principal Financial Officer:
John F. Rivera /s/ John F. Rivera
------------------------------------
Vice President, Treasurer,
Chief Financial Officer and Director
Principal Accounting Officer:
Peter K. Gallagher /s/ Peter K. Gallagher
------------------------------------
Controller and Director
45
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Xerox Credit Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, cash flows and common shareholders' equity
present fairly, in all material respects, the financial position of Xerox Credit
Corporation and its subsidiaries ("the Company") at December 31, 2001 and 2000,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As disclosed in Note 1, the Company and its parent, Xerox Corporation, engage in
extensive intercompany transactions, and the Company receives all of its
operational and administrative support from Xerox Corporation. Such transactions
cannot be presumed to be carried out on the same basis as transactions among
wholly-unrelated parties. Additionally, as disclosed in Note 5, the Company had
notes receivable from Xerox Corporation at December 31, 2001 amounting to $1,377
million. Accordingly, the Company is dependant on Xerox Corporation complying
with its contractual obligations.
As discussed in Note 2, the Company has restated its consolidated financial
statements for the year ended December 31, 2000, previously audited by other
independent accountants.
/s/ PricewatersCoopers LLP
PricewaterhouseCoopers LLP
Stamford, Connecticut
June 26, 2002
46
XEROX CREDIT CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(In Millions)
ASSETS
2001 2000*
---- -----
Cash and cash equivalents $ - $ -
Investments:
Contracts receivable 3,244 6,355
Unearned income (331) (755)
Allowance for losses (78) (140)
------ -------
Total investments 2,835 5,460
Notes receivable - Xerox and affiliates 1,377 -
Other assets 76 34
------- -------
Total assets $ 4,288 $ 5,494
======= =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Notes payable within one year:
Commercial paper $ - $ 32
Current portion of notes payable after one year 1,630 326
Current portion of secured borrowing 130 134
Notes payable - Xerox and affiliates - 388
Notes payable after one year 1,743 3,665
Secured borrowing due after one year 24 191
Due to Xerox Corporation, net 40 96
Accounts payable and accrued liabilities 10 49
Derivative Liabilities 53 -
------- -------
Total liabilities 3,630 4,881
------- -------
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 424 371
Accumulated other comprehensive income (8) -
-------- -------
Total shareholder's equity 658 613
------- -------
Total liabilities and shareholder's equity $ 4,288 $ 5,494
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
*As restated, see Note 2.
47
XEROX CREDIT CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2001, 2000 and 1999
(In Millions)
2001 2000* 1999
---- ----- ----
Earned Income:
Contracts receivable $ 400 $ 441 $ 435
----- ----- -----
Expenses:
Interest 261 292 243
Derivative instruments fair value
Adjustments 37 - -
General and administrative 11 12 12
----- ----- -----
Total expenses 309 304 255
----- ----- -----
Income before income taxes 91 137 180
Provision for income taxes 35 54 70
----- ----- -----
Income before cumulative effect
of change in accounting principle 56 83 110
Cumulative effect of change in
accounting principle, net (3) - -
----- ----- -----
Net income $ 53 $ 83 $ 110
===== ===== =====
The accompanying notes are an integral part of the consolidated financial
statements.
* As restated, see Note 2.
48
XEROX CREDIT CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
Years Ended December 31, 2001, 2000 and 1999
(In Millions)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Income Total
------ ------- -------- ------------- -----
Balance at December 31, 1998 $ 23 $ 219 $ 348 $ - $ 590
Net Income - - 110 - 110
Dividends - - (170) - (170)
---- ----- ------ ------ -----
Balance at December 31, 1999 23 219 288 - 530
Net Income* - - 83 - 83
Dividends - - - - -
---- ----- ----- ------ -----
Balance at December 31, 2000* 23 219 371 - 613
Net Income* - - 53 - 53
SFAS No. 133 transition
adjustment, net - - - (20) (20)
Net changes on cash flow hedges - - - 12 12
------
Comprehensive Income - - - - 45
Dividends - - - - -
---- ----- ----- ------ ------
Balance at December 31, 2001 $ 23 $ 219 $ 424 $ (8) $ 658
==== ===== ===== ====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
* As restated, see Note 2.
49
XEROX CREDIT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(In Millions)
2001 2000* 1999
---- ----- ----
Cash Flows from Operating Activities
Net income $ 53 $ 83 $ 110
Adjustments to reconcile net income to net cash
provided by operating activities:
Net loss on derivative instruments 23 - -
Net gain on sales of contracts receivable - - (24)
Net change in operating assets and liabilities (35) (9) 21
Derivative collateralization payment (47) - -
------- ------- ------
Net cash (used in) provided by operating activities (6) 74 107
------- ------ ------
Cash Flows from Investing Activities
Purchases of investments (908) (2,496) (2,911)
Proceeds from investments 1,906 1,874 1,890
Proceeds from sales of contract receivables 1,592 - 1,150
Advances to Xerox (1,377) - -
Proceeds from sale of other assets 23 - -
------- ------ ------
Net cash provided by (used in) investing activities 1,236 (622) 129
------- ------- ------
Cash Flows from Financing Activities
Change in commercial paper, net (32) (128) (1,350)
Payments on notes with Xerox and affiliates, net (643) (287) (249)
Proceeds from long-term debt - 2,690 2,608
Proceeds from secured borrowings - 411 -
Principal payments of long-term debt and
secured borrowings (555) (2,138) (1,075)
Dividends - - (170)
------- ------ -------
Net cash provided by (used in) financing activities (1,230) 548 (236)
------ ------ -------
Increase (decrease)in cash and cash equivalents - - -
Cash and cash equivalents, beginning of year - - -
------ ------ ------
Cash and cash equivalents, end of year $ - $ - $ -
====== ====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
*As restated, see Note 2.
50
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Xerox Credit
Corporation (the Company, we, our or us) and its subsidiaries. We are a
wholly-owned subsidiary of Xerox Financial Services, Inc. (XFSI), which is in
turn wholly-owned by Xerox Corporation (XC, and together with its consolidated
subsidiaries, Xerox). All significant transactions between the Company and its
subsidiaries have been eliminated.
Description of Business
Until July 2001, we were primarily a funding entity, which purchased contracts
consisting of payments received for non-cancelable installment sale and lease
contracts originated by the domestic marketing operations of XC. We historically
raised debt in the capital markets to fund our purchase of these contracts. We
have no international operations and do not purchase contracts for international
customers. Purchases of contracts from XC and the subsequent administration of
those receivables by XC were undertaken pursuant to an Operating Agreement
between XC and us. Under the Operating Agreement, XC transferred to us whatever
security interest it had in its receivables and equipment.
The purchase price of the receivable contracts was calculated as the present
value of the future cash flows. The interest rates utilized to discount the cash
flows were determined by certain reference interest rates plus a prescribed
spread. The interest rate utilized for the cost calculation was the adjusted
monthly as each new set of contracts is purchased.
XC provided all billing, collection and other services related to the
administration of the receivables, for which the Company pays a fee. Receivables
collected by XC on our behalf, net of amounts we owed XC for receivables we
purchase from XC, were recorded in an intercompany account. Also recorded in
this intercompany account were fees we owed XC under the Operating Agreement.
Periodically, generally monthly, net cash settlements of this account were made.
Since all services were provided by XC, we maintained minimal facilities and had
no separate infrastructure or employees.
As discussed in Note 3, certain costs and expenses presented in the consolidated
financial statements represent allocations and management's estimates of the
costs of services provided to us by XC.
The Company and XC engage in extensive intercompany transactions and the Company
receives all of its 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.
In September 2001, XC entered into framework agreements with General Electric
Capital Corporation (GE Capital) under which GE Capital (or an affiliate
thereof) (GECC) would 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 GECC 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 and our existing portfolio of contracts will
51
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
ultimately run-off as amounts are collected or contracts are sold back to XC as
part of its efforts to monetize existing receivables. 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.
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 have been previously discussed, 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 us and XC,
including the unavailability of uncommitted bank lines, very limited ability to
utilize derivative instruments to hedge foreign and interest currency exposures,
thereby increasing volatility to changes in exchange rates, and higher interest
rates on borrowings. Additionally, as more fully disclosed below, 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 outstanding
revolving credit facility. An amended $4.2 billion facility replaced the
previous $7 billion facility. However, XC currently has no incremental borrowing
capacity under the facility as the entire $4.2 billion is outstanding as of such
date. 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 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.
The New Credit Facility is discussed in more detail in Note 12. The New Credit
Facility contains more stringent financial covenants than the prior facility,
including the following:
o Minimum EBITDA based on rolling quarters, as defined;
o Maximum leverage (total adjusted debt:EBITDA, as defined)
o Maximum capital expenditures (annual test);
o Minimum consolidated net worth (quarterly test, as defined);
52
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Any failure of XC to be in compliance with any material provision of the New
Credit Facility 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 the obligations of XC under the New Credit Facility, 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 projected liquidity is sufficient to meet current operating cash
flow requirements and satisfy its 2002 scheduled debt maturities and other cash
flow requirements. However, Xerox's ability to meet obligations beyond 2002 is
dependent on its ability to generate positive cash flow from a combination of
operating improvements, capital markets transactions, third party vendor
financing programs and receivable monetizations. Failure to implement these
initiatives could have a material effect on Xerox's liquidity and operations and
it would need to implement alternative plans that could include additional asset
sales, additional reductions in operating costs, deferral of capital
expenditures, further reductions in working capital and further debt
restructurings. 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 Xerox would be successful in implementing them.
Recognition of Earned Income
We utilize the interest method for the recognition of earned income associated
with contracts receivable. Under this method, the difference between the amount
of gross contracts receivable and the cost of the contract is recorded as
unearned income. The unearned income is amortized into income over the life of
the contract using an effective yield method.
Cash and Cash Equivalents
All highly liquid investments, if any, with a maturity of three months or less
at date of purchase are considered to be cash equivalents.
Restricted Investments
At December 31, 2001, we had $46 million of cash held in escrow as collateral
for out-of-the-money positions on certain derivative contracts. These restricted
amounts are included in Other assets, net in the balance sheet as of December
31, 2001. The amount of required collateral will change based on changes in the
fair value of the underlying derivative contracts.
53
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Securitizations and Transfers of Financial Instruments
Sales, transfers and securitizations of recognized financial assets are
accounted for under Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" (SFAS No. 140). From time to time, in the normal course of
business, we may securitize or sell contracts receivable with or without
recourse and/or discounts. The receivables are removed from the Consolidated
Balance Sheet at the time they are sold and the risk of loss has transferred to
the purchaser. However, we maintain risk of loss on any retained interest in
such receivables. Sales and transfers that do not meet the criteria for
surrender of control or were sold to a consolidated special purpose entity
(non-qualified special purpose entity) under SFAS No. 140 are accounted for as
secured borrowings.
When we sell receivables the value assigned to the retained interests in
securitized contracts receivable is based on the relative fair values of the
interest retained and sold in the securitization. We estimate fair value based
on the present value of future expected cash flows using management's best
estimates of the key assumptions, consisting of receivable amounts, anticipated
credit losses and discount rates commensurate with the risks involved. Gains or
losses on the sale of the receivables depend in part on the previous carrying
amount of the financial assets involved in the transfer, allocated between the
assets sold and the retained interests based on their relative fair value at the
date of transfer.
Allowance for Losses
As part of the administrative services it provides to us, XC computes the
allowance for losses on all of our contracts based upon historical experience
and current trends. When we purchase contracts from XC, we deduct the portion of
XC's allowance allocable to the purchased contracts from the purchase price and
record it as Allowance for Losses. If more contracts are charged off than were
forecast in the initial allowance-for-loss calculation, XC reimburses us for the
excess charge-offs. Conversely, if charge-off experience is better than
forecast, XCC reimburses XC for the difference between the original forecast and
amounts ultimately realized. The resultant effect of the above is to relieve us
of any exposure to losses associated with the contracts, and therefore, no bad
debt expense is included in our Consolidated Statements of Income.
Charge-Off of Delinquent Receivables
We charge-off delinquent receivables against established reserves as soon as it
becomes probable that we will not collect the receivables through normal means.
Fair Value of Financial Instruments
The fair value of cash and equivalents and commercial paper approximate carrying
amounts due to the short maturities of these instruments. There were no balances
outstanding for these instruments as December 31, 2001 and 2000. The fair value
of investments, notes payable, and interest rate swaps are discussed in Notes 3,
6, and 8, respectively.
54
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Accounting Changes
Effective January 1, 2001, we adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS No. 133) which requires companies to recognize all derivatives
as assets or liabilities measured at their fair value regardless of the purpose
or intent of holding them. Gains or losses resulting from changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, depending on the type of hedge transaction.
Changes in fair value for derivatives not designated as hedging instruments and
the ineffective portions of hedges are recognized in earnings in the current
period. The adoption of SFAS No. 133, resulted in a net cumulative after-tax
loss of $3 million in the statement of operations and a net cumulative after-tax
loss of $20 million in Accumulated Other Comprehensive Income. Further, as a
result of recognizing all derivatives at fair value, including the differences
between the carrying values of related hedged assets and liabilities, we
recognize a $10 million increase in assets and a $33 million increase in
liabilities.
New Accounting Standards
In 2001, the Financial Accounting Standards Board 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). Adoption of these
standards is not expected to have any significant 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 significant impact on our financial reporting. We implemented the
provisions related to the rescission of Statement 4 in the second quarter of
2002.
Reclassifications
Certain prior year balances have been reclassified to conform to the current
year presentation.
(2) Correction of Error in Comparative Financial Statements
Our 2000 financial statements have been restated to correct an understatement in
interest expense reported in 2000, resulting from an error in calculation of
accrued interest on an interest rate swap in that year. The correction was
originally reflected in the reported first quarter 2001
55
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
financial statements. A summary of the restated amounts is as follows:
(in millions) 2000 2000
As Reported Adjustment Restated
Retained earnings $374 (3)* $371
Accounts payable and accrued liabilities 44 5 49
Interest Expense 287 5 292
Net Income 86 (3)* 83
* Net of $2 million in taxes
(3) Investments
Contracts receivable represent purchases from XC as described in Note 1.
Contract terms range primarily from three to five years. We purchased contracts
from XC totaling $908 million in 2001, $2,496 million in 2000, and $2,911
million in 1999. The Company was charged $9 million in 2001 and $10 million in
both 2000 and 1999 by XC for costs associated with the administering the
contracts.
The Company estimates that the fair value of these investments approximates
their carrying amounts at December 31, 2001 and 2000.
The scheduled maturities of contracts receivable at December 31, 2001 are as
follows (in millions):
2002 $1,247
2003 909
2004 654
2005 327
2006 101
Thereafter 6
------
Total $3,244
======
Experience has shown that a portion of these contracts receivable will be
prepaid prior to maturity. Accordingly, the timing of collections we receive in
the future may differ from those noted in the preceding schedule.
Sales of Contracts
In July 2001, we sold back to XC $643 million of contracts receivable as part of
a structured transaction in which XC transferred receivables to a special
purpose entity (SPE). Our sale of contracts to XC was accounted for as a sale at
book value, which approximated fair value. The SPE in turn sold $513 million of
floating-rate asset-backed notes to third-party investors. XC received cash
proceeds of $480 million net of $3 million of fees in connection with this
transaction. An additional $30 million of proceeds is being held in reserve by
the SPE as additional collateral until the notes are repaid, which is currently
estimated to be in or around August 2003. We have no continuing involvement nor
retained interests in the receivables sold and all risk of loss in such
receivables was transferred back to XC.
In November 2001, XC entered into an agreement with GE Capital from time-to-time
to sell certain receivables in the U.S. to a special purpose entity (SPE) up to
a maximum amount of $2.6 billion (Monetization Agreement). In connection with
the Monetization Agreement, during 2001 we sold back to XC an aggregate of
56
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
$949 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 nor retained interests in the receivables sold
and all the risk of loss in such receivables was transferred back to XC.
In 1999, we sold certain contracts receivable to third party financial
institutions generating gross proceeds of $1,150 million. The transactions were
accounted for as sales of receivables. At December 31, 2001, the balance of the
transferred receivables associated with these transactions was $202 million and
the balance due investors was $73 million. The balance due to investors was paid
off during the first half of 2002.
Secured Borrowings
In 2000, we transferred $457 million of contracts receivable to a special
purpose entity for cash proceeds of $411 million and a subordinated intercompany
loan of $46 million. The transfer agreement included a repurchase option;
accordingly, the proceeds were accounted for as a secured borrowing. At December
31, 2001, the balance of the transferred receivables was $230 million, and is
included in Total investments, net in the Consolidated Balance Sheet. The
remaining secured borrowing balance was $154 million and is included in Debt.
(4) Allowance for Losses
The analysis of the Allowance for Losses for the three-year period ending
December 31, 2001 is as follows ($ in millions):
Additions
Balance Charged Upon Balance
at to Purchase at
Beginning Costs and End
of and Subsequently of
Period Expenses Provided Deductions Period
------ -------- -------- ---------- ------
(A)
2001
Allowance for losses $ 140 $ - $ 27 $ 89 $ 78
2000
Allowance for losses $ 138 $ - $ 66 $ 64 $ 140
1999
Allowance for losses $ 136 $ - $ 81 $ 79 $ 138
(A) Includes, amounts written-off, net of recoveries.
(5) Notes Receivable - Xerox and affiliates
We will make demand loans to XC of all proceeds from the sale or collection of
our receivables. As of December 31, 2001, demand loans to XC totaled $1,377
million. These loans bear interest at a rate equal to the result of adding the
H.15 Two-Year Swap Rate and H.15 Three-Year Swap Rate (each as defined in the
Master Note between Xerox and us) and dividing by two (2) and then adding 2.00%
(200 basis points). We will demand repayment of these loan amounts from XC as
and to the extent necessary
57
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
to repay our maturing debt obligations, fund our operations, or for such other
purposes that we determine to be appropriate.
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.
(6) Sale of Assets
In 1990, we discontinued our third-party financing business. As of December
2000, we had one leveraged lease remaining from this business which was included
in Other assets in our Consolidated Balance Sheet. In the first quarter of 2001,
this last remaining third party lease was sold for proceeds of $23 million. The
sale resulted in no gain or loss.
(7) Notes Payable
A summary of notes payable at December 31, 2001 and 2000 follows:
(In Millions)
2001 2000
---- ----
Floating Rate Notes due 2001 (a) $ - $ 300
3.25% Medium Term Notes due 2001 - 26
6.00% Medium Term Notes due 2002 179 180
0.80% Yen Denominated Medium Term Notes due 2002 381 436
Floating Rate Notes due 2002 (a) 50 50
6.10% Medium Term Notes due 2003 201 200
7.00% Medium Term Notes due 2003 264 260
1.50% Yen Denominated Medium Term Notes due 2005 762 904
2.00% Yen Denominated Medium Term Notes due 2007 231 270
Medium Term Notes due 2008 (b) 25 25
Medium Term Notes due 2012 (b) 125 125
Medium Term Notes due 2013 (b) 60 60
Medium Term Notes due 2014 (b) 50 50
Medium Term Notes due 2018 (b) 25 25
Secured borrowings due 2001-2003 (c) 154 325
Floating Rate Notes due 2048 (d) - 60
Revolving credit agreement, maturing in 2002(e) 1,020 1,020
------ ------
Subtotal $3,527 $4,316
Less current maturities (1,760) ( 460)
------ ------
Total Notes Payable after one year $1,767 $3,856
====== ======
(a) The notes bear interest at rates that are based primarily on spreads above
certain reference rates such as U.S. LIBOR.
(b) Medium Term Notes due in 2008 through 2018 have a weighted average interest
rate of 6.72% percent and are callable by us. We do not expect to call the notes
during 2002.
(c) Refer to note 3 for further discussion of secured borrowings.
(d) The notes were repaid in 2001 at the option of the noteholder.
(e) Refer to Note 8 for further discussion of the revolving credit agreement.
58
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The carrying amounts on certain debt instruments have been adjusted by
transition adjustments associated with the adoption of SFAS No. 133.
Expected principal repayments on notes payable during the next five years are
(in millions):
2002 $ 1,760
2003 489
2004 -
2005 762
2006 and Thereafter 516
-------
Total $ 3,527
=======
Certain of our debt agreements allow us to redeem outstanding debt, usually at
par, prior to scheduled maturity. Outstanding debt issues with such call
features are classified on the balance sheet and in the preceding five-year
maturity summary according to final scheduled maturity, which is in accordance
with our current expectations. The actual decision as to early redemption is
made at the time the early redemption option becomes exercisable and will be
based on economic and business conditions at that time.
Cash interest paid on notes payable for 2001, 2000 and 1999 were $277 million,
$252 million, and $161 million, respectively. Any original issue discount and
other expenses associated with the debt offerings are amortized over the term of
the related issue. Interest payments on commercial paper for 2001, 2000 and 1999
were $0.3 million, $59 million and $62 million, respectively. The
weighted-average commercial paper interest rates for 2000 and 1999 were 6.5
percent and 5.1 percent, respectively. At December 31, 2001, we had no
commercial paper outstanding.
At December 31, 2001 and 2000, carrying values of notes payable totaled $3,527
million and $4,316 million, respectively. The fair values of our notes payable
at December 31, 2001 and 2000 were $3,050 million and $2,917 million,
respectively, based on quoted market prices for our notes or those of comparable
issuers with similar features and maturity dates. The difference between the
fair value and the carrying value represents the theoretical net discount we
would have received if we had retired all notes payable at December 31, 2001 or
2000, respectively. We have no plans to retire our notes payable prior to their
call or final maturity dates.
Historically, it had been our intent to maintain a target debt-to-equity ratio
of 8 to 1. However, as described in Note 1, due to our cessation of purchases of
contracts receivable from XC and our decision to run-off or sell our existing
portfolio, we will no longer be able to maintain a specific debt-to-equity
ratio.
(8) Lines of Credit
As of December 31, 2001, Xerox had $7 billion of loans outstanding (including a
borrowing by us in the amount of $1.0 billion) under a revolving credit
agreement (Old Revolver) entered into in 1997 with a group of banks, which had a
stated maturity date of October 22, 2002. Amounts borrowed under this facility
were at rates based, at Xerox's option, on spreads above certain reference rates
such as LIBOR. See also Note 12 for subsequent events.
59
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(9) Financial Instruments
We adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS No. 133), as of January 1,
2001. The adoption of SFAS 133 is expected to increase the future volatility of
reported earnings and other comprehensive income. In general, the amount of
volatility will vary with the level of derivative and hedging activities and the
market volatility during any period. However, as more fully described below, our
ability to enter into new derivative contracts is severely constrained. The
following is a summary of our SFAS No. 133 activity during 2001:
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. The downgrades of our debt during
2000, 2001 and 2002, 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 described below. For
this reason, we anticipate increased volatility in our results of operations due
to market changes in interest rates and foreign currency rates. Therefore, while
the following paragraphs describe our overall risk management strategy as
intended our current ability to employ that strategy effectively has been
severely limited.
Interest Rate Swaps - Single Currency: We enter into interest rate swap
agreements to manage interest rate exposure, although the recent downgrades of
our indebtedness have limited our ability to manage this exposure. Virtually all
customer financing assets earn fixed rates of interest. Accordingly, through the
use of interest rate swaps in conjunction with the contractual maturity terms of
outstanding debt, we "lock in" an interest spread by arranging fixed-rate
interest obligations with maturities similar to the underlying assets. This
practice effectively eliminates the risk of a major decline in interest margins
resulting from adverse changes in the interest rate environment. Conversely,
this practice also effectively eliminates the opportunity to materially increase
margins when interest rates are declining. More specifically,
pay-fixed/receive-variable interest rate swaps are often used in place of more
expensive fixed-rate debt for the purpose of match funding fixed-rate customer
contracts. Pay-variable/receive-variable interest rate swaps (basis swaps) are
used to transform variable rate, medium-term debt into commercial paper or local
currency LIBOR rate obligations. Pay-variable/receive-fixed interest rate swaps
are used to transform term fixed- rate debt into variable rate obligations.
Where possible, the transactions performed within each of these three categories
have enabled the cost-effective management of interest rate exposures. While our
remaining portfolio of
60
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
derivative instruments is intended to economically hedge interest rate risks to
the extent possible, differences between the contract terms of our derivatives
and the underlying related debt reduce our ability to obtain hedge accounting in
accordance with SFAS No. 133.
This results in mark-to-market valuation of the majority of our derivatives
directly through earnings, which accordingly leads to increased earnings
volatility. At December 31, 2001 and 2000 we had outstanding single currency
interest rate swap agreements with aggregate notional amounts of $683 million
and $4,236 million respectively. The asset/(liability) fair values at December
31, 2001 and 2000 were $(9) million and $(25) million, respectively.
Foreign Currency Swap Agreements: We enter into cross-currency interest rate
swap agreements, whereby we issue foreign currency-denominated debt and swap the
proceeds and related interest payments with a counter-party. In return, we
receive and effectively denominate the debt in local currencies. Currency swaps
are utilized as economic hedges of the underlying foreign currency borrowings.
At December 31, 2001 and 2000, we had outstanding Yen/U.S. Dollar cross currency
interest rate swap agreements with aggregate notional amounts of $1,373 million
and $1,599 million, respectively. The asset/ (liability) fair values at December
31, 2001 and 2000 were $(247) million and $(136) million, respectively.
During 2000, as a result of the reductions in our debt ratings, we were required
to terminate certain third party Yen/U.S. Dollar cross-currency interest rate
swaps for 115 billion yen that were scheduled to mature from 2002 to 2007. We
entered into new cross-currency interest rate swaps with XC to replace these
terminated derivative agreements. The U.S. dollar notional value of these
intercompany swaps were $877 million and $1,005 million at December 31, 2001 and
2000 respectively, and are included in the notional amounts noted above. The
intercompany derivatives are accounted for in accordance with SFAS No. 133 in a
manner similar to third party derivative contracts.
SFAS. No. 133 Results - During 2001, in accordance with SFAS No. 133, we
recorded net losses of $30 million from the mark-to-market valuation of our
interest rate derivatives primarily as a result of losses on our match funding
(pay fixed/receive variable) swaps. Hedge accounting was not applied to any of
our single-currency interest rate swaps during 2001, due to the reasons
discussed above.
Fair Value Hedges - During 2001, the third-party Yen/U.S. dollar cross-currency
interest rate swaps with a notional amount of 65 billion yen were designated and
accounted for as fair-value hedges. The net ineffective portion recorded to
earnings during 2001 was a loss of $7 million and is included in Derivative
instruments fair value Adjustments, net. All components of each derivatives gain
or loss are included in the assessment of the hedge effectiveness. Hedge
accounting was discontinued in the fourth quarter due to the termination of the
swaps. Previous adjustments of $4 million that were made to the carrying amount
of the hedged debt will be amortized to earnings over the remaining term of the
underlying debt. Hedge accounting is not being applied for any of our
cross-currency interest rate swaps as of December 31, 2001.
61
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The aggregate notional amounts of all interest rate swaps by maturity date and
type at December 31, 2001 and 2000 follow:
(In Millions)
2001 2000
---- ----
Pay fixed/receive variable $ 428 $3,435
Pay variable/receive fixed 1,628 2,403
------ ------
$2,056 $5,838
====== ======
Average interest payment rates 3.35% 6.65%
====== ======
The fair values for all interest rate swap agreements are calculated by the
Company based on market conditions and supplemented with quotes from banks. They
represent amounts we would receive (pay) to terminate/replace these contracts.
We have no present plans to terminate /replace a significant portion of these
agreements prior to their scheduled maturities. The maturities of our swaps
outstanding as of December 31, 2001 are as follows: 2002 - $658 million, 2003 -
$124 million, 2004 - $110 million, 2005 - $910 million, 2006 and thereafter -
$254 million.
We had a remaining after-tax loss in Accumulated Other Comprehensive Income of
$8 million at December 31, 2001 associated with the SFAS No. 133 transition
adjustment recorded during 2001. The transition adjustment was recorded for cash
flow derivatives in place at transition. This balance is expected to be
reclassified to earnings during 2002.
(10) Income Taxes
XCC and XC file consolidated U.S. income tax returns. Generally, pursuant to the
tax allocation arrangement between XC and us, we record our tax provisions on a
separate company basis and make payments to XC for taxes due or receive payments
from XC for tax benefits utilized. In connection with the tax allocation
arrangement, we paid XC $80 million, $53 million, and $58 million in 2001, 2000
and 1999, respectively. In years 2001, 2000, and 1999, amounts we paid to taxing
authorities for our operations not included in XC's consolidated tax returns
were less than $1 million.
62
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The components of income before income taxes and the provision for income taxes
are as follows:
(In Millions)
2001 2000* 1999
---- ----- ----
Income before income taxes: $ 91 $ 137 $ 180
====== ====== ======
Federal income taxes
Current $ 53 $ 54 $ 52
Deferred (21) (6) 11
State income taxes
Current 5 7 6
Deferred (2) (1) 1
------ ------- ------
Total provision for income taxes $ 35 $ 54 $ 70
====== ====== ======
A reconciliation of the effective tax rate from the U.S. Federal statutory tax
rate follows:
2001 2000 1999
---- ---- ----
U.S. Federal statutory rate 35.0% 35.0% 35.0%
State income taxes, net of Federal
income tax benefit 3.9 3.9 3.9
----- ----- -----
Effective tax rate 38.9% 38.9% 38.9%
===== ===== =====
The tax effects of temporary differences that give rise to significant portions
of deferred taxes at December 31, 2001 and 2000 follows:
(In Millions)
2001 2000
---- ----
Tax effect of future tax deductions:
Unrealized derivative losses $ 21 $ -
Real estate and other 12 12
Tax effect of future taxable income:
Asset securitizations (4) (5)
Leveraged leases and other(1) (4) (27)
------ -----
Total deferred tax asset (liability), net $ 25 $ (20)
====== ======
(1) See Note 6 for description of sale of leveraged lease in 2001.
We believe that it is more likely than not that the deferred tax assets will be
realized in the ordinary course of operations based on scheduling of deferred
tax liabilities and income from operating activities.
*As restated, see Note 2.
(11) 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
63
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(formerly 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.
(12) Subsequent Events
On May 1, 2002, Xerox Capital Services (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 will pay
a fee to XCS rather than to XC, for these services. The fees paid are expected
to be equal to fees paid to XC.
In connection with XC's Monetization Agreement with GE Capital, in March and May
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.
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 dated October 22, 1997 among XC, us and certain
Overseas Borrowers, as Borrowers, various Lenders, and Morgan Guaranty Trust
Company of New York, The Chase Manhattan Bank, Citibank, N.A. and Bank One, as
Agents (the "Old Revolver"). At that time, XC permanently repaid $2.8 billion of
the Old Revolver. Of the $2.8 billion payment, we paid all of our $1.0 billion
of borrowings under the Old Revolver. We are not and will not become a borrower
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 is currently $4.2 billion of loans
outstanding, 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 maturing on April 30, 2005, a $500 million
"Tranche B" term loan, and a $700 million "Tranche C" term loan which matures on
September 15, 2002. XC is currently, and will remain, the borrower of all of the
term loans.
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.
64
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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, 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.
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 to
Xerox in certain circumstances. Despite a general limitation on the creation of
liens, the New Credit Facility provides for 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.
65
XEROX CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The New Credit Facility also contains financial covenants which the Old Revolver
did not contain, including:
* Minimum EBITDA (rolling four quarters, as defined)
* Maximum Leverage (total adjusted debt:EBITDA, as defined)
* Maximum Capital Expenditures (annual test)
* Minimum Consolidated Net Worth (quarterly test, as defined)
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 (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 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, 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 filed as exhibits to this Annual Report on Form 10-K.
66
(13) Quarterly Results of Operations (Unaudited)
A summary of interim financial information follows:
(In Millions)
First Second Third Fourth
Quarter* Quarter Quarter Quarter Total
-------- ------- ------- ------- -----
2001:
Earned income $ 126 $ 121 $ 91 $ 62 $ 400
Interest expense 77 84 63 37 261
Derivative instruments fair
value adjustments, net (1) 8 15 15 37
General and administrative
expenses 3 3 3 2 11
------ ------ ------ ------ ------
Income before income taxes 47 26 10 8 91
Income taxes 18 10 4 3 35
------ ------ ------ ------ ------
Income before cumulative effect
of change in accounting
principle 29 16 6 5 56
Cumulative effect of change in
accounting principle (3) - - - (3)
------ ------ ------ ------ ------
Net income $ 26 $ 16 $ 6 $ 5 $ 53
====== ====== ====== ====== ======
First Second Third Fourth
Quarter Quarter Quarter Quarter* Total*
------- ------- ------- -------- -----
2000:
Earned income $ 103 $ 108 $ 113 $ 117 $ 441
Interest expense 67 70 74 81 292
General and administrative
expenses 3 3 3 3 12
------ ------ ------ ------ ------
Income before income taxes 33 35 36 33 137
Income taxes 13 14 14 13 54
------ ------ ------ ------ ------
Net income $ 20 $ 21 $ 22 $ 20 $ 83
====== ====== ====== ====== ======
*As restated, see Note 2.
Previously Reported
(In Millions)
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
2001:
Earned income $ 126 $ 121 $ 91 $ 62 $ 400
Interest expense 82 84 63 37 266
Derivative instruments fair
value adjustments, net (1) 8 15 15 37
General and administrative
Expenses 3 3 3 2 11
------ ------ ------- ------ -----
Income before income taxes 42 26 10 8 86
Income taxes 16 10 4 3 33
------ ------ ------- ------ ------
Income before cumulative effect
of change in accounting
principle 26 16 6 5 53
Cumulative effect of change in
accounting principle (3) - - - (3)
------ ------ ------ ------ ------
Net income $ 23 $ 16 $ 6 $ 5 $ 50
====== ====== ======= ====== ======
67
2000:
Earned income $ 103 $ 108 $ 113 $ 117 $ 441
Interest expense 67 70 74 76 287
Operating and administrative
expenses 3 3 3 3 12
------ ------ ------ ------ ------
Income before income taxes 33 35 36 38 142
Income taxes 13 14 14 15 56
------ ------ ------ ------ ------
Net income $ 20 $ 21 $ 22 $ 23 $ 86
====== ====== ====== ====== ======
68
XEROX CREDIT CORPORATION
Form 10-K
For the Year Ended December 31, 2001
Index of Exhibits
Document
(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.
(4)(a) Indenture dated as of October 2, 1995, between Registrant and State
Street Bank and Trust Company (State Street), relating to unlimited
amounts of debt securities which may be issued from time to time by
Registrant when and as authorized by Registrant's Board of Directors
(the October 1995 Indenture).
Incorporated by reference to Exhibit 4(a) to Registrant's
Registration Statement Nos. 33-61481 and 333-29677.
(b)(1) Indenture dated as of April 1, 1999, between Registrant and
Citibank, N.A., relating to unlimited amounts of debt securities
which may be issued from time to time by Registrant when and as
authorized by Registrant's Board of Directors or Executive Committee
of the Board of Directors (the April 1999 Indenture).
Incorporated by reference to Exhibit 4(a) to Registrant's
Registration Statement No. 33-61481.
(2) Instrument of Resignation, Appointment and Acceptance dated as of
February 1, 2001, among Registrant, Citibank, N.A., as resigning
trustee, and Wilmington Trust Company, as successor trustee,
relating to the April 1999 Indenture.
Incorporated by reference to Exhibit 4(c)(2) to Registrant's Annual
Report on form 10-K for the fiscal year ended December 31, 2000.
(c) $7,000,000,000 Revolving Credit Agreement dated October 22, 1997,
among Xerox Corporation (Xerox), Registrant and certain Overseas
Borrowers, as Borrowers, various lenders and Morgan Guaranty Trust
Company of New York, The Chase Manhattan Bank, Citibank, N.A. and
Bank One, National Association (as successor by merger with The
First National Bank of Chicago), as Agents.
Incorporated by reference to Exhibit 4(d) to Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2000.
(d)(1) Indenture dated as of January 17, 2002 between Xerox and Wells
Fargo Bank Minnesota, National Association ("Wells Fargo"), as
trustee, relating to Xerox's 9-3/4% Senior Notes due 2009
69
(Denominated in U.S. Dollars) ("January 17, 2002 U.S. Dollar
Indenture").
Incorporated by reference to Exhibit (4)(h)(1) to Xerox
Corporation's Annual Report on Form 10-K for the Year Ended December
31, 2001.
(2) Indenture dated as of January 17, 2002 between Xerox and Wells Fargo
Bank, as trustee, relating to Xerox's 9-3/4% Senior Notes due 2009
(Denominated in Euros) ("January 17, 2002 Euro Indenture").
Incorporated by reference to Exhibit (4)(h)(2) to Xerox
Corporation's Annual Report on Form 10-K for the Year Ended,
December 31, 2001.
(3) First Supplemental Indenture dated as of June 21, 2002 between
Xerox Corporation and Wells Fargo, as trustee, to the
January 17, 2002 U.S. Dollar Indenture.
Incorporated by reference to Exhibit (4)(h)(5)to Xerox Corporation's
Current Report on Form 8-K dated June 21, 2002.
(2) First Supplemental Indenture dated as of June 21, 2002 between Xerox
Corporation and Wells Fargo, as trustee, to the January 17, 2002
Euro Indenture.
Incorporated by reference to Exhibit (4)(h)(6) to Xerox
Corporation's Current Report on Form 8-K dated June 21, 2002.
(e)(1) Amended and Restated Revolving Credit Agreement, dated as of June
21, 2002, among Xerox Corporation and the Overseas Borrowers, as
Borrowers, various Lenders and Bank One, N.A., JPMorgan Chase Bank
and Citibank, N.A., as Agents (the "Amended Credit Agreement").
Incorporated by reference to Exhibit 4 (l) (1) to Xerox
Corporation's Current Report on Form 8-K dated June 21, 2002.
(2) Guarantee and Security Agreement dated as of June 21, 2002 among
Registrant, the Subsidiary Guarantors and Bank One, N.A., as Agent,
relating to the Amended Credit Agreement.
Incorporated by reference to Exhibit 4 (l) (2) to Xerox
Corporation's Current Report on Form 8-K dated June 21, 2002.
(f) Instruments with respect to long-term debt where the total amount of
securities authorized thereunder does not exceed 10% of the total
assets of Registrant and its subsidiaries on a consolidated basis
have not been filed. Registrant agrees to furnish to the Commission
a copy of each such instrument upon request.
(10)(a) Amended and Restated Operating Agreement originally made and entered
into as of November 1, 1980, amended and restated as of June 30,
1998, between Registrant and Xerox.
Incorporated by reference to Exhibit 10(a) of Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998.
(b) Support Agreement dated as of November 1, 1980, between Registrant
and Xerox.
70
Incorporated by reference to Exhibit 10(b) to Registration
Statement No. 2-71503.
(c) Tax Allocation Agreement dated as of January 1, 1981, between
Registrant and Xerox.
Incorporated by reference to Exhibit 10(c) to Registration
Statement No. 2-71503.
(d) Master Note dated November 20, 2001 between Registrant and Xerox
Corporation
(12)(a) Computation of Registrant's Ratio of Earnings to Fixed Charges.
(b) Computation of Xerox' Ratio of Earnings to Fixed Charges.
(21) Subsidiaries of Registrant
(23) Consent of PricewaterhouseCoopers LLP.
71