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RNS Number:0074M Xerox Corp 23 October 2001 For additional Information contact: Leslie P. Varon Cynthia B. Johnston Vice President, Investor Relations Manager, Investor Relations 203-968-3110 203-968-3489 Leslie.Varon@usa.xerox com Cynthia.Johnston@usa.xerox.com Xerox 2001 Third Quarter Earnings Announcement Reminder Conference Call and Live Webcast Xerox Corporation will be holding a telephone conference with Anne Mulcahy, President and Chief Executive Officer, and Barry Romeril, Vice Chairman and Chief Financial Officer at 10:00 a.m. (Eastern Time) Tuesday, October 23, 2001 following the release of our 2001 third quarter financial results. The conference will be available by live webcast in Real Audio at www.xerox.com/investor or http://ir.ccbn.com/ir.zhtml?t=XRX&s=1100 or by calling (847) 413-3237 at approximately 9:45 a.m. You may also hear a recording of the conference in Real Audio at www.xerox.com/investor or http://ir.ccbn.com/ir.zhtml?t=XRX&s=1100 or by calling (402) 220-4350 after 12:30 P.M. on October 23rd. No password is required. The telephone recording will be available until October 25th. The earnings announcement will be available by 7:00 a.m. on First Call, e-mail, and the Internet at www.xerox.com/investor We look forward to your participation. XEROX REPORTS THIRD-QUARTER RESULTS STAMFORD, Conn., Oct. 23, 2001 - Xerox Corporation (NYSE: XRX) today announced a third-quarter loss of 24 cents per share, excluding restructuring charges of 5 cents per share. The loss includes 5 cents from unhedged currency exposure, 3 cents from an adjustment to the underlying tax rate on the 2001 first-half loss, and 1 cent from a $10 million property insurance loss related to the Sept, 11 tragedy. As previously reported, Xerox's liquidity position continued to improve. The company had $2.4 billion in cash as of Sept. 30 compared to $2.2 billion at the end of June. Xerox's net debt is down $3.4 billion since the end of September 2000, a 20 percent reduction. The company said that it has recently initiated discussions with its agent banks to refinance a portion of its $7 billion revolving line of credit and extend its maturity from October 2002. Third-quarter revenue was $3.9 billion, 13 percent lower than the third quarter of last year. Pre-currency revenue declined 12 percent. "Xerox was prepared for significant challenges in the third quarter due to weakened economies. Despite expected revenue declines, our results in July and August exceeded expectations, evidence of our much improved operations," said Anne M. Mulcahy, Xerox president and chief executive officer. "However, the dramatic economic downturn since the events of Sept. 11 resulted in an unprecedented loss in September, driven by disproportionate revenue decreases during the last two weeks of the month." While revenue in North America and Europe declined, both regions showed significant year-over-year bottom-line improvement led by increased profitability in North America. Revenue in the company's developing markets was down 34 percent, reflecting weakened economies and reduced equipment placements in Latin America as the company reconfigures these operations to maximize liquidity versus gaining market share. Gross margins increased from the third quarter of last year to 36.2 percent, and represent the first year-over-year margin improvement since Xerox launched its turnaround program in the fourth quarter of 2000. In October of last year, Xerox announced plans to reduce $1 billion in costs by the close of 2001. Today the company reported that it has implemented actions that will achieve the entire $1 billion target, including the reduction of close to 11,000 positions worldwide through the combination of early retirement and voluntary leave programs, attrition and layoffs. "In the past 12 months, Xerox has implemented a strategy to restore the company's financial strength by generating cash, reducing debt and cutting costs - all while investing in the future through research and development," added Mulcahy. "While our progress to date has been significant, we will intensify our cost-reduction activities to help lessen the impact from heightened economic concerns." Commenting on expectations for the fourth quarter, Mulcahy said, "We remain cautiously optimistic that the benefits from our turnaround program will position the company for a return to operational profitability. However, the uncertainty in the marketplace presents significant challenges and will lessen the sequential increase in fourth-quarter revenue." Xerox also reiterated that it remains in full compliance with its debt covenants and estimates that its consolidated tangible net worth cushion is approximately $175 million. This release contains forward-looking statements and information relating to Xerox that are based on our beliefs as well as assumptions made by and information currently available to us. The words "anticipate," "believe," "estimate," "expect," "intend," "will" and similar expressions, as they relate to us, are intended to identify forward-looking statements. Actual results could differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause actual results to differ materially is included in the company's Form 10-Q for the quarter ended June 30, 2001. XEROX(R), The Document Company(R) and the digital X(R) are trademarks of XEROX CORPORATION. Xerox Corporation Financial Summary Three Months Nine Months Ended September 30, Ended September 30, (In millions, except per-share data) (unaudited) 2001 2000** % 2001 2000** % Growth Growth Revenues $ 3,902 $ 4,503 (13%) $12,241 $13,820 (11%) Income (Loss) before special items, extraordinary gain & cumulative effect of change in accounting principle $ (175) $ (193) 9% $ (294) $ 202 (246%) SOHO disengagement charge, net of taxes of $6 and ($72) 6 - * (190) - * Restructuring & Tektronix IPRD charges, net of taxes of ($13), $2, ($50), and ($182) (43) 2 * (139) (439) 68% Gain on sale of 50% of interest in Fuji Xerox, net of taxes of $469 - - - 300 - * Loss before extraordinary gain & cumulative effect of change in accounting principle (212) (191) (11%) (323) (237) (36%) Extraordinary gain, net of taxes of $1 and $23 1 - * 36 - * Cumulative effect of change in accounting principle, net of taxes of ($1) - - - (2) - * Net Loss $ (211) $ (191) (10%) $ (289) $ (237) (22%) Diluted Earnings (Loss) per Share Income (Loss) before special items, extraordinary item & cumulative effect of change in accounting principle $(0.24) $(0.30) 20% $ (0.44) $ 0.27) (263%) SOHO disengagement charge 0.01 - (0.27) - * Restructuring & Tektronix IPRD charges (0.06) - * (0.20) (0.66) 70% Gain on sale of 50% of interest in Fuji Xerox - - - 0.43 - * Diluted Loss per share before extraordinary gain & cumulative effect of change in accounting principle (0.29) (0.30) 3% (0.48) (0.39) (23%) Extraordinary gain, net - - - 0.05 - * Cumulative effect of change in accounting principle - - - - - - Diluted Loss per Share $(0.29) $(0.30) 3% $ (0.43) $(0.39) (10%) * Calculation not meaningful ** As restated Xerox Consolidated Statements of Operations Three Months Nine Months Ended September 30, Ended September 30, (In millions, except per-share data) (unaudited) 2001 2000** % 2001 2000** % Growth Growth Revenues Sales $ 1,842 $ 2,420 (24%) $ 5,878 $ 7,341 (20%) Service, outsourcing, financing and rentals 2,060 2,083 (1%) 6,363 6,479 (2%) Total Revenues 3,902 4,503 (13%) 12,241 13,820 (11%) Costs and Expenses Cost of sales 1,262 1,582 (20%) 4,049 4,460 (9%) Cost of service, outsourcing, financing and rentals 1,226 1,344 (9%) 3,860 3,986 (3%) Inventory charges - - - 24 90 (73%) Research and development expenses 284 269 6% 779 774 1% Selling, administrative and general expenses 1,215 1,428 (15%) 3,629 4,074 (11%) Restructuring charge and asset impairments 44 - * 436 504 (13%) Gain on sale of half of interest in Fuji Xerox - - - (769) - * Gain on affiliate's sale of stock - - - - (21) * Purchased in-process research and development - - - - 27 * Other, net 119 115 3% 370 274 35% Total Costs and Expenses 4,150 4,738 (12%) 12,378 14,168 (13%) Income (Loss) before Income Taxes (Benefits), Equity Income (Loss), Minorities' Interests, Extraordinary Gain, and Cumulative Effect of Change in Accounting Principle (248) (235) (6%) (137) (348) 61% Income taxes (benefits) (56) (44) (27%) 187 (84) * Income (Loss) after Income Taxes (Benefits) before Equity Income and Minorities' Interests (192) (191) (1%) (324) (264) (23%) Equity in net income of unconsolidated affiliates (1) 10 (110%) 32 60 (47%) Minorities' interests in earnings of subsidiaries 19 10 90% 31 33 (6%) Net Loss before extraordinary gain and principle (212) (191) (11%) (323) (237) (36%) Extraordinary gain, net of taxes of $1 and $23 1 - * 36 - * Cumulative effect of change in accounting principle - - - (2) - * Net Loss $ (211) $ (191) (10%) $ (289) $ (237) (22%) Calculation of Loss Per Share Net Loss $ (211) $ (191) (10%) $ (289) $ (237) (22%) Diluted Earnings (Loss) per Share Preferred dividends, net of tax and other - (8) * (12) (26) 54% Interest on convertible debt, net of tax - - - 1 - * Income(Loss) available for common (211) (199) (6%) (300) (263) (14%) Weighted average shares outstanding 717.6 666.7 8% 697.9 667.2 5% Diluted Earnings (Loss) per Share $ (0.29) $ (0.30) 3% $(0.43) $(0.39) (10%) *Calculation not meaningful ** As restated Financial Review Summary The Company has restated its 1999 and 1998 consolidated financial statements. This restatement has also impacted the quarterly financial information previously presented for the quarter ended September 30, 2000. These restatements are the result of two separate investigations conducted by the Audit Committee of the Board of Directors involving previously disclosed issues in our Mexico operations and a review of our accounting policies and procedures and the application thereof. The restatements are fully discussed in the Form 10-K filed June 27, 2001 and the Form 10-Q filed August 13, 2001 with the Securities and Exchange Commission. The following table presents the effects of the adjustments on pre-tax income (loss)*: Three Months Ended Sept. 30, 2000 Increase (decrease) to pre-tax income (loss)*: Mexico $ 21 Lease issues, net 22 Other, net (82) Total $(39) *Pre-tax income (loss) refers to income (loss) from Operations before income taxes (benefits), Equity Income (Loss), Minorities Interests, Extraordinary gain, and Cumulative effect of change in accounting principle. Throughout the following Financial Review all referenced amounts reflect the above described restatement adjustments. Total third quarter 2001 revenues of $3.9 billion declined 13 percent (12 percent pre-currency) from $4.5 billion in the 2000 third quarter. This decline was driven by increased competitive pressure and continued weakness in the economy exacerbated by the events of September 11. While revenue in North America and Europe declined, both regions showed significant year-over-year profitability improvements led by North America. Developing Markets Operations third quarter 2001 revenues were 34 percent below the 2000 third quarter as we reconfigure our Latin American Operations to a new business approach prioritizing liquidity and profitable revenue rather than market share. Including additional net after-tax restructuring provisions of $37 million associated with the company's previously announced Turnaround Program and disengagement from our worldwide small office / home office (SOHO) business and a $1 million after tax gain on early retirement of debt, the third quarter 2001 net loss was $211 million. Excluding these items, the third quarter 2001 after tax loss was $175 million. In the 2001 third quarter, we incurred a $37 million loss in our worldwide SOHO operations. The 2001 third quarter loss reflected the revenue decline, but our operating margin stabilized together with an improvement in the gross margin. Our loss per share was $0.29 in the 2001 third quarter. Excluding the $0.05 restructuring provision the 2001 third quarter loss was $0.24 compared with a $0.30 loss per share in the 2000 third quarter. Liquidity The company's worldwide cash balance at September 30, 2001 was $2.4 billion versus $2.2 billion at June 30, 2001 and $1.7 billion at December 31, 2000. Total debt, net of cash on hand at September 30, 2001, was $13.6 billion, reflecting reductions of approximately $0.4 billion from June 30, 2001 and $2.7 billion from December 31, 2000. The decrease from June 30, 2001 largely reflects the July 2001 sale of $0.5 billion of asset-backed securities supported by U.S. finance receivables. Inventory at September 30, 2001 declined approximately $850 million from the September 30, 2000 level, approximately $400 million from December 31, 2000 and approximately $25 million from June 30, 2001. Third quarter 2001 days sales outstanding improved by approximately 4 days from the 2000 third quarter but deteriorated by approximately 5 days from the 2001 second quarter. Capital spending was approximately $40 million in the third quarter 2001. 2001 year to date capital spending was approximately $160 million compared with $324 million through the first 9 months in 2000. At September 30, 2001 the company had approximately $1.3 billion of debt obligations expected to be repaid during the remainder of 2001 including $0.2 billion related to the recently approved early redemption of #125 million ($184 million) 8 3/4 percent bonds. Debt obligations due in 2002 of $9.0 billion include $7.0 billion under our Revolving Credit Agreement (Revolver), which matures in October 2002. We have recently initiated discussions with our agent banks to refinance a portion of the Revolver and extend its maturity. We continue to be in full compliance with our debt covenants and have a cushion of approximately $175 million in the Consolidated Tangible Net Worth covenant at September 30, 2001. The company continues to implement global initiatives to reduce costs, improve operations, transition customer equipment financing to third-party vendors and sell certain assets that we believe will positively affect our capital resources and liquidity position when completed. The company's objective is to fund the debt maturities in 2001 and 2002 with cash on hand, operating cash flows, proceeds from asset sales and other liquidity and financing initiatives, including renegotiation of the Revolver. Several initiatives which enhance liquidity were announced since the end of the 2001 second quarter. In July we completed the offering of floating rate asset backed notes supported by U.S. finance receivables for proceeds of $480 million. As part of our plan to transition customer equipment financing to third parties, in September we announced a framework agreement with GE Capital under which, GE Capital's Vendor Financial Services Group will become the primary equipment financing provider for Xerox customers in the United States. We also agreed to the principal terms of a financing agreement under which we will receive approximately $1 billion from GE Capital, secured by portions of Xerox's U.S. finance receivables. We expect both agreements to close in the fourth quarter. In October we announced a manufacturing agreement with Flextronics which includes payment to Xerox of approximately $220 million and assumption of certain liabilities for the sale of inventory, property and equipment and a five-year contract for Flextronics to manufacture certain office equipment and components. The actual amount of cash proceeds will vary based upon the actual net asset levels at the time of the closings. The first sales are expected to close in the fourth quarter. A more complete discussion of the company's liquidity strategies is included in Form 10-Q filed August 13, 2001 with the Securities and Exchange Commission. Pre-Currency Growth To understand the trends in the business, we believe that it is helpful to adjust revenue and expense growth (except for ratios) to exclude the impact of changes in the translation of European and Canadian currencies into U.S. dollars. We refer to this adjusted growth as "pre-currency growth." Latin American currencies are shown at actual exchange rates for both pre-currency and post-currency reporting, since these countries generally have volatile currency and inflationary environments. A substantial portion of our consolidated revenues is derived from operations outside of the United States where the U.S. dollar is not the functional currency. When compared with the average of the major European and Canadian currencies on a revenue-weighted basis, the U.S. dollar was approximately 2 percent stronger in the 2001 third quarter than in the 2000 third quarter. As a result, currency translation had an unfavorable impact of approximately one percentage point on revenue growth. Segment Analysis Revenues and year-over-year revenue growth rates by segment are as follows: Pre-Currency Revenue Growth 3Q 2001 2000* 2001 Post Currency Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Revenue Growth Total Revenues 8% *% (2)% (9)% (1)% (5)% (12)% (12)% $ 3.9 (13)% Production 1 (2) (8) (12) (6) (2) (8) (7) 1.4 (8) Office 4 5 4 (3) 2 3 (5) (4) 1.6 (5) Small Office / 35 (3) (2) 1 6 (24) (30) (22) 0.1 (23) Home Office Developing Markets 36 4 (3) (21) - (21) (31) (33) 0.4 (34) Other 7 (9) (1) (4) (2) (16) (17) (26) 0.4 (27) Memo: Color 64 60 74 54 62 17 1 (4) 0.7 (6) * As restated Dollars are in billions. 2000 pre-currency revenue growth includes the beneficial impact of the January 1, 2000 acquisition of the Tektronix, Inc. Color Printing and Imaging Division. Production revenues include DocuTech, Production Printing, color products for the production and graphic arts markets and light-lens copiers over 90 pages per minute sold predominantly through direct sales channels in North America and Europe. Third quarter 2001 revenues declined 8 percent (7 percent pre-currency). Third quarter 2001 pre-currency revenues declined 3 percent in North America and 7 percent in Europe from the 2000 third quarter. Monochrome production revenue declines reflect the downturn in the economy, competitive product introductions and continued movement to distributed printing and electronic substitutes. In addition, revenue was adversely impacted by reduced DocuTech sales to Fuji Xerox and unfavorable product mix reflecting installations of the recently introduced DocuTech 75 and DocuPrint 75. Post equipment install revenues continue to be adversely affected by reduced equipment placements in earlier quarters and lower print volumes. Production color revenues declined as the weaker economic environment impacted sales of color equipment and competitive product introductions continued. Revenues from the successful DocuColor 2000 series, which began shipments in June 2000, continued to grow reflecting increased equipment sales and recurring revenues. Reduced DocuColor 30/40 and mid-range installs combined with more aggressive pricing resulted in revenue declines. Production revenues represented 35 percent of third quarter 2001 revenues compared with 33 percent in the 2000 third quarter. Third quarter 2001 gross margin for the production segment improved from the 2000 third quarter as significant improvement in document outsourcing margins and improved service productivity were only partially offset by unfavorable mix. Office revenues include our family of Document Centre digital multi-function products; light-lens copiers under 90 pages per minute; and our color laser, solid ink and monochrome laser desktop printers, digital copiers and facsimile products sold through direct and indirect sales channels in North America and Europe. Third quarter 2001 revenues declined 5 percent (4 percent pre-currency) from the third quarter 2000. Black and white revenues declined as equipment sales were impacted by the weaker economy, continued competitive pressures and light lens declines and our decision in Europe to reduce our participation in very aggressively priced competitive customer bids and tenders as we reorient our focus from market share to profitable revenue. Shipments of the Document Centre 490, the fastest in its class at 90 pages-per-minute began in North America in September. European launch is scheduled for the first quarter 2002. Strong office color revenue growth was driven by continued growth in the Document Centre ColorSeries 50 partially offset by office color printer equipment sales declines. The Document Centre ColorSeries 50 is the industry's first color-enabled digital multi-function product. Office revenues represented 41 percent of third quarter 2001 revenues compared with 38 percent in the 2000 third quarter. Third quarter 2001 gross margin for the office segment improved significantly from the 2000 third quarter primarily as a result of our reduced participation in very aggressively priced competitive bids and tenders, improving Document Centre margins facilitated by strong Document Centre 480 placements and initial Document Centre 490 placements, improved manufacturing and service productivity, favorable currency and significantly improved document outsourcing margins. Small Office/Home Office (SOHO) revenues include inkjet printers and personal copiers sold through indirect channels in North America and Europe. On June 14 we announced our disengagement from the SOHO business. Third quarter 2001 SOHO revenues declined 23 percent (22 percent pre-currency) from the 2000 third quarter and gross margin declined as we exit this business and reduce equipment inventory in a very difficult market environment. SOHO revenues represented 3 percent of revenues in both the 2001 and 2000 third quarters. Developing Markets Operations (DMO) includes operations in Latin America, Russia, India, the Middle East and Africa. Third quarter 2001 revenue declined significantly in Brazil from the 2000 third quarter reflecting reduced equipment placements and the transition of its business model to maximize liquidity and profitable revenue rather than market share, compounded by an average 29 percent devaluation in the Brazilian Real. Third quarter 2000 revenues in Brazil included a $30 million structured transaction but there were no similar arrangements in the 2001 third quarter. Revenue declined throughout the other Latin American countries due to weaker economies and our decision to focus on liquidity and profitable revenue rather than market share. DMO revenues represented 11 percent of third quarter 2001 revenues compared with 14 percent in the 2000 third quarter. DMO incurred a substantial pre-tax loss in the third quarter 2001. Gross margin declined in DMO as a result of lower equipment and service margins, currency devaluation not offset by price increases, weak mix and the absence of any structured transaction in Brazil. Revenue By Type The pre-currency growth rates by type of revenue are as follows: 2000* 2001 Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Equipment Sales 13% (1)% (9)% (21)% (8)% (13)% (27)% (27)% All Other Revenues 6 1 2 1 2 (2) (3) (5) Total Revenues 8% -% (2)% (9)% (1)% (5)% (12)% (12)% *As restated 2000 pre-currency revenue growth includes the beneficial impact of the January 1, 2000 acquisition of the Tektronix, Inc. Color Printing and Imaging Division. Third quarter 2001 equipment sales declined 27 percent from the third quarter 2000 as increased competition and the weakened economic environment following the events of September 11 significantly impacted sales for the balance of the month which are typically the strongest weeks of the quarter. Third quarter 2001 equipment sales declined 60 percent in DMO and 53 percent in SOHO compared to the 2000 third quarter. 2001 third quarter equipment sales declined 10 percent in North America and 15 percent in Europe from the third quarter 2000. All other revenues, including revenues from service, document outsourcing, rentals, standalone software, supplies, paper and finance income, represent the revenue stream that follows equipment placement. All other revenues in the 2001 third quarter declined 5 percent from the third quarter 2000. Over one percentage point of the decline was due to lower third quarter 2001 paper revenues reflecting lower European volume and prices and the transfer of certain accounts to Georgia Pacific following the June 2000 sale of our North American commodity paper business. Approximately one percentage point of the decline was due to the December 2000 sale of our China Operations, Service and supplies revenues continue to be adversely affected by reduced equipment placements in earlier quarters and lower page volumes. Document Outsourcing revenues are split between Equipment Sales and all other revenues. Where document outsourcing contracts include revenue accounted for as equipment sales, this revenue is included in Equipment Sales, and all other document outsourcing revenues, including service, equipment rental, supplies, paper, and labor are included in all other revenues. Document Outsourcing, excluding equipment sales revenue, grew 8 percent in the 2001 third quarter and the gross margin improved significantly. The backlog of future estimated document outsourcing revenue was $8.4 billion in the 2001 third quarter, a 4 percent decline from the 2000 third quarter largely due to a focus on only entering those contracts with satisfactory margins. Key Ratios and Expenses The trend in key ratios was as follows: 2000* 2001 Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Gross Margin 39.1%* 40.4% 35.0% 35.1% 37.4%* 33.6% 35.8%** 36.2% SAG % Revenue 28.0 28.8 31.7 32.2 30.2 27.4 30.6 31.1 *Includes inventory charges associated with the 2000 restructuring. If excluded the gross margin would have been 41.1 percent and 37.9 percent, respectively. **Includes inventory charges associated with the SOHO disengagement. If excluded the gross margin would have been 36.4 percent. The third quarter 2001 gross margin improved by 1.2 percentage points from the 2000 third quarter as improved manufacturing and service productivity and favorable currency were only partially offset by unfavorable mix. Weak performance in DMO reduced the gross margin by 0.7 percentage points. Excluding SOHO operations, the 2001 third quarter gross margin was 37.7 percent. Selling, administrative and general expenses (SAG) declined 15 percent (14 percent pre-currency) in the 2001 third quarter from the third quarter 2000 reflecting continued benefits from our Turnaround Program including significantly lower labor costs and advertising and marketing communications spending. These reductions were partially offset by professional costs related to our regulatory filings and related matters. Third quarter 2001 bad debt provisions of $185 million were $14 million higher than the 2000 third quarter despite an improvement in Mexico. Increased provisions in North America primarily associated with higher risk smaller customers in this weakened economic environment more than offset the 2000 third quarter provisions in Mexico. Research and development (R&D) expense was $15 million higher in the 2001 third quarter than the 2000 third quarter reflecting increased DocuColor iGen3 expenses. Full year 2001 R&D spending is expected to represent approximately 6 percent of revenue as we continue to invest in technological development, particularly color, to maintain our position in the rapidly changing document processing market. Xerox R&D remains technologically competitive and is strategically coordinated with Fuji Xerox. Worldwide employment declined by 2,300 in the 2001 third quarter to 83,300 primarily as a result of employees leaving the company under our restructuring programs. Excluding divestitures, worldwide employment has declined by 10,900 since implementation of our Turnaround Program in October, 2000. Other, net was $119 million in the 2001 third quarter compared to $115 million in the third quarter 2000. In the third quarter 2001 we incurred $54 million of net currency losses resulting from the remeasurement of unhedged foreign currency-denominated assets and liabilities. These currency exposures are unhedged in 2001 largely due to our restricted access to the derivatives markets. Also included in Other, net in the 2001 third quarter is $10 million of property losses related to the September 11 incident. In addition, the 2000 third quarter included approximately $30 million of non-recurring interest income related to an income tax refund receivable. Lower third quarter 2001 net non-financing interest expense of $94 million primarily reflects lower interest rates and lower debt levels as compared to the prior year, including net gains of $46 million from the mark-to-market of our remaining interest rate swaps required to be recorded as a result of applying SFAS 133 accounting rules. This was primarily driven by sharply lower variable rates in the quarter. Differences between the contract terms of our interest rate swaps and the underlying related debt preclude hedge accounting treatment in accordance with SFAS 133 which requires us to record the mark-to-market valuation of these derivatives directly through earnings. Due to the inherent volatility in the interest and foreign currency markets, the company is unable to predict the amount of the above-noted remeasurement and mark-to-market gains or losses in future periods. During the fourth quarter of 2000 we announced a Turnaround Program in which we outlined a wide-ranging plan to sell assets, cut costs and strengthen our strategic core. We announced plans that were designed to reduce costs by at least $1.0 billion annually, the majority of which will affect 2001. As part of the cost cutting program, we continue to take additional charges for finalized initiatives under the Turnaround Program. As a result of these actions and changes in estimates related to previously established reserves, in the 2001 third quarter we provided an incremental $56 million ($43 million after taxes) to complete our open initiatives under the Turnaround and March 2000 plans. We expect additional provisions will be required in 2001 as additional plans are finalized. The restructuring reserve balance at September 30, 2001 for both the Turnaround Program and March 2000 program was $142 million. Income Taxes, Equity in Net Income of Unconsolidated Affiliates and Minorities' Interests in Earnings of Subsidiaries Pre-tax income (loss) was $(248) million in the 2001 third quarter including the restructuring provisions. Excluding these items, the pre-tax loss was $(204) million in the 2001 third quarter compared to a loss of $(235) million in the 2000 third quarter. The effective tax rate, including the net tax benefit related to additional restructuring provisions and an adjustment to the underlying tax rate on the 2001 first half loss was 22.6 percent in the 2001 third quarter. Excluding these items, the 2001 third quarter tax rate was 33.7 percent compared to the 2000 third quarter tax rate of 34.9 percent. This reduction in the tax rate is due primarily to continued losses in low-tax rate jurisdictions and in jurisdictions where losses could not be tax effected, offset by a favorable tax audit. The third quarter change in the tax rate from 42.0 percent to 33.7 percent required a catch up adjustment to the previously recorded first half tax benefits. This catch-up adjustment reduced the tax benefit and increased the third quarter 2001 net loss by $21 million. A similar 2000 third quarter adjustment reduced that tax benefit and increased the net loss by $41 million. Equity in net income of unconsolidated affiliates is principally our 25 percent share of Fuji Xerox income. Total 2001 third quarter equity in net income declined by $11 million from the third quarter 2000 largely reflecting our reduced ownership in Fuji Xerox. Our share of total Fuji Xerox net income of $4 million in the 2001 third quarter decreased by $11 million from the 2000 third quarter. In the third quarter 2001, we retired $12 million of long-term debt through the exchange of 1.2 million shares of common stock valued at $10 million which resulted in a pre-tax extraordinary gain of $1.7 million. In the first nine months of 2001, we retired $340 million of debt through the exchange of 37.4 million shares of common stock valued at $283 million, resulting in pre-tax extraordinary gains of $59 million ($36 million after taxes) for a net equity increase of approximately $319 million. In the 2001 second quarter, we sold our leasing businesses in four European countries to Resonia Leasing AB for proceeds of approximately $370 million. These sales are part of an agreement under which Resonia will provide on-going, exclusive equipment financing to our customers in those countries. In June 2001, the Ad Hoc Committee of the Board of Directors approved the disengagement from our SOHO business. In connection with this disengagement in the second quarter, we recorded a pre-tax charge of $274 million including provisions for the elimination of approximately 1,200 jobs worldwide by the end of 2001, the closing of facilities and the write-down of certain assets to net realizable value. As we continue to disengage from the SOHO business, charges associated with this action are updated accordingly. In the 2001 third quarter, changes in estimates for employee termination and decommitment costs reduced the original reserve by approximately $12 million ($6 million after taxes). The year to date $262 million pretax charge for the SOHO disengagement consists of approximately $30 million in employee termination costs, $144 million of asset impairments, $29 million in inventory charges, $24 million in purchase commitments, $16 million in decommitment costs, and $19 million in other miscellaneous charges. The SOHO disengagement reserve balance at September 30, 2001 was $49 million. Over the remainder of the fourth quarter we will discontinue our line of personal inkjet and xerographic printers, copiers, facsimile machines and multi- function devices which are sold primarily through retail channels to small offices, home offices and personal users (consumers). We intend to sell the remaining inventory through current channels. We will continue to provide service, support and supplies, including the manufacturing of such supplies, for customers who currently own SOHO products during a phase-down period to meet customer commitments. In July 2001, we completed the offering of $513 million of floating rate asset backed notes. In conjunction with this offering, we received cash proceeds of $480 million net of $3 million paid in expenses and fees. The remaining cash proceeds of approximately $30 million will be held in reserve over the term of the asset backed notes. As part of the transaction we sold approximately $639 million of domestic finance receivables to a qualified special purpose entity in which we have a retained interest of approximately $159 million, including the cash proceeds held in reserve. The transaction was accounted for as a sale of finance receivables at approximately book value. In September 2001 Xerox and GE Capital announced a framework agreement for GE Capital's Vendor Financial Services Unit to become the primary equipment financing provider for Xerox customers in the United States. The two companies also agreed to the principal terms of a financing arrangement under which Xerox will receive from GE Capital approximately $1 billion secured by portions of Xerox's finance receivables in the United States. As part of this transaction, Xerox will transition nearly all of its U.S. customer administration operations into a jointly managed joint venture with GE Capital Vendor Financial Services. It is anticipated that Xerox employees who work in Xerox customer financing and administration offices will join the new joint venture on January 2, 2002. Their work, which includes order processing, credit approval, financing programs, billing and collections, is expected to continue in the current locations, ensuring further continuity for Xerox customers and employees. The arrangements are expected to close in the fourth quarter subject to the negotiation of definitive agreements and satisfaction of closing conditions, including completion of due diligence. In October 2001, we announced a manufacturing agreement with Flextronics, a $12 billion global electronics manufacturing services (EMS) company. The agreement includes a five-year supply contract for Flextronics to manufacture certain office equipment and components, payment of approximately $220 million to Xerox for inventory, property and equipment at a modest premium over book value, and the assumption of certain liabilities. The premium will be amortized over the life of the five-year supply contract. As a result of these actions, we expect to incur restructuring charges in the fourth quarter of 2001. Flextronics will purchase four Xerox office manufacturing operations including manufacturing assets and inventory. The approximately 3,650 current Xerox employees in these operations are expected to transfer to Flextronics. We will also stop production by the end of the second quarter 2002 at our printed circuit board factory in El Segundo, California, and our customer replaceable unit plant in Utica, New York. Flextronics will build this work into its global network of manufacturing plants. In addition, we have begun consultations with European works councils regarding the sale of our office manufacturing operations in Venray, The Netherlands, and the transfer to Flextronics of some production work currently performed at our site in Mitcheldean, England. In total, the agreement with Flextronics represents approximately 50 percent of our overall manufacturing operations. The first sales are expected to close in the fourth quarter, beginning a one-year transition period for Flextronics to assume manufacturing of Xerox-designed office products and related components. The actual cash proceeds will vary, based upon the actual net asset levels at the time of the closings. The SEC is continuing its investigation into Mexican accounting issues and other accounting matters. The company is continuing to fully cooperate with the investigation. The company cannot predict when the SEC will conclude its investigation or its outcome. Forward-Looking Statements This earnings release and financial review contain forward-looking statements and information relating to Xerox that are based on our beliefs as well as assumptions made by and information currently available to us. The words "anticipate," "believe," "estimate," "expect," "intend," "will" and similar expressions, as they relate to us, are intended to identify forward-looking statements. Actual results could differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause actual results to differ materially is included in the company's second quarter 2001 10-Q filed with the SEC. We do not intend to update these forward- looking statements.
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