FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to___________
Commission File Number 1-4471
XEROX CORPORATION
(Exact Name of Registrant as
specified in its charter)
New York 16-0468020 _
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
P.O. Box 1600
Stamford, Connecticut 06904-1600
(Address of principal executive offices)
(Zip Code)
(203) 968-3000 _
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at October 31,1996
Common Stock 324,561,501 shares
This document consists of 28 pages.
(THIS PAGE IS INTENTIONALLY LEFT BLANK)
Xerox Corporation
Form 10-Q
September 30, 1996
Table of Contents
Page
Part I - Financial Information
Item 1. Financial Statements
Consolidated Statements of Income 4
Consolidated Balance Sheets 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Document Processing 12
Discontinued Operations 18
Capital Resources and Liquidity 22
Hedging Instruments 23
Part II - Other Information
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
Exhibit Index
Computation of Net Income per Common Share 27
Computation of Ratio of Earnings to Fixed Charges 28
Restated Certificate
of Incorporation (filed in electronic form only)
Financial Data Schedule (filed in electronic form only)
For additional information about The Document Company Xerox,
please visit our World-wide Web site at http:\\www.xerox.com and
select "Investor Information"
PART I - FINANCIAL INFORMATION
Xerox Corporation
Consolidated Statements of Income
Three months ended Nine months ended
September 30, September 30,
(In millions, except per-share data) 1996 1995 1996 1995
Revenues
Sales $ 2,172 $ 2,066 $ 6,289 $ 6,011
Service and rentals 1,733 1,700 5,258 5,073
Finance income 253 246 756 749
Total Revenues 4,158 4,012 12,303 11,833
Costs and Expenses
Cost of sales 1,215 1,183 3,500 3,478
Cost of service and rentals 889 861 2,667 2,544
Equipment financing interest 131 123 386 378
Research and development expenses 261 242 779 707
Selling, administrative and general
expenses 1,256 1,145 3,691 3,411
Gain on affiliates' sales of stock, net (11) - (11) -
Other, net 34 43 65 121
Total Costs and Expenses 3,775 3,597 11,077 10,639
Income before Income Taxes, Equity Income
and Minorities' Interests 383 415 1,226 1,194
Income taxes 138 160 441 462
Equity in net income of unconsolidated
affiliates 30 38 92 102
Minorities' interests in earnings of
subsidiaries 25 37 97 137
Income from Continuing Operations 250 256 780 697
Discontinued Operations - (20) - (76)
Net Income $ 250 $ 236 $ 780 $ 621
Primary Earnings per Share
Continuing Operations $ 0.71 $ 0.74 $ 2.24 $ 2.01
Discontinued Operations - (.06) - (.23)
Primary Earnings per Share $ 0.71 $ 0.68 $ 2.24 $ 1.78
Fully Diluted Earnings per Share
Continuing Operations $ 0.68 $ 0.70 $ 2.14 $ 1.91
Discontinued Operations - (.05) - (.21)
Fully Diluted Earnings per Share $ 0.68 $ 0.65 $ 2.14 $ 1.70
See accompanying notes.
Xerox Corporation
Consolidated Balance Sheets
September 30, December 31,
(In millions, except share data in thousands) 1996 1995
Assets
Cash $ 136 $ 136
Accounts receivable, net 2,099 1,914
Finance receivables, net 4,101 4,069
Inventories 3,099 2,656
Deferred taxes and other current assets 1,032 1,095
Total Current Assets 10,467 9,870
Finance receivables due after one year, net 6,505 6,406
Land, buildings and equipment, net 2,180 2,105
Investments in affiliates, at equity 1,337 1,314
Goodwill 620 627
Other assets 933 876
Investment in discontinued operations 4,501 4,810
Total Assets $ 26,543 $ 26,008
Liabilities and Equity
Short-term debt and current portion of
long-term debt $ 3,276 $ 3,274
Accounts payable 483 578
Accrued compensation and benefit costs 631 731
Unearned income 184 228
Other current liabilities 1,997 2,216
Total Current Liabilities 6,571 7,027
Long-term debt 9,088 7,867
Postretirement medical benefits 1,033 1,018
Deferred taxes and other liabilities 2,389 2,437
Discontinued operations liabilities -
policyholders' deposits and other 2,350 2,810
Deferred ESOP benefits (547) (547)
Minorities' interests in equity of subsidiaries 823 755
Preferred stock 727 763
Common shareholders' equity 4,109 3,878
Total Liabilities and Equity $ 26,543 $ 26,008
Shares of common stock issued and outstanding 324,551 325,029
See accompanying notes.
Xerox Corporation
Consolidated Statements of Cash Flows
Nine months ended September 30 (In millions) 1996 1995
Cash Flows from Operating Activities
Income from Continuing Operations $ 780 $ 697
Adjustments required to reconcile income to cash
flows from operating activities:
Depreciation and amortization 528 528
Provisions for doubtful accounts 164 152
Provision for postretirement medical benefits 30 37
Charges against 1993 restructuring reserve (147) (258)
Minorities' interests in earnings of subsidiaries 97 137
Undistributed equity in income of affiliated companies (91) (99)
Increase in inventories (747) (871)
Increase in finance receivables (379) (123)
Increase in accounts receivable (242) (256)
(Decrease)Increase in accounts payable and accrued
compensation and benefit costs (223) 1
Net change in current and deferred income taxes 194 207
Other, net (287) (138)
Total (323) 14
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment (340) (274)
Proceeds from sales of land, buildings and equipment 30 35
Purchase of additional interest in Rank Xerox - (972)
Proceeds from sale of Constitution Re - 526
Total (310) (685)
Cash Flows from Financing Activities
Net change in debt 1,314 1,009
Dividends on common and preferred stock (330) (292)
Proceeds from sale of common stock 97 120
Repurchase of common and preferred stock (269) (65)
Dividends to minority shareholders (1) (64)
Proceeds received from minority shareholders - 20
Total 811 728
Effect of Exchange Rate Changes on Cash (2) (2)
Cash Provided by Continuing Operations 176 55
Cash Used by Discontinued Operations (176) (39)
Increase in Cash - 16
Cash at Beginning of Period 136 41
Cash at End of Period $ 136 $ 57
See accompanying notes.
Xerox Corporation
Notes to Consolidated Financial Statements
1. The consolidated financial statements presented herein have
been prepared by Xerox Corporation ("the Company") in accordance
with the accounting policies described in its 1995 Annual Report
to Shareholders and should be read in conjunction with the notes
thereto. Effective with 1996 reporting, the Company's China
operations are fully consolidated. The 1995 financial statements
presented herein have been restated to reflect this change and
several other accounting reclassifications to conform with the
1996 presentation. The impact of these changes is not material
and did not affect net income.
In the opinion of management, all adjustments (consisting only of
normal recurring adjustments) which are necessary for a fair
statement of operating results for the interim periods presented
have been made. Interim financial data presented herein are
unaudited.
References herein to "we" or "our" refer to Xerox and
consolidated subsidiaries unless the context specifically
requires otherwise.
2. Inventories consist of (in millions):
September 30, December 31,
1996 1995
Finished products $ 1,893 $ 1,646
Work in process 114 88
Raw materials and supplies 399 295
Equipment on operating leases, net 693 627
Total $ 3,099 $ 2,656
3. Common shareholders' equity consists of (in millions):
September 30, December 31,
1996 1995
Common stock $ 331 $ 327
Additional paid-in-capital 1,293 1,334
Retained earnings 2,769 2,321
Net unrealized gain (loss) on
investment securities 2 (1)
Translation adjustments (215) (103)
Treasury stock (71) -
Total $ 4,109 $ 3,878
4. Our Consolidated Balance Sheet at September 30, 1996 includes
current and non-current accrued liabilities of $149 million and
$92 million, respectively, associated with the Document
Processing restructuring program announced in December 1993. At
December 31, 1995, the corresponding accrued liabilities
aggregated $395 million. During the nine month period ended
September 30, 1996, restructuring-related activity reduced the
accrued liability by $154 million. Management believes the
aggregate reserve balance of $241 million at September 30, 1996
is adequate for the completion of the restructuring program.
Additional information concerning the progress of the
restructuring program is included in the accompanying
Management's Discussion and Analysis on page 15.
5. Interest expense totaled $446 million and $452 million for
the nine months ended September 30, 1996 and 1995, respectively.
6. At our annual meeting on May 16, 1996, shareholders approved
an increase in the number of authorized shares of common stock,
from 350 million to 1.05 billion to effect a three-for-one stock
split. The effective date of the split was June 6 for
shareholders of record as of May 23. All share and per share
amounts have been restated to retroactively reflect the stock
split.
7. The Board of Directors has authorized the Company to
repurchase up to $1 billion of Xerox common stock. The stock
will be purchased from time to time on the open market depending
on market conditions. As of September 30, 1996, we have
repurchased 5 million shares for $232 million.
8. In the third quarter of 1996, we recognized an $11 million
pre-tax gain which reflects our proportionate share of the
increase in equity of certain small affiliated companies as a
result of recent sales by these affiliates of additional shares
of common stock in the open markets.
9. In January 1996, we announced agreements to sell all of our
remaining Talegen Holdings, Inc. (Talegen) insurance units
(Coregis Group, Inc., Crum & Forster Holdings, Inc., Industrial
Indemnity Holdings, Inc., Westchester Specialty Group, Inc. and
two insurance-related service companies) and The Resolution
Group, Inc. (TRG) to investor groups led by Kohlberg Kravis
Roberts & Co. (KKR) and Talegen/TRG management. In connection
with the transactions, we recorded in 1995 a $1.546 billion
after-tax charge. On September 11, 1996, we and KKR announced
that we had mutually agreed to terminate the transactions. No
additional charges are required as a result of the terminated
agreements. Steps have been initiated for the marketing of each
of the remaining Talegen units and TRG. We expect our strategy
of exiting the financial services business to be either fully
completed or substantially completed on or before the end of
1997.
Summarized operating results of Insurance follow:
Third Quarter Nine Months
(In millions) 1996 1995 1996 1995
Revenues
Insurance premiums earned $ 433 $ 464 $1,287 $1,497
Investment and other income 112 106 325 337
Total Revenues 545 570 1,612 1,834
Costs and Expenses
Insurance losses and loss expenses 349 406 1,054 1,261
Insurance acquisition costs and
other operating expenses 178 145 461 475
Interest expense 50 54 153 175
Administrative and general expenses 10 33 19 102
Total Costs and Expenses 587 638 1,687 2,013
Realized Capital Gains - 32 2 46
Income (loss) before income taxes (42) (36) (73) (133)
Income Tax Benefits 16 16 31 57
Income (loss) from Insurance $ (26)* $ (20) $ (42)* $ (76)
* The 1996 total insurance after-tax loss of $26 million in the third quarter
and $42 million in the first nine months was charged to reserves established
for this purpose and, therefore, does not impact the Company's earnings.
The net assets at September 30, 1996 and December 31, 1995 of the
Insurance businesses included in our consolidated balance sheets
as discontinued operations are as follows:
September 31, December 31,
1996 1995
Insurance Assets
Investments $ 8,042 $ 7,871
Reinsurance recoverable 2,450 2,616
Premiums and other receivables 1,111 1,191
Deferred taxes and other assets 1,324 1,450
Total Insurance assets $12,927 $13,128
Insurance Liabilities
Unpaid losses and loss expenses $ 8,571 $ 8,761
Unearned income 855 859
Notes payable 323 372
Other liabilities 1,314 1,458
Total Insurance liabilities $11,063 $11,450
Investment in Insurance, net $ 1,864 $ 1,678
10. Litigation
Continuing Operations
On March 10, 1994, a lawsuit was filed in the United States
District Court for the District of Kansas by two independent
service organizations (ISOs) in Kansas City and St. Louis and
their parent company. Plaintiffs claim damages predominately
resulting from the Company's alleged refusal to sell parts or
license diagnostic software for high volume copiers and printers
to plaintiffs prior to 1994 and the Company's alleged continued
refusal to sell parts at nonexclusionary prices or to license
diagnostic software on nonexclusionary terms. In addition to
monetary damages in excess of $10 million (to be trebled),
injunctive relief is sought. The Company's policies and
practices with respect to the sale of parts to ISOs were at issue
in an antitrust class action in Texas, which was settled by the
Company during 1994. Claims for individual lost profits of ISOs
who were not named parties, such as the plaintiffs in the Kansas
action, were not included in that class action. The Company has
asserted counterclaims against the plaintiffs alleging patent and
copyright infringement, misappropriation of Xerox trade secrets,
conversion and unfair competition and/or false advertising. On
December 11, 1995, the District Court issued a preliminary
injunction against the parent company for copyright infringement.
A trial date of April 15, 1997 has been set. The Company denies
any wrongdoing and intends to vigorously defend these actions and
pursue its counterclaims.
On August 5, 1996, the District Court dismissed the complaint of
20 different ISOs and the cross complaint of the Company against
those 20 ISOs as a result of a settlement between the parties.
The terms of the settlement will have no material effect on the
Company.
Discontinued Operations
Farm & Home Savings Association, now known as Roosevelt Bank,
(Farm & Home) and certain Talegen insurance companies (Insurance
Companies) entered into an agreement (Indemnification Agreement)
under which the Insurance Companies are required to defend and
indemnify Farm & Home from certain actual and punitive damage
claims being made against Farm & Home relating to the Brio
superfund site (Brio). In a number of lawsuits pending against
Farm & Home in the District Courts of Harris County, Texas,
several hundred plaintiffs seek both actual and punitive damages
allegedly relating to injuries arising out of the hazardous
substances at Brio. The Insurance Companies have been defending
these cases under a reservation of rights because it is unclear
whether certain of the claims fall under the coverage of either
the policies or the Indemnification Agreement. The Insurance
Companies have been successful in having some claims dismissed
which were brought by plaintiffs who were unable to demonstrate a
pertinent nexus to the Southbend subdivision. However, there are
numerous plaintiffs who do have a nexus to the Southbend
subdivision. The Insurance Companies have been in settlement
discussions with respect to claims brought by plaintiffs who have
or had a pertinent nexus to the Southbend subdivision. In
addition, Farm & Home presently has pending motions for summary
judgment which would dispose of many of the claims asserted. If
not settled or resolved by summary judgment, one or more of these
cases can be expected to be tried in 1997.
Xerox Corporation
Management's Discussion and Analysis of
Results of Operations and Financial Condition
Document Processing
Income from Continuing Operations
Income from continuing operations declined 2 percent to $250
million in the 1996 third quarter and grew 12 percent to $780
million in the first nine months of 1996.
Although enterprise printing revenue growth accelerated in all
major geographic areas, overall revenue growth was adversely
affected by a modest decline in black-and-white copier revenues.
Our investments in sales coverage and promotion did not yield the
results we expected in the quarter. We expect some improvement in
the fourth quarter, with somewhat slower growth in costs and
expenses. We continue to be optimistic about 1997.
Primary earnings per share declined 4 percent to 71 cents in the
1996 third quarter and grew 12 percent to $2.24 in the first nine
months. Fully diluted earnings per share declined 3 percent to
68 cents and grew 12 percent to $2.14 for the first nine months.
All earnings per share amounts reflect the 3 for 1 stock split on
June 6, 1996.
Underlying 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 foreign
currencies into U.S. dollars. We refer to this adjusted growth
as "underlying growth."
A substantial portion of our consolidated revenues is derived
from operations outside of the United States in subsidiaries
where the U.S. dollar is not the functional currency, primarily
in Europe. When compared with the major European currencies, the
U.S. dollar was approximately 2 percent stronger in the 1996
third quarter than in the 1995 third quarter. As a result,
foreign currency translation had an unfavorable impact of 1
percentage point on total revenues in the 1996 third quarter.
Revenues denominated in currencies where the local currency is
the functional currency are not hedged for purposes of
translation into U.S. dollars.
Revenues
For the major product categories, the underlying revenue growth
rates are estimated as follows:
1996 1995 _
Q3 Q2 Q1 FY Q4 Q3 Q2 Q1
Total Revenues 5% 6% 4% 7% 2% 8% 8% 11%
Enterprise Printing 23 21 19 17 10 18 20 22
Black & White Copiers (4) - - 2 (2) 3 2 4
Third quarter enterprise printing revenue growth accelerated from
the second quarter in all major geographical areas. DocuTech and
color products revenue growth was excellent and printing systems
products growth was good. Revenues from enterprise printing
represented 30 percent of total revenues in the 1996 third
quarter compared with 29 percent in the 1996 second quarter and
25 percent for the 1995 full year.
Black-and-white copier revenues declined as a result of several
important factors, including price pressures and difficult
economic environments in Europe and a number of emerging markets.
In addition, there was a significant slowdown in growth in
Brazil, following two years of exceptional growth. Longer term
trends also continued of volume transferring to DocuTech
production publishing and document outsourcing. The trend to
document outsourcing has the effect of diverting revenues from
up-front equipment sales as well as service and finance income.
Revenues from black-and-white copying represented 56 percent of
total document processing revenues in the 1996 third quarter, 57
percent in the 1996 second quarter and 59 percent in the 1996
first quarter and for the 1995 full year.
Geographically, the underlying revenue growth rates are estimated
as follows:
1996 1995 _
Q3 Q2 Q1 FY Q4 Q3 Q2 Q1
Total Revenues 5% 6% 4% 7% 2% 8% 8% 11%
United States 5 6 5 3 (3) 5 5 8
Rank Xerox 2 2 (2) 8 10 2 5 13
Other Areas 6 10 11 16 2 27 25 17
Third quarter U.S. revenue growth was due to accelerated growth
in enterprise printing revenues and increased OEM printer engine
sales to IBM and Apple, partially offset by a decline in black-
and-white copier revenues and lower paper prices.
Rank Xerox (Rank Xerox Limited and related companies)
manufactures and markets Xerox products principally in Europe.
The modest revenue growth in Rank Xerox reflects good growth in
the U.K., a modest decline in France, essentially flat revenues
in Germany, modest growth in the rest of western Europe, and
declines in most of the eastern European markets.
Other Areas include operations principally in Latin America and
Canada. Lower revenue growth in the 1996 third quarter, compared
with the first and second quarters, was due primarily to a
significant slowdown in black-and-white copier revenue growth in
Brazil, following two years of exceptional growth. Cycles
consisting of strong growth, consolidation and then further
growth are not unusual in Brazil. Our 1995 revenues were
approximately $1.3 billion in Brazil and $200 million in Mexico.
We estimate that the components of underlying revenue growth were
as follows:
1996 1995 _
Q3 Q2 Q1 FY Q4 Q3 Q2 Q1
Total Revenues 5% 6% 4% 7% 2% 8% 8% 11%
Sales
Equipment* 6 9 7 6 (1) 12 8 8
Supplies 9 6 - 9 (1) 9 10 21
Paper (12) (7) (2) 39 22 42 42 54
Total 6 7 2 9 - 11 12 18
Service/Rentals/Outsourcing/Other
Service (2) (1) 1 2 1 1 4 3
Rentals 1 2 2 1 1 3 (2) 3
Document Outsourcing 51 51 48 46 51 44 43 46
Total 3 4 6 6 5 6 6 6
Finance Income 4 - 1 (4) (1) (7) (2) (4)
Memo: Revenues Excluding
Equipment Sales* 4 4 2 7 4 6 9 12
* Equipment sales to end-users only
Equipment sale revenue growth to end users of 6 percent in the
1996 third quarter reflects an acceleration in enterprise
printing equipment sales growth but lower copier sales
principally reflecting the slowdown in revenue growth in Brazil.
The 1996 second quarter growth of 9 percent included excellent
enterprise printing equipment sales growth and modest copier
growth.
Revenues from supplies, paper, service, rentals, document
outsourcing and other revenues, and income from customer
financing represented 67 percent of total revenues in the 1996
third quarter. Growth in these revenues is primarily a function
of the growth in our installed population of equipment, usage and
pricing.
Supplies sales: The improved growth in the 1996 third quarter
from prior quarters is due principally to continuing excellent
growth in enterprise printing and an increase in sales of OEM
printer cartridges.
Paper sales: Our strategy is to charge a spread over mill
wholesale prices to cover our costs and value added as a
distributor. The decline in the 1996 third quarter is due to
lower prices because of excess industry supply.
Service revenues: The decline in the 1996 third and second
quarters and the modest growth in the preceding quarters reflects
the increasing impact of customer preference for document
outsourcing as well as competitive price pressures.
Rental revenues: Rental revenues outside the U.S. continued the
long term trend of declining rentals and increasing equipment
sales. This decline has been more than offset by growth in the
U.S. where there has been an increasing trend toward cost-per-
copy rental plans, which adversely affects up-front equipment
sales, as well as service revenues and finance income.
Document Outsourcing: This growth reflects the trend of customers
to outsource their document processing requirements to Xerox. In
part, this has the effect of diverting revenues from up-front
equipment sales as well as service and finance income. This trend
reduces current period total revenues but increases revenues in
future periods.
Finance income: Our strategy for financing equipment sales is to
charge a spread over our cost of borrowing and to lock in that
spread by match-funding the notes receivable with borrowings of
similar maturities. The growth in the third quarter was due
primarily to continuing growth in the financing of equipment
sales in Latin America. U.S. interest income had modest growth,
reflecting higher interest rates, after several quarters of
decline resulting from lower average interest rates, and the
trends to document outsourcing and rental plans.
Productivity Initiatives
In 1993, we announced a restructuring program to significantly
reduce the cost base and to improve productivity. Our objectives
were to reduce our worldwide work force by more than 10,000
employees and to close or consolidate a number of facilities.
To date, the activities associated with the 1993 restructuring
program have reduced employment by 13,600, achieved pre-tax cost
reductions of approximately $350 million in 1994 and $650 million
in 1995, and we are on track towards achieving our restructuring
program objectives. A portion of the savings has been reinvested
to reengineer business processes, to support the expansion in
growth markets, and to mitigate pricing pressures.
As a result of hiring in our fast-growing document outsourcing
business, worldwide employment increased by 400 in the 1996 third
quarter to 87,000. Increases in sales and manufacturing were
offset by reductions due to productivity actions.
Gross Profit and Expenses
Gross profit increased 4 percent as a result of volume and an
improvement in gross margins.
The gross margins by revenue stream were as follows:
1996 1995 _
Q3 Q2 Q1 FY Q4 Q3 Q2 Q1_
Total Gross Margin 46.2% 47.9% 46.0% 46.1% 46.7% 46.0% 46.5% 45.2%
Sales 44.0 45.8 43.0 43.0 45.0 42.7 42.7 40.9
Service/Rental/
DocOut 48.7 50.3 48.9 49.6 48.9 49.3 50.8 49.3
Financing 48.3 49.5 49.0 49.7 50.1 50.1 48.3 50.4
Total gross margins improved by 0.2 percentage points in the 1996
third quarter from the 1995 third quarter, compared with a 1.4
percentage point improvement in the 1996 second quarter from the
1995 second quarter.
The improvement of 1.3 percentage points in the sales gross
margin from the 1995 third quarter was principally due to cost
reductions and favorable currency, partially offset by pricing
pressures. The erosion in the service and rentals gross margin
of 0.6 percentage points from the 1995 third quarter was largely
due to mix, pricing pressures and economic cost increases,
partially offset by the benefits from productivity initiatives.
Financing gross margins fluctuate due to country mix.
Research and development (R&D) expense increased 8 percent in the
1996 third quarter and 10 percent in the 1996 first nine months
reflecting increased investment in future product introductions.
The lower growth in the third quarter from earlier in 1996
reflects product program calendarization. We will continue to
invest in technological development to maintain our premier
position in the rapidly changing document processing market. We
expect to introduce a stream of new, technologically innovative
products in the coming months. Xerox R&D is strategically
coordinated with that of Fuji Xerox Co., Ltd., an unconsolidated
joint venture between Rank Xerox Limited and Fuji Photo Film
Company Limited. Fuji Xerox invested approximately $600 million
in R&D in 1995.
Selling, administrative and general expenses (SAG) increased 10
percent in the 1996 third quarter and 9 percent in the 1996 first
nine months. SAG was 30.2 percent of revenue in the third
quarter, an increase of 1.6 percentage points from the 1995 third
quarter. The growth was due to economic cost increases, and
investments to increase worldwide sales effectiveness, including
the expansion of direct sales coverage and indirect distribution
channels, new product advertising, marketing support, and systems
to improve productivity in various administrative functions. We
expect somewhat slower growth in the fourth quarter of 1996.
Gain on affiliates' sales of stock, net reflects our
proportionate share of the increase in equity of certain small
affiliated companies as a result of recent sales by these
affiliates of additional shares of common stock in the open
markets.
The $9 million decrease in other expenses, net, from the 1995
third quarter was due to reduced interest expense and currency
losses from balance sheet translation in our Latin American
operations. Other expenses, net are lower by $56 million for the
first nine months of 1996 reflecting lower interest expense and
the non-recurrence of several one-time charges in 1995.
Income Taxes, Equity in Net Income of Unconsolidated Affiliates
and Minorities' Interests in the Earnings of Subsidiaries
Income before income taxes, equity in net income of
unconsolidated affiliates and minorities' interests declined 8
percent to $383 million in the 1996 third quarter from $415
million in the 1995 third quarter.
The effective tax rate was 36.0 percent in the 1996 third quarter
and in the 1996 year to date compared with 38.5 percent in the
1995 third quarter and 38.7 percent in the 1995 year to date.
The decline was primarily due to a lower statutory tax rate in
Brazil and the mix of profits from our worldwide operations.
Equity in the net income of unconsolidated affiliates,
principally Fuji Xerox, decreased in the 1996 third quarter to
$30 million from $38 million in the 1995 third quarter and
declined for the first nine months to $92 million in 1996 from
$102 million in 1995. The underlying growth in Fuji Xerox income
was more than offset by the adverse impact of currency
translation and declines in income from smaller investments.
Minorities' interests in the earnings of subsidiaries was $25
million in the 1996 third quarter compared with $37 million in
the 1995 third quarter primarily due to lower Rank Xerox income.
Discontinued Operations
The net investment in the discontinued financial services
businesses which includes Insurance, Other Financial Services and
Third-Party / Real-Estate totaled $2.151 billion at September 30,
1996 compared with $2.000 billion at December 31, 1995. The
increase primarily includes scheduled funding of reinsurance
coverage to the Talegen companies by Ridge Reinsurance Limited
(Ridge Re) and interest for the period on the assigned debt,
partially offset by reductions in third-party assets (primarily
from sales and run-off activity). A discussion of the
discontinued businesses follows.
Insurance Segment
In January 1996, Xerox announced agreements to sell all of its
Remaining Talegen insurance units (Coregis Group, Inc., Crum &
Forster Holdings, Inc., Industrial Indemnity Holdings, Inc.,
Westchester Specialty Group, Inc. and two insurance-related
service companies) and The Resolution Group, Inc. (TRG) to
investor groups led by Kohlberg Kravis Roberts & Co. (KKR) and
Talegen/TRG management. In connection with the transactions,
Xerox recorded in 1995 a $1.546 billion after-tax charge.
On September 11, 1996, Xerox and KKR announced that they had
mutually agreed to terminate the transactions. Steps have been
initiated for the marketing of each of the Remaining Talegen
units and TRG with the objective of completing the individual
sale transactions as soon as possible. No additional charges are
considered necessary as a result of the aforementioned
termination of the transactions. The insurance segment has been
classified as a discontinued operation for all periods presented
and its operating results did not affect the Company's earnings
in the first nine months of 1996.
Insurance Operating Results
Operating results for the discontinued Insurance segment
(Talegen/TRG, Ridge Re and Xerox Financial Services, Inc. holding
company expenses, primarily assigned interest) in the third
quarter and first nine months of 1996 and 1995 follow:
Third Quarter Nine Months
(In millions) 1996 1995 1996 1995
Total Insurance Revenue $ 545 $ 557 $1,612 $1,588
Insurance Pre-Tax Income
Underwriting $ (92) $ (87) $ (226) $ (240)
Investment Income 112 101 323 299
Net Realized Capital Gains - 32 2 46
Interest Expense (50) (53) (153) (175)
Other Expenses (12) (26) (19) (53)
Insurance Pre-Tax
Income (Loss) $ (42) $ (33) $ (73) $ (123)
After-Tax Income
Insurance $ (26) $ (22) $ (42) $ (71)
Dispositioned Companies - 2 - (5)
Total After-Tax
Income (Loss) $ (26)* $ (20) $ (42)* $ (76)
* The 1996 total insurance after-tax loss of $26 million in the
third quarter and $42 million in the first nine months was
charged to reserves established for this purpose and, therefore,
does not impact the Company's earnings.
The preceding table's revenue and pre-tax income excludes the
results of Constitution Re Corporation (CRC) and Viking which
were sold during the second and third quarters of 1995,
respectively. The results of those units are shown on an after-
tax basis under the caption "Dispositioned Companies."
Revenues from Insurance totaled $545 million in the third quarter
of 1996 compared with $557 million in the third quarter of 1995.
A modest decline in earned premiums, which reflects competition
and pricing pressure in the industry, was partially offset by an
improvement in investment income. Revenues for the first nine
months of 1996 totaled $1.612 billion, a growth of 2 percent from
the first nine months of 1995 and included improvements in both
earned premiums and investment income.
The decline in 1996 third quarter Insurance pre-tax income
compared with 1995 primarily reflects the absence of capital
gains from the repositioning of the Talegen portfolio in the
third quarter, 1995 and a small deterioration in underwriting
results. Partially offsetting these declines are improvements in
investment income. Additionally, interest and other expenses,
which are primarily XFS holding company costs, were also lower
due to reduced debt levels and the absence of disengagement-
related provisions recorded in the third quarter, 1995. The
improvement in Insurance pre-tax income for the first nine months
of 1996 compared with 1995 primarily includes the previously
mentioned items plus the absence of the 1995 settlement between
Monsanto and Talegen which benefited underwriting results by $34
million on a year-over-year basis.
The investment at September 30, 1996 totaled $1.864 billion
compared with a restated balance of $1.678 billion at December
31, 1995. The increase primarily includes contractual payments
to Ridge Re for annual premium installments and associated
finance charges and interest on the insurance debt that will
continue until the closing of the sales of the Remaining Talegen
units and TRG.
Property and Casualty Operating Trends
The industry's profitability can be significantly affected by
cyclical competitive conditions, as well as by volatile and
unpredictable developments, including changes in the propensity
of courts to grant large awards, fluctuations in interest rates
and other changes in the investment environment (which affect
market prices of insurance companies' investments, the income
from those investments and inflationary pressures that may tend
to affect the size of losses), and judicial decisions affecting
insurers' liabilities. Talegen's operating results have
historically been influenced by these industry trends, as well as
by Talegen's exposure to uncollectible reinsurance, which had
been greater than most other insurers.
Disposal of Insurance Business
During the disposal process, we will continue to be subject to
all business risks and rewards of the insurance businesses. We
expect our strategy of exiting the insurance business to be
either fully completed or substantially completed on or before
the end of 1997; however, no assurances can be given as to the
timing of the disengagement process, the amount and timing of
proceeds of sales or other forms of disengagement from insurance
units or the ultimate impact the remaining insurance businesses
will have on the Company's total results from operations.
Our objective is to continue to obtain appropriate value from the
Insurance investments. The ultimate value will depend on the
success of the operational improvements, timing, the level of
interest rates, and the relative value of insurance properties.
Other Financial Services
The net investment in Other Financial Services (OFS) at September
30, 1996 was $99 million compared with a restated $114 million at
December 31, 1995. The decrease in the investment primarily
reflects the sale of the remaining portion of First Quadrant
Corp.
On June 1, 1995, Xerox Financial Services, Inc. (XFSI) completed
the sale of Xerox Financial Services Life Insurance Company and
related companies (Xerox Life Companies) to a subsidiary of
General American Life Insurance Company. After the sale, the
Xerox Life Companies names were changed to replace the name
"Xerox" in the corporate titles with the name "Cova" (Cova
Companies). OakRe Life Insurance Company (OakRe), an XFSI
subsidiary formed in 1994, has assumed responsibility for
existing Single Premium Deferred Annuity (SPDA) policies issued
by Xerox Life's Missouri and California companies via coinsurance
agreements (Coinsurance Agreements). The Coinsurance Agreements
include a provision for the assumption (at their election) by the
Cova Companies, of all of the SPDA policies at the end of their
current rate reset periods. A Novation Agreement with an
affiliate of the new owner provides for the assumption of the
liability under the Coinsurance Agreements for any SPDA policies
not so assumed by the Cova Companies. Other policyholders (of
Immediate, Whole Life, and Variable annuities as well as a minor
amount of SPDAs issued by Xerox Life New York) will continue to
be the responsibility of the Cova Companies.
As a result of the Coinsurance Agreements, at September 30, 1996,
OakRe retained approximately $2.1 billion of investment portfolio
assets (transferred from the Xerox Life Companies) and
liabilities related to the reinsured SPDA policies. Interest
rates on these policies are fixed and were established upon
issuance of the respective policies. Substantially all of these
policies will reach their rate reset periods within the next four
years and will be assumed under the Agreements as described
above. The Xerox Life Companies' portfolio was designed to
recognize that policy renewals extended liability "maturities",
thereby permitting investments with average duration somewhat
beyond the rate reset periods. OakRe's practice is to
selectively improve this match over time as market conditions
allow.
In connection with the aforementioned sale, XFSI established a
$500 million letter of credit and line of credit with a group of
banks to support OakRe's coinsurance obligations. The term of
this letter of credit is five years and it is unused and
available at September 30, 1996. Upon a drawing under the letter
of credit, XFSI has the option to cover the drawing in cash or to
draw upon the credit line.
Third-Party / Real-Estate
Third-party and real-estate assets at September 30, 1996 totaled
$460 million, a $29 million reduction from the December 31, 1995
level. The asset decrease includes a $82 million reduction in
third-party assets and a $53 million increase in reported real-
estate net assets. Assigned debt decreased to $222 million at
September 30, 1996, a $9 million decrease from the year-end 1995
level. The third-party asset decline primarily includes sales of
assets and run-off activity. The increase in reported real-
estate assets includes $47 million related to the Company's
decision to fund the retirement of certain debt of its
discontinued real-estate subsidiary with lower cost Company
financing. This increased the assets and assigned debt of
discontinued operations, but had no effect on the reported net
investment in discontinued operations. The $9 million assigned
debt decrease includes the previously mentioned increase in real-
estate debt, fully offset by reductions from the sales of third-
party sales and run-off activity.
Capital Resources and Liquidity
Total debt, including ESOP and Discontinued Operations debt not
shown separately in our consolidated balance sheets, increased to
$12,959 million at September 30, 1996, from $11,794 million at
December 31, 1995. The changes in consolidated indebtedness since
year end and versus the first nine months of 1995 are summarized
as follows:
(In millions) 1996 1995
Total Debt as of January 1 $11,794 $10,955
Non-Financing Businesses:
Document Processing Operations 553 515
Increased financial interest in Rank Xerox - 972
Discontinued Businesses 132 (421)
Total Non-Financing 685 1,066
Financing Businesses (15) (140)
Total Operations 670 926
Shareholder dividends 330 292
Exercise of stock options (97) (120)
Repurchase of common and preferred stock 269 65
Cash balance and other changes, net (7) 10
Total Debt as of September 30 $12,959 $12,128
For purposes of capital ratio analysis, total equity includes
common equity, preferred stock and minorities' interests in the
equity of subsidiaries.
The following table summarizes the changes in total equity during
the first nine months of 1996 and 1995:
(In millions) 1996 1995
Total equity as of January 1 $5,396 $6,042
Income from Continuing Operations 780 697
Shareholder dividends paid (330) (292)
Exercise of stock options 97 120
Repurchase of common and preferred stock (269) (65)
Change in unrealized gain on
investment securities 3 432
All Other, net (18) (219)
Balance as of September 30 $5,659 $6,715
On a consolidated basis, inclusive of deferred ESOP benefits, the
debt-to-capital ratio at September 30,1996 was 72 percent
compared with 71 percent at December 31, 1995.
Non-Financing Operations
The following table summarizes Document Processing non-financing
operations cash generation and borrowing for the nine months
ended September 30, 1996 and 1995:
Cash Generated/(Borrowed)
Nine Months Ended September 30,
(In millions) 1996 1995
Document Processing
Non-Financing:
Income $ 663 $ 534
Depreciation and Amortization 528 528
Restructuring Payments (147) (258)
Capital Expenditures (340) (274)
Working Capital/Other (1,257) (1,045)
Total $ (553) $ (515)
Nine-month cash usage of $553 million was $38 million greater
than in the first nine months of 1995 due primarily to increased
growth in capital spending related to facilities infrastructure
and new digital products, and lower accounts payable and accrued
compensation costs largely offset by higher net income, reduced
inventory growth, and lower restructuring payments.
Financing Businesses
Financing business debt was reduced by $15 million and $140
million during the first nine months of 1996 and 1995,
respectively. This smaller decline in 1996 reflects growth in
new customer financing contracts driven by higher equipment sales
activity.
Hedging Instruments
We have entered into certain financial instruments to manage
interest rate and foreign currency exposures. These instruments
are held solely for hedging purposes and include interest rate
swaps, forward foreign exchange contracts and foreign currency
swaps. We do not enter into derivative instrument transactions
for trading purposes and employ long-standing policies
prescribing that derivative instruments are only to be used to
achieve a set of very limited objectives:
Currency derivatives are primarily arranged in conjunction
with underlying transactions that give rise to foreign
currency-denominated payables and receivables: for example, an
option to buy foreign currency to settle the importation of
goods from suppliers, or a forward foreign-exchange contract
to fix the rate at which a dividend will be paid by a foreign
subsidiary. In addition, when cost-effective, currency
derivatives may be used to hedge balance sheet exposures in
hyperinflationary economies.
We do not hedge foreign currency-denominated revenues of our
foreign subsidiaries since these do not represent cross-border
cash flows.
With regard to interest rate hedging, virtually all customer
financing assets earn fixed rates of interest and, therefore,
we "lock in" an interest rate spread by arranging fixed-rate
liabilities with similar maturities as the underlying assets.
Additionally, customer financing assets in one currency are
consistently funded with liabilities in the same currency. We
refer to the effect of these conservative practices as "match
funding" customer financing assets. This practice effectively
eliminates the risk of a major decline in interest margins
resulting from a rising interest rate environment. Conversely,
this practice effectively eliminates opportunities to
materially increase margins when interest rates are declining.
More specifically, pay fixed-rate and receive variable-rate
swaps are typically used in place of more expensive fixed-rate
debt. Pay variable-rate and receive variable-rate swaps are
used to transform variable-rate medium-term debt into
commercial paper or local currency Libor obligations.
Additionally, pay variable-rate and receive fixed-rate swaps
are used from time to time to transform longer-term fixed-rate
debt into commercial paper or Libor-based rate obligations.
The transactions performed within each of these three
categories enable the cost effective management of interest
rate exposures. The potential risk attendant to this strategy
is the non-performance of swap counterparties. 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.
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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth under Note 10 contained in the "Notes
to Consolidated Financial Statements" on pages 10-11 of this
Quarterly Report, on Form 10-Q, is incorporated by reference in
answer to this item.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 3(a)(1) Restated Certificate of Incorporation of
Registrant filed by the Department of State of the State of
New York on October 29, 1996 (in electronic form only).
Exhibit 3(b) By-Laws of Registrant, as amended through
May 29, 1991. Incorporated by reference to Exhibit 3(b)(2)
to Registrant's Quarterly Report For the Quarter Ended
June 30, 1991.
Exhibit 11 Computation of Net Income per Common Share.
Exhibit 12 Computation of Ratio of Earnings to Fixed
Charges.
Exhibit 27 Financial Data Schedule (in electronic form
only).
(b) Current report on Form 8-K dated September 11, 1996
reporting Item 5 "Other Events" was filed during the quarter for
which this Quarterly Report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
XEROX CORPORATION
(Registrant)
/s/Philip Fishbach
Date: November 8, 1996 By Philip D. Fishbach
Vice President and Controller
(Principal Accounting Officer)