EXHIBIT 13
Consolidated Statements of Income
Year ended December 31 (in millions, except per-share data) 1996 1995 1994
================================================
- --------------------------------------------------------------------------------------------
Revenues
Sales $ 9,285 $ 8,750 $ 7,823
Service and rentals 7,078 6,830 6,255
Finance income 1,015 1,008 1,006
------------------------------------------------
Total Revenues 17,378 16,588 15,084
------------------------------------------------
Costs and Expenses
Cost of sales 5,132 4,984 4,668
Cost of service and rentals 3,591 3,442 3,028
Equipment financing interest 513 507 502
Research and development expenses 1,044 949 895
Selling, administrative and general expenses 5,074 4,719 4,363
Gain on affiliates' sales of stock, net (11) -- --
Other, net 91 138 114
------------------------------------------------
Total Costs and Expenses 15,434 14,739 13,570
------------------------------------------------
Income before Income Taxes, Equity Income and
Minorities' Interests 1,944 1,849 1,514
Income Taxes 700 615 595
Equity in Net Income of Unconsolidated Affiliates 123 131 88
Minorities' Interests in Earnings of Subsidiaries 161 191 213
------------------------------------------------
Income from Continuing Operations 1,206 1,174 794
Discontinued Operations -- (1,646) --
------------------------------------------------
Net Income (Loss) $ 1,206 $ (472) $ 794
================================================
Primary Earnings (Loss) per Share
- --------------------------------------------------------------------------------------------
Continuing Operations $ 3.49 $ 3.40 $ 2.24
Discontinued Operations -- (4.96) --
------------------------------------------------
Primary Earnings per Share $ 3.49 $ (1.56) $ 2.24
================================================
Fully Diluted Earnings (Loss) per Share
- --------------------------------------------------------------------------------------------
Continuing Operations $ 3.31 $ 3.21 $ 2.15
Discontinued Operations -- (4.96) --
------------------------------------------------
Fully Diluted Earnings per Share $ 3.31 $ (1.75) $ 2.15
================================================
The accompanying notes on pages 48 to 67 are an integral part of the
consolidated financial statements.
26
Our Results of Operations and Financial Condition
Summary of Total Company Results
Document Processing revenues grew 6 percent on a pre-currency basis to $17.4
billion in 1996, driven by 10 percent growth in equipment sales and 47 percent
growth in document outsourcing. Service and rental revenues were essentially
unchanged from 1995. The strong equipment sales growth is the direct result of
our investments in sales coverage and marketing support, and excellent customer
acceptance of our new digital products. Revenues increased 7 percent on a
pre-currency basis to $16.6 billion in 1995 and 7 percent to $15.1 billion in
1994.
Beginning in 1995, the results of our Insurance operations were accounted
for as discontinued operations. The Document Processing business is now the only
component of continuing operations.
The following table summarizes net income and earnings per share (EPS):
(In millions) 1996 1995 1994
- -------------------------------------------------------------------------------
Document Processing before
Brazil tax gain $ 1,206 $ 1,076 $ 794
Brazil tax gain -- 98 --
- -------------------------------------------------------------------------------
Continuing operations 1,206 1,174 794
Discontinued operations -- (1,646) --
- -------------------------------------------------------------------------------
Net Income (Loss) $ 1,206 $ (472) $ 794
===============================================================================
Fully Diluted EPS
Document Processing
before Brazil tax gain $ 3.31 $ 2.94 $ 2.15
Brazil tax gain -- .27 --
- -------------------------------------------------------------------------------
Continuing operations 3.31 3.21 2.15
Discontinued operations -- (4.96) --
- -------------------------------------------------------------------------------
Fully Diluted EPS $ 3.31 $ (1.75) $ 2.15
===============================================================================
Document Processing income increased in 1996 by 12 percent and in 1995 by 36
percent, both before a $98 million gain from a reduction in the Brazilian tax
rate in 1995.
Fully diluted earnings per share for continuing operations increased 13
percent in 1996 and 37 percent in 1995, both before the Brazilian tax gain. The
earnings per share have been adjusted to reflect the 3 for 1 stock split
effective June 6, 1996.
Quarterly results of operations for 1996 and 1995 are shown on page 68.
The results for discontinued operations in 1996 were charged to reserves
previously established for such purposes and did not affect our reported net
income. Discontinued operations had a loss of $1.646 billion in 1995 compared
with break-even results in 1994. The 1995 results include fourth quarter
after-tax charges of $1.546 billion as a result of the discontinuance of the
Insurance segment. These charges consisted of a non-cash loss of $978 million
and $568 million primarily to cover additional insurance loss reserves and all
estimated future expenses associated with excess of loss reinsurance coverage.
[CHART APPEARS HERE]
Continuing Operations Fully Diluted Earnings Per Share*
1994 $2.15
1995 $2.94
1996 $3.31
* Before special items
Document Processing
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."
27
[Pictured here is a flat panel display]
dpiX flat-panel display
Malcolm J. Thompson, Gayathri Sundaresan and Pedro Goncalves, dpiX, with a dpiX
flat-panel display that shows lifelike computer images and text as sharp as the
output from a laser printer. A new Eagle-5 cockpit avionics display gives
fighter aircraft a tactical edge with video and high resolution infrared
imagery.
dpiX, a Xerox New Enterprise company, designs and manufactures high-performance
products for image capture and display. dpiX has produced advanced flat-panel
displays that provide image resolution of 300 dots per inch over an area the
size of an 8.5-inch by 11-inch page. These displays are being used for
detail-critical applications, such as mapping, image analysis, avionics and
high-end computer graphics.
dpiX FlashScan X-ray image sensors replace X-ray film in medical imaging
systems, enabling a fully digital system for faster patient diagnosis. X-ray
images are captured in a fraction of a second and can be analyzed immediately on
a computer screen.
dpiX image capture-and-display products are an example of our effort to
capitalize on the most promising technological breakthroughs from our research
organizations. dpiX is part of Xerox New Enterprises, our business development
arm that focuses on high-growth-potential new technology ventures. Ultimately,
these companies either will be merged into the Xerox mainstream, become majority
owned, become publicly traded subsidiaries or be sold. In 1996, we concluded two
successful Initial Public Offerings to launch Documentum and Document Sciences
as publicly traded companies.
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, primarily in Europe. When compared with the major European
currencies, the U.S. dollar was on average approximately 2 percent stronger in
1996, 10 percent weaker in 1995 and 2 percent stronger in 1994. As a result,
foreign currency translation had an unfavorable impact of 1 percentage point on
total revenues in 1996, a favorable impact of 3 percentage points on revenues in
1995, and an unfavorable impact of 1 percentage point in 1994.
Revenues denominated in currencies where the local currency is the
functional currency are not hedged for purposes of translation into U.S.
dollars.
Revenues by Product Category
Underlying Growth
-------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Total Revenues 6% 7% 7%
================================================================================
Digital products 23 17 20
Light lens copiers (1) 2 4
Paper and other products -- 14 3
================================================================================
Revenues from digital products, composed of production publishing, color copying
and printing, data center printing, multifunction products and network printing,
represented 30 percent of total revenues in 1996, 25 percent in 1995 and 22
percent in 1994. Revenues from light lens copying represented 56 percent of
total revenues in 1996, 59 percent in 1995 and 63 percent in 1994. The revenues
from paper and other products were 14 percent of total revenues in 1996, 16
percent in 1995 and 15 percent in 1994.
Total revenues from the DocuTech family of production publishing products
reflected excellent growth to approximately $1.8 billion in 1996 from $1.4
billion in 1995 and $1.1 billion in 1994. Revenues from color products reflected
excellent growth to approximately $1.0 billion in 1996, $600 million in 1995 and
$400 million in 1994.
The DocuColor 40 and the Document Centre Systems family contributed 3
percentage points to the
28
digital product revenue growth of 23 percent in 1996. The DocuColor 40, which
was introduced in early 1996, copies and prints at 40 full-color pages per
minute and is the industry's fastest and most affordable digital color document
production system. Document Centre Systems products, which were introduced in
late 1995, can print, scan, fax and copy documents for workgroups, with all
operations managed over the network from each user's personal computer or on a
walk-up basis. Revenues from these products accelerated throughout 1996 and
contributed 6 percentage points to the digital product revenue growth of 26
percent in the fourth quarter.
The decline in light lens copier revenue growth reflects several important
factors, including price pressures and difficult economic environments in Europe
and a number of emerging markets. Over time, digital products will take an
increasing share of total revenues. The fluctuations in other products revenues
were principally due to swings in paper prices and OEM sales.
Revenues by Geography
Geographically, the underlying revenue growth rates were:
Underlying Growth
--------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Total Revenues 6% 7% 7%
================================================================================
United States 6 3 7
Rank Xerox 1 8 7
Other Areas 10 16 7
Memo: Fuji Xerox 12 10 5
================================================================================
United States revenues were 49 percent of total revenues in 1996 which is
consistent with prior years. Revenues of Rank Xerox Limited and related
companies (Rank Xerox), which manufacture and market our products in eastern
hemisphere countries, were 31 percent of total revenues. Revenues of Other
Areas, which primarily include operations principally in Latin America and
Canada, were 20 percent of total revenues.
Revenue growth in the United States was driven by excellent growth in
equipment sales of digital products and good growth in equipment sales of light
lens copiers. The decline in U.S. revenue growth in 1995 principally reflects
disruption in the sales force.
[Pictured here is a Xerox copier]
X Team members (left to right) are: Tony Jalali, Steven Lee, Kamran Rahbaran and
Karen LaPointe. What's an X Team? It is the Xerox designation for the highest
level of team achievement for an empowered team.
29
The decline in revenue growth in Rank Xerox in 1996 reflects weak economic
environments principally in France, Germany, the U.K. and Spain.
The strong revenue growth in the Other Areas reflects excellent growth in
Brazil, strong growth in Canada and Mexico, and revenue declines in the rest of
Latin America and China due to difficult economic environments. The improved
revenue growth in the Other Areas in 1995 is attributable, in part, to a strong
demand in Brazil, partially offset by a significant revenue decline in Mexico
due to currency and the continuing economic disruption following devaluation of
the Mexican peso in December 1994. Our revenues in Brazil were approximately
$1.6 billion in 1996, $1.3 billion in 1995 and $0.9 billion in 1994.
Fuji Xerox Co., Ltd., an unconsolidated joint venture between Rank Xerox
Limited and Fuji Photo Film Company Limited, develops, manufactures and
distributes document processing products in Japan and other areas of the Pacific
Rim, Australia and New Zealand. The strong revenue growth in 1996 and 1995
reflects excellent growth in the Asia Pacific countries and strong growth in
Japan driven by excellent growth in digital product sales.
[Pictured here are two Fuji Xerox employees]
No. 1 In Color
Fuji Xerox continues to focus on networked color and multifunction products in
all global business areas. It achieved a No. 1 ranking in domestic market share
in terms of the number of shipped units of digital color copiers.
[CHART APPEARS HERE]
Equipment Non-Equipment Total Xerox
Sales Growth Revenue Growth Revenue Growth
(Pre-currency) (Pre-currency) (Pre-currency)
-------------- -------------- --------------
1994 10% 5% 7%
1995 6% 7% 7%
1996 10% 4% 6%
30
Revenues by Type
Underlying Growth
-----------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Total Revenues 6% 7% 7%
================================================================================
Equipment sales (excluding OEM) 10 6 10
Non-equipment revenues 4 7 5
Supplies 6 9 11
Paper (7) 39 4
Service -- 2 4
Rentals -- 1 (1)
Document outsourcing* 47 46 34
Finance income 1 (4) (4)
================================================================================
* Excludes outsourcing contracts that are accounted for as equipment sales.
The improvement in equipment sales revenue growth (excluding OEM sales) in 1996
from 1995 was due to a significant acceleration in sales of production
publishing and color copying and printing products, particularly in the U.S. The
lower growth in equipment sales in 1995 principally reflected disruption in the
U.S. sales force. The growth in 1994 reflected excellent growth in production
publishing and a near doubling of color copier and printer equipment sales.
Non-equipment revenues from supplies, paper, service, rentals, document
outsourcing and income from customer financing represented 66 percent of total
revenues in 1996, and 67 percent in 1995 and 1994. Growth in these revenues is
primarily a function of the growth in our installed population of equipment,
usage and pricing.
Supplies: Good growth was maintained in 1996, although at a lower rate than
1995. The decline in growth is due principally to customer preference for
document outsourcing and weak economic environments in some countries in Europe
and Latin America.
Paper: The decline in 1996 is the result of lower wholesale prices which
were partially offset by volume increases. The significant improvement in the
growth rate in 1995 is primarily due to higher prices after several years of
declining prices. Our strategy is to charge a spread over mill wholesale prices
to cover our costs and value added as a distributor.
Service: The declining growth reflects the substitutive impact of customer
preference for document outsourcing as well as competitive price pressures.
[Pictured here is Xerox recycled paper and a Xerox employee]
Revenues from the sale of paper and related equipment supplies continue to
contribute to overall revenues and profit growth. Customers continue to look to
Xerox for their media needs and equipment supplies to insure maximum performance
and output quality with their equipment. Photographed here with Xerox recycled
paper is Lisa Miura, Printing Systems Operations.
31
Rental: Outside the U.S., rental revenues have declined reflecting the
long-term trend to increasing equipment sales. This decline has been offset by
strong 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: The excellent growth reflects the trend of customers
to focus on their core businesses and outsource their document processing
requirements to Xerox. In part, this has the effect of diverting revenues from
up-front equipment sales as well as supplies, service and finance income. This
trend reduces current period total revenues but increases revenues in future
periods.
Finance income: In 1996, the strong growth in the financing of equipment
sales in Latin America offset the impact on financing contracts of the
continuing decline in interest rates and the increasing customer preference for
document outsourcing rather than purchase and finance. Approximately 80 percent
of customers finance purchases of equipment through Xerox in the U.S. and 75
percent in Western Europe. 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 finance receivables with borrowings of similar maturities.
Restructuring
The activities associated with the 1993 restructuring program have reduced
employment by 14,000. We have achieved our restructuring program objectives with
pre-tax cost reductions of approximately $350 million in 1994, $650 million in
1995 and $770 million in 1996. A portion of the savings is being reinvested to
reengineer business processes, to support the expansion in growth markets and to
mitigate pricing pressures.
Worldwide employment increased by 800 in 1996 to 86,700 as hiring to
increase the sales force and to support our fast-growing document outsourcing
business more than offset reductions in other areas.
[CHART APPEARS HERE]
Selling, Administrative
and General Expenses
(Percent of Revenues)
---------------------
1994 28.9%
1995 28.4%
1996 29.2%
[Pictured here is a AAA Triptik(R) routing map]
AAA Triptik(R) routing map printed on
Xerox equipment
The American Automobile Association uses Xerox highlight color printers to
produce Triptiks or customized routing maps for millions of travelers who tour
the U.S. each year. The printers produce about 80 Triptiks per hour; the average
size is 30 pages per booklet.
32
Costs and Expenses
Gross profit increased 6 percent in 1996 and 11 percent in 1995 as a result of
increased volume and an improvement in gross margins.
The gross margins by revenue stream were as follows:
Gross Margins
----------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Total 46.9% 46.1% 45.7%
================================================================================
Sales 44.7 43.0 40.3
Service and rentals 49.3 49.6 51.6
Finance income 49.5 49.7 50.1
================================================================================
The improvement in sales gross margins has been principally due to productivity
driven cost reductions, favorable product and geographic mix, principally
Brazil, partially offset by pricing pressures. The erosion in service and
rentals gross margins has been largely due to pricing pressures, partially
offset by productivity improvements.
Research and development (R&D) expense increased 10 percent in 1996 and 6
percent in 1995 reflecting increased investment in future product introductions.
We will continue to invest in technological development to maintain our premier
position in the rapidly changing document processing market and 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, which
invested $537 million in R&D in 1996.
Selling, administrative and general expenses (SAG) increased 8 percent in
1996 on an underlying basis, 5 percent in 1995 and declined 1 percent in 1994.
SAG as a percent of revenues was 29.2 percent in 1996, 28.4 percent in 1995 and
28.9 percent in 1994. The increase in the ratio in 1996 was primarily due to
investments in sales coverage and marketing support. The improvement in 1995 was
due to productivity initiatives and expense controls partially offset by
investments to increase worldwide sales effectiveness. We expect the ratio to
decline in 1997 due to improved productivity resulting from prior year
investments and ongoing expense controls.
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 of additional equity by these affiliates.
Other expenses, net, were $91 million in 1996, $138 million in 1995 and
$114 million in 1994. The reduction of $47 million in 1996 reflects reduced
interest expense due to lower rates, higher interest income and the
non-recurrence of several one-time charges in 1995. The increase in Other
expenses, net, of $24 million in 1995 reflects higher interest expense and
[Pictured here is a computer laboratory]
University Network
Hokkaido University uses an information network system designed and constructed
by Fuji Xerox to connect numerous academic departments, research centers,
hospitals, libraries, offices and other facilities as well as community printing
centers.
33
goodwill amortization, principally resulting from our increased financial
interest in Rank Xerox, and the non-recurrence of one-time gains in 1994,
partially offset by lower foreign currency losses from balance sheet translation
in our Brazilian operations.
Income Taxes, Equity in Net Income of Unconsolidated Affiliates, and Minorities'
Interests in Earnings of Subsidiaries before Special Items
Income before special items and income taxes was $1,944 million in 1996, $1,849
million in 1995 and $1,514 million in 1994.
In 1995, we recognized a $98 million benefit from the favorable revaluation
of the deferred tax liability due to a change in the Brazilian statutory income
tax rate. Excluding this gain, the effective tax rates were 36 percent in 1996,
and 39 percent in 1995 and 1994. The decline in the 1996 tax rate was primarily
due to the lower Brazilian tax rate.
Equity in the Net Income of Unconsolidated Affiliates is principally the
Rank Xerox share of Fuji Xerox income as well as investments in several smaller
companies. Total equity in income in 1996 declined 6 percent to $123 million
principally due to one-time declines in income from smaller investments. The
Rank Xerox 50 percent share of Fuji Xerox income increased 4 percent to $116
million in 1996 from $112 in 1995. The excellent underlying growth in Fuji Xerox
income was largely offset by the weakening of the Japanese yen against the U.S.
dollar. Total equity in income grew 49 percent in 1995 to $131 million as Fuji
Xerox income increased 31 percent due to strong underlying growth and the
strengthening of the yen. The Rank Xerox 50 percent share of Fuji Xerox income
was $86 million in 1994.
Minorities' Interests in Earnings of Subsidiaries, principally The Rank
Group Plc share of Rank Xerox profits, were $161 million in 1996, $191 million
in 1995 and $213 million in 1994. In 1996, minorities' interests declined
primarily due to lower Rank Xerox profits.
[Pictured here are two Xerox employees who are included in the Guardian Angel
program]
Programa Anjo Da Guarda Coloca "Clientes Em Primeiro Lugar" no Brasil
Guardian Angels put "Customers First" in Brazil
Our Guardian Angel program was started by Xerox do Brasil. Employees are
assigned customers to call periodically to find out if the customers are
satisfied with our equipment. If they are not, that same Guardian Angel is
responsible for solving the problem from beginning to end. Jose Carlos and
Daniela Oliveira appeared in a Xerox videotape on the program.
34
Consolidated Balance Sheets
December 31 (in millions) 1996 1995
=====================================
Assets
- ----------------------------------------------------------------------------------------
Cash $ 104 $ 136
Accounts receivable, net 2,022 1,914
Finance receivables, net 4,386 4,069
Inventories 2,676 2,656
Deferred taxes and other current assets 964 1,095
-------------------------------------
Total Current Assets 10,152 9,870
Finance receivables due after one year, net 6,986 6,406
Land, buildings and equipment, net 2,256 2,105
Investments in affiliates, at equity 1,282 1,314
Goodwill 623 627
Other assets 1,121 876
Investment in discontinued operations 4,398 4,810
-------------------------------------
Total Assets $ 26,818 $ 26,008
=====================================
Liabilities and Equity
- ----------------------------------------------------------------------------------------
Short-term debt and current portion of long-term debt $ 3,536 $ 3,274
Accounts payable 577 578
Accrued compensation and benefits costs 761 731
Unearned income 208 228
Other current liabilities 2,122 2,216
-------------------------------------
Total Current Liabilities 7,204 7,027
Long-term debt 8,424 7,867
Postretirement medical benefits 1,050 1,018
Deferred taxes and other liabilities 2,429 2,437
Discontinued operations liabilities - policyholders' deposits and other 2,274 2,810
Deferred ESOP benefits (494) (547)
Minorities' interests in equity of subsidiaries 843 755
Preferred stock 721 763
Common shareholders' equity 4,367 3,878
-------------------------------------
Total Liabilities and Equity $ 26,818 $ 26,008
=====================================
Shares of common stock issued and outstanding at December 31, 1996 were (in
thousands) 325,902 and 323,681, respectively. Shares of common stock issued and
outstanding at December 31, 1995 were (in thousands) 325,029.
- --------------------------------------------------------------------------------
The accompanying notes on pages 48 to 67 are an integral part of the
consolidated financial statements.
35
The 1995 decrease was due to our increased financial interest in Rank Xerox,
partially offset by excellent growth in Rank Xerox income, reflecting good
revenue growth and productivity benefits.
Income
In 1996, Document Processing income of $1,206 million grew 12 percent compared
with $1,076 million of income in 1995 before the Brazilian tax gain. 1995 income
on the same basis grew 36 percent from $794 million in 1994.
[Pictured here is a map of Peru]
Impresion Electronica
Electronic Printing
Banco de Credito, Peru's largest bank, shipped half of the pages it printed to
branch offices, some of which were in remote locations. The bank faced rising
print-and-distribute shipping costs. A distributed printing solution connected
Xerox laser printers in the branch offices to the bank's network and reduced
costs and eliminated delivery problems.
Return on Assets
Return on Assets (ROA) is an important measure throughout all levels of the
Document Processing organization, combining a focus on both asset turnover and
margin improvement.
The internal measurement for ROA is defined as Document Processing before
tax profits plus equity in the net income of unconsolidated affiliates divided
by average ROA assets. These assets are Document Processing assets less
investments in affiliates and Xerox equipment financing debt.
ROA, as defined above, was 17.8 percent in 1996, 18.5 percent in 1995 and
16.1 percent in 1994.
1994 Antitrust Lawsuit Settlement
In January 1994, we reached agreement to settle a 1992 antitrust lawsuit. Under
the settlement, we agreed to sell service parts to independent service
organizations, and $225 million of discount certificates were provided for use
over a three-year period as partial payment for Xerox products. Through 1996,
$180 million of certificates were applied against purchases.
Additional Financial Interest in Rank Xerox
On February 28, 1995, we paid The Rank Group Plc $972 million to increase our
financial interest in Rank Xerox to 80 percent from 67 percent. Minorities'
interests in earnings of subsidiaries have declined by approximately 40 percent
as a result of the transaction. These savings were partially offset by an
increase in interest expense related to the funding of the transaction and
annual goodwill amortization of $16 million.
Rank Xerox and Latin American Fiscal-Year Change in 1995
Effective January 1, 1995, we changed Rank Xerox and Latin American operations
to calendar-year financial reporting. The 1994 fiscal year ended on October 31
for Rank Xerox and on November 30 for Latin American operations. The results
that occurred between the 1994 and 1995 fiscal years (the stub period) were
accounted for as a direct charge to equity.
36
Capital Resources and Liquidity
Total debt, including ESOP and discontinued operations debt not shown separately
in our consolidated balance sheets, increased to $12,448 million at December 31,
1996 from $11,794 million in 1995 and $10,955 million in 1994.
The following table summarizes the changes in total equity during 1996,
1995 and 1994:
Total Equity
----------------------------------
(In millions) 1996 1995 1994
- --------------------------------------------------------------------------------
Balance as of January 1 $ 5,396 $ 6,042 $ 5,882
Income from continuing operations 1,206 1,174 794
Loss from discontinued operations -- (1,646) --
Change in unrealized gains (losses)
on investment securities -- 432 (439)
Shareholder dividends paid (438) (389) (395)
Change in minorities' interests 88 (276) 177
Purchase of treasury stock (306) -- --
Exercise of stock options 84 109 76
All other, net (99) (50) (53)
- -------------------------------------------------------------------------------
Balance as of December 31 $ 5,931 $ 5,396 $ 6,042
================================================================================
We manage the capital structure of our non-financing operations separately from
that of our more highly leveraged captive financing activities. The following
table summarizes the ratios of earnings to fixed charges and interest expense;
and debt, equity and total capital for our non-financing and financing
activities for the three-year period ended December 31, 1996:
(Dollars in millions) 1996 1995 1994
- --------------------------------------------------------------------------------
Non-Financing:
Ratio of Earnings to
Fixed Charges 4.67x 3.79x 3.59x
================================================================================
Ratio of Earnings to
Interest Expense 6.65x 5.17x 5.75x
- --------------------------------------------------------------------------------
Debt $ 2,960 $ 3,012 $ 2,667
Equity 4,565 4,045 4,742
- --------------------------------------------------------------------------------
Total Capital $ 7,525 $ 7,057 $ 7,409
================================================================================
Debt-to-Capital Ratio 39.3% 42.7% 36.0%
================================================================================
Financing:
Debt $ 9,488 $ 8,782 $ 8,288
Equity 1,366 1,351 1,300
- --------------------------------------------------------------------------------
Total Capital $10,854 $10,133 $ 9,588
================================================================================
Debt-to-Equity Ratio 7.0x 6.5x 6.4x
================================================================================
Ratio of Earnings to
Fixed Charges 1.66x 1.71x 1.81x
================================================================================
[Pictured here is a Xerox employee and a color laser printer]
The XPrint Plus family of color laser printers is the first of several Xerox
printers capable of printing resident Chinese fonts used in the People's
Republic of China. It uses Adobe's PostScript interpreter with simplified
Chinese fonts from Changzhou SinoType Technology Co. Inc. Pictured here is Xiao
Ping Sun, Desktop Printers Unit.
37
As a result of retained earnings growth, the 1996 debt-to-capital ratio for
non-financing operations, including ESOP debt and discontinued operations debt,
was 39.3 percent or 3.4 points below its year-end 1995 level. Conversely, the
1995 ratio increased by 6.7 points versus year-end 1994 as proceeds from the
sales of Constitution Re Corporation, Viking Insurance Holdings, Inc. and the
Xerox Financial Services Life Insurance Company and related companies were more
than offset by the purchase of the increased financial interest in Rank Xerox
and non-cash charges in connection with the sales of remaining Talegen units.
With respect to our financing operations, we "match fund" by arranging
fixed-rate liabilities with maturities similar to the underlying customer
financing assets. Our guideline debt-to-equity ratio for the financing
operations is 7.0 to 1, up from 6.5 to 1 at year-end 1995, reflecting both the
high credit quality of the underlying assets and the excellent financial returns
from our captive financing businesses.
The following table summarizes the principal causes for changes in
consolidated indebtedness for the three-year period ended December 31, 1996:
(In millions) 1996 1995 1994
- --------------------------------------------------------------------------------
Total Debt* as of January 1 $ 11,794 $ 10,955 $ 10,084
- --------------------------------------------------------------------------------
Non-Financing Businesses:
Document Processing operations (678) (543) (989)
Increased financial interest in
Rank Xerox -- 972 --
Yen financing repayment -- -- 116
ESOP (53) (49) (45)
Discontinued businesses 47 (399) 605
- --------------------------------------------------------------------------------
Non-Financing (684) (19) (313)
Financing Businesses, net 706 494 650
- --------------------------------------------------------------------------------
Shareholder dividends 438 389 395
- --------------------------------------------------------------------------------
Equity redemption
and other changes 194 (25) 139
- --------------------------------------------------------------------------------
Total Debt* as of December 31 $ 12,448 $ 11,794 $ 10,955
================================================================================
* Including discontinued operations
[Pictured here is a Document Centre System 35]
London book publisher HarperCollinsPublishers finds that its 12 Document Centre
systems in the London office and five in Scotland help workers optimize their
productivity by managing document production from the desktop. Photographed here
are Jonathan Edwards, Amanda Abernethy and Simon McMurdy, Rank Xerox, with Mike
Naylor, group purchasing director, HarperCollinsPublishers.
38
Non-Financing Operations
The following table summarizes 1996, 1995 and 1994 Document Processing
non-financing operations cash generation and borrowing:
Cash Generated/(Borrowed)
====================================
(In millions) 1996 1995 1994
- --------------------------------------------------------------------------------
Document Processing
Non-Financing:
Income $ 1,004 $ 970 $ 565
Depreciation and amortization:
Buildings and equipment 372 376 446
Other 343 343 203
Capital expenditures (510) (438) (389)
Assets sold 40 90 220
Restructuring payments (197) (331) (423)
Working capital/other (374) (467) 367
- --------------------------------------------------------------------------------
Net Cash Generation $ 678 $ 543 $ 989
================================================================================
1996 cash generation of $678 million was $135 million greater than in 1995 as
higher income, and lower restructuring payments and inventory growth more than
offset higher capital spending and tax payments. 1995 cash generation was $446
million below the 1994 level due to higher capital spending and lower fixed
asset sales, inventory growth and 1994 profit sharing paid in 1995 which
together more than offset 1995 net income growth and lower restructuring
payments.
Discontinued businesses used $47 million of cash in 1996 and generated $399
million of cash in 1995. This year-over-year change primarily reflects 1995 cash
proceeds relating to the sales of Constitution Re Corporation, Viking Insurance
Holdings, Inc. and the Xerox Financial Services Life Insurance Company and
related companies.
Financing Businesses
Financing business debt grew by $706 million in 1996 or $212 million more than
in 1995 due to higher growth in equipment sales revenue and the modest increase
to our leverage guideline. Financing debt growth of $494 million in 1995 was
$156 million less than in 1994 due to lower equipment sales revenue growth and
the effects of translating foreign currencies into U.S. dollars.
Debt related to discontinued third-party financing and real estate
investments, which is included in Financing Business debt, totaled $223 million
in 1996 and $231 million in 1995 and 1994. Sales of third-party financing assets
and portfolio run-off in 1996 more than offset growth in reported debt caused by
our
[Pictured here are four Xerox employees in front of the Senate building in
Brasilia]
Solucao de impressao Xerox
para o Senado Brasileiro
Xerox printing solution for Brazilian Senate
The information and data processing center for the Federal Senate of Brazil
relies on 150 Xerox printers to handle Senate printing. Photographed here in
front of the Senate building in Brasilia are the members of the Xerox team: Joao
Inacio, Renato Furtado, Flavio Peixoto Gomes and Francisco Rincon.
39
decision to fund the retirement of certain debt of our discontinued real estate
business with lower cost Company borrowing. Portfolio run-off in 1995 was offset
by timing differences related to tax payments resulting in no net change when
compared with year-end 1994.
Funding Plans for 1997
Non-financing debt levels will be significantly reduced by expected sales of the
remaining Talegen insurance operating units including the announced sale of
Coregis to a subsidiary of GE Capital Corporation. However, the reduction will
be partially offset by borrowings related to repurchases of our common stock. In
January 1997, to provide future financial flexibility, a special purpose
subsidiary of the Company completed the sale to investors of 650,000 shares of 8
percent Capital Securities thereby generating net proceeds of $643 million.
Customer financing-related debt is planned to increase in line with 1997
sales growth while third-party financing-related debt is expected to continue to
decline.
We believe that we have adequate short-term credit facilities available to
fund day-to-day operations and have readily available access to the capital
markets to meet any longer-term financing requirements. Xerox and Xerox Credit
Corporation (XCC) have a $5.0 billion revolving credit agreement with a group of
banks, which expires in 2000. This facility is unused and available to provide
back-up to Xerox and XCC commercial paper borrowings, which amounted to $3.1
billion and $2.8 billion at December 31, 1996 and 1995, respectively. In
addition, our foreign subsidiaries have unused committed long-term lines of
credit aggregating $2.1 billion, in various currencies at prevailing interest
rates, that are used to provide back-up to short-term indebtedness.
At December 31, 1996, Xerox and XCC had domestic shelf capacity of $850
million and $450 million, respectively. In addition, a $2 billion Euro-debt
facility is available to both the Company and XCC of which $1.397 billion
remained unused at December 31, 1996.
[Pictured here is a Xerox employee and a pie chart depicting the investors in a
long-term financing]
Doug Mahoney, North American Capital Markets, discusses one of several
attractive long-term financings arranged in 1996.
40
Decisions in 1997 regarding the size and timing of any new term debt
financing will be made based on cash flows, match funding needs, refinancing
requirements and capital market conditions.
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 swap agreements, forward exchange contracts
and foreign currency swap agreements. 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 exchange contract to fix the
dollar value of a foreign currency-denominated loan. In addition, when
cost-effective, currency derivatives are also used to hedge balance sheet
exposures.
Revenues denominated in currencies where the local currency is the
functional currency are not hedged.
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 adverse changes in the interest rate
environment. Conversely, this practice effectively eliminates the opportunity 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 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 obligations. The transactions
performed within each of these three categories enable more cost-effective
management of interest rate exposures. The potential risk attendant to this
strategy is the performance of the swap counterparty. We
[Pictured here is a DocuTech 135 advertisement in Brazil]
Brazil printer Grafica Tullio Samorini features the DocuTech in its advertising.
We now have 350 DocuTechs installed in Brazil.
41
Consolidated Statements of Cash Flows
Year ended December 31 (in millions) 1996 1995 1994
=============================================
- ------------------------------------------------------------------------
Cash Flows from Operating Activities
Income from Continuing Operations $ 1,206 $1,174 $ 794
Adjustments required to reconcile income to cash flows
from operating activities:
Depreciation and amortization 715 719 649
Provision for doubtful accounts 259 235 202
Provision for postretirement medical benefits, net of payments 38 40 54
Charges against 1993 restructuring reserve (197) (331) (423)
Minorities' interests in earnings of subsidiaries 161 191 213
Undistributed equity in income of affiliated companies (84) (90) (54)
Increase in inventories (422) (663) (472)
Increase in finance receivables (1,220) (701) (887)
Increase in accounts receivable (180) (173) (266)
Increase in accounts payable and accrued
compensation and benefit costs 63 179 205
Net change in current and deferred income taxes 293 263 258
Other, net (308) (244) 206
---------------------------------------------
Total 324 599 479
---------------------------------------------
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment (510) (438) (389)
Proceeds from sales of land, buildings and equipment 40 90 220
Net change in payables to Discontinued Operations (51) (57) (124)
Proceeds from sale of Constitution Re and Viking -- 526 --
Purchase of additional interest in Rank Xerox -- (972) --
---------------------------------------------
Total (521) (851) (293)
---------------------------------------------
Cash Flows from Financing Activities
Net change in debt 990 766 550
Yen financing repayment -- -- (116)
Dividends on common and preferred stock (438) (389) (395)
Proceeds from sale of common stock 95 111 74
Repurchase of preferred and common stock (316) (41) (229)
Dividends to minority shareholders (68) (86) (97)
Proceeds received from (returned to) minority shareholders 32 20 (32)
---------------------------------------------
Total 295 381 (245)
---------------------------------------------
Effect of Exchange Rate Changes on Cash (6) (5) (78)
---------------------------------------------
Cash Provided (Used) by Continuing Operations 92 124 (137)
Cash Provided (Used) by Discontinued Operations (124) (29) 106
---------------------------------------------
Increase (Decrease) in Cash (32) 95 (31)
Cash at Beginning of Year 136 41 72
---------------------------------------------
Cash at End of Year $ 104 $ 136 $ 41
=============================================
The accompanying notes on pages 48 to 67 are an integral part of the
consolidated financial statements.
42
address this risk by arranging swaps exclusively with a diverse group of
strong-credit counterparties, regularly monitoring their credit ratings, and
determining the replacement cost, if any, of existing transactions.
On an overall worldwide basis, and including the impact of our hedging
activities, weighted average interest rates for 1996, 1995 and 1994 approximated
6.9 percent, 7.7 percent and 7.5 percent, respectively.
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.
Liquidity
Our primary sources of liquidity are cash generated from operations and
borrowings. The consolidated statements of cash flows detailing changes in our
cash balances are on page 42.
Operating activities, including growth in finance receivables, generated
positive cash flows in each of the past three years. Cash generation of $324
million in 1996 was below that of 1995 and 1994 due to higher finance
receivables associated with improved equipment sales performance.
Investing activities resulted in net cash usage in all three years. Net
usage in 1996 was $521 million, $330 million less than in 1995 but $228 more
than in 1994. Lower 1996 usage versus the prior year is mainly the result of the
1995 payment to the Rank Group Plc which increased our financial interest in
Rank Xerox and was only partially offset by proceeds from the sales of certain
Talegen units. The lower level of investing in 1994 was primarily due to asset
sales related to our information management outsourcing initiative.
Financing activities generated $295 million and $381 million of cash in
1996 and 1995, respectively, but used $245 million of cash in 1994. Included
within financing activities is borrowing related to the repurchase of common and
preferred stock.
Overall, continuing operations provided $92 million and $124 million of
cash in 1996 and 1995, respectively, and used $137 million in 1994.
Discontinued operations used $124 million and $29 million of cash in 1996
and 1995, respectively, and generated $106 million in 1994.
On a combined basis, continuing and discontinued operations produced $32
million of growth in cash balances during the three years ended December 31,
1996.
Discontinued Operations - Insurance and Other Financial Services
In January 1993, we announced our decision to sell or otherwise disengage from
the Insurance and Other Financial Services (IOFS) businesses. IOFS consists of
our Insurance, Other Financial Services, and Third-Party Financing and
Real-Estate segments. In connection with this decision, during 1995 we sold
Xerox Financial Services Life Insurance Company, Constitution Re Corporation
(CRC) and Viking Insurance Holdings, Inc. (Viking) and in 1996 we sold the
remaining portion of First Quadrant Corp.
In January 1996, we announced agreements to sell all of our "Remaining"
insurance companies, which includes Coregis Group, Inc. (Coregis), Crum &
Forster Holdings, Inc. (CFI), Industrial Indemnity Holdings, Inc. (II),
Westchester Specialty Group, Inc. (WSG), The Resolution Group, Inc. (TRG) and
three insurance-related service companies, to investor groups led by Kohlberg
Kravis Roberts & Co. (KKR) and Talegen/TRG management. In connection with the
transactions, we recorded a $1,546 million after-tax charge in 1995.
On September 11, 1996, Xerox and KKR announced that they had mutually
agreed to terminate the transactions. No additional charges are considered
necessary as a result of the termination of the KKR transactions. In September
1996, the Board of Directors of Xerox formally approved a plan of disposal under
which we have retained investment bankers to assist us in the
43
simultaneous marketing of each of the remaining insurance and service companies.
During the disposal process, we will continue to be subject to all business
risks and rewards of the insurance businesses. Although we believe that the
disposal of the Remaining insurance companies will be either fully or
substantially completed by the end of 1997, and that the proceeds received from
such disposals will be consistent with our net carrying value of these
businesses, until such Remaining insurance companies are actually sold, no
assurances can be given as to the ultimate impact the Remaining insurance
companies will have on our total results from operations.
Our objective is to continue to maximize value from our Insurance
investments. The ultimate value will depend on the success of operational
improvements, timing, the level of interest rates and the relative value of
insurance properties.
In January 1997, we announced an agreement to sell the Coregis insurance
unit to a subsidiary of GE Capital Corporation for $375 million in cash and the
assumption of $75 million in debt. The selling price is in excess of book value
and is consistent with the estimated value for the unit when we discontinued the
insurance operations in 1995. The transaction is subject to customary closing
conditions and regulatory approvals. In 1996, Coregis had gross written premiums
of $423 million and at December 31, 1996, policyholders surplus of $271 million.
Also in January 1997, in an unrelated transaction, Andersen Consulting
agreed to acquire certain assets of Apprise Corp., one of Talegen's
insurance-related service companies, and enter into separate multi-year
information technology service agreements with each of the Remaining insurance
companies. The financial terms of this transaction were not material.
The net investment in the discontinued IOFS businesses totaled $2,124
million at December 31, 1996, compared with $2,000 million and $3,710 million at
December 31, 1995 and 1994, respectively. The increase in 1996 over 1995
primarily includes scheduled funding of reinsurance coverage for the Talegen
companies by Ridge Reinsurance Limited (Ridge Re) and interest for the period on
the assigned debt, partially offset by asset sales and run-off activity
associated with the Third-Party Financing and Real-Estate segment. A discussion
of the discontinued businesses follows.
Status of Insurance
In 1993, Talegen completed a restructuring that established and capitalized the
following seven insurance operating groups as independent legal entities: CRC,
Coregis, CFI, II, Viking, WSG and TRG. The insurance segment now includes
Talegen, which is the holding company of Coregis, CFI, II and WSG and three
insurance-related service companies; TRG, a former Talegen company, primarily
involved in run-off activities, collection of reinsurance and management of
latent exposure claims; Ridge Re; and that portion of the Xerox Financial
Services, Inc. (XFSI) headquarters costs and interest expense associated with
the insurance business activities.
In connection with the restructuring of Talegen, XFSI agreed that support
would be provided to the seven insurance operating groups in the form of
aggregate excess of loss reinsurance. This reinsurance protection is provided
through XFSI's single purpose, wholly-owned reinsurance company Ridge Re, which
was established in 1992.
XFSI is obligated to pay annual premium installments of $49 million, plus
finance charges, for 10 years, for coverage totaling $1,245 million, which is
net of 15 percent coinsurance. A total of six annual premium installments remain
to be paid as of December 31, 1996 and Xerox has guaranteed the payment by XFSI
of all such premiums. Xerox has also guaranteed Ridge Re's performance under a
$400 million letter of credit facility required to provide security with respect
to aggregate excess of loss reinsurance obligations under contracts with the
Remaining insurance companies.
44
XFSI may also be required, under certain circumstances, to purchase over
time, additional redeemable preferred shares of Ridge Re, up to a maximum of
$301 million. In addition, XFSI has guaranteed to the Remaining insurance
companies that Ridge Re will meet all of its financial obligations under the
foregoing excess of loss reinsurance issued to them.
Sale of Talegen Insurance Companies
In April 1995, CRC was sold to EXOR America Inc. for a purchase price of $421
million in cash. In July 1995, Viking was sold to Guaranty National Corporation
for approximately $103 million in cash plus future upward price adjustments
based on loss reserve development. The purchase price of both transactions
approximated book value. The proceeds of both transactions were primarily used
to retire debt.
Insurance Operating Results
Operating results for the discontinued Insurance segment are summarized below:
Year-ended December 31,
----------------------------------
(In millions) 1996 1995 1994
- -------------------------------------------------------------------------------
Total Insurance Revenue1 $ 2,143 $ 2,106 $ 2,069
================================================================================
Insurance Pre-Tax Income (Loss):
Underwriting $ (515) $ (751) $ (229)
Investment income 438 405 353
Net realized capital gains 4 60 12
Interest expense (203) (228) (218)
Ridge Re related and other 44 (501) (23)
- --------------------------------------------------------------------------------
Pre-Tax Loss From Operations (232) (1,015) (105)
Loss on disposal -- (978) --
- --------------------------------------------------------------------------------
Total Insurance Pre-Tax Loss1 $ (232) $(1,993) $ (105)
================================================================================
After-Tax Income (Loss):
Insurance $ (135) $(1,641) $ (48)
Dispositioned companies -- (5) 48
- --------------------------------------------------------------------------------
Total After-Tax Income (Loss)2 $ (135) $(1,646) $ --
================================================================================
1 Revenue and pre-tax income excludes the results of CRC and Viking, which were
sold in 1995. The results of those units are shown on an after-tax basis under
the caption "Dispositioned companies."
2 The 1996 total Insurance after-tax loss of $135 million was charged against
reserves established for this purpose and, therefore, does not impact our
earnings.
Revenues for 1996 totaled $2,143 million, a growth of 2 percent from 1995 due to
improvements in both earned premiums and investment income.
The 1996 Insurance pre-tax loss of $232 million declined by $1,761 million
compared with 1995, primarily due to the provision in the fourth quarter of 1995
as a result of the discontinuance of the Insurance segment. The 1995 after-tax
provision consisted of a non-cash loss of $978 million (including a goodwill
write-off of $245 million), reserve strengthening at the Remaining insurance
companies of $176 million, and Ridge Re related and other accruals of $392
million to cover all estimated future expenses associated with the excess of
loss reinsurance coverage to Talegen and TRG. Other items impacting the
year-over-year results include improvements in investment income, lower interest
expense and lower Ridge Re related and other expenses, partially offset by lower
net realized capital gains due to the portfolio repositioning in the third
quarter of 1995 and strengthening of TRG's latent exposure reserves in 1996.
The net investment in the discontinued Insurance segment at December 31,
1996 totaled $1,846 million compared with $1,678 million and $3,212 million at
December 31, 1995 and 1994, respectively. The increase in 1996 over 1995 is
primarily due to contractual payments to Ridge Re for annual premium
installments and associated finance charges and interest on the assigned
insurance debt that will continue until the Remaining insurance companies are
sold.
Property and Casualty Operating Trends
The industry's profitability can be significantly affected by cyclical
competitive conditions, judicial decisions affecting insurers' liabilities, and
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
45
to affect the size of losses). Talegen's and TRG's operating results have
historically been influenced by these industry trends, as well as by their
exposure to uncollectible reinsurance, which had been greater than most other
insurers.
Latent Exposures
Claims resulting from asbestos, environmental and other latent exposures have
provided unique and difficult challenges to the insurance industry and to
certain of the Remaining insurance companies due to their historical writings.
The possibility that these claims would emerge was often not contemplated at the
time the policies were written and traditional actuarial reserving methodologies
have not been useful in accurately estimating ultimate losses.
Prior to 1995, the Remaining insurance companies established case and
incurred but not reported (IBNR) reserves for latent exposure claims that had
been reported. The IBNR reserves were established primarily to cover adverse
development on known claims. Case reserves have been and continue to be
determined by a specialized claim and legal staff. Building on methodologies
first published in the third quarter of 1994 by the Casualty Actuarial Society
and utilizing data from policyholders and third parties such as the
Environmental Protection Agency, Talegen initiated a project in 1995 to create
and implement comprehensive, sophisticated costing methodologies to provide
estimates of aggregate ultimate losses for asbestos and environmental exposures.
During 1996 and 1995, results of the costing methodologies led the Remaining
insurance companies to strengthen their gross asbestos reserves by $525 million
and gross environmental reserves by $549 million. Additionally, case development
and IBNR reserve strengthening led to an increase in gross other latent exposure
reserves of $223 million during 1996 and 1995.
The development of costing methodologies for asbestos, environmental and
other latent exposures is considered by management to be substantially complete.
However, additional liabilities and reinsurance recoverables could arise as
judicial patterns emerge through the appellate process and remove or add to
uncertainties surrounding these latent exposure areas, as new claim information
is received and assessed, and as refinements to the costing methodologies are
made. The Remaining insurance companies do not believe that liabilities
associated with incurred latent exposure claims will have a material adverse
effect on their future liquidity or financial position. However, given the
complexity of coverage and other legal issues, and the significant assumptions
necessarily used in estimating such exposures, actual results could
significantly differ from current estimates.
Reserves for the Remaining Insurance Companies
Gross and net unpaid losses and loss expenses for the Remaining insurance
companies as of December 31, 1996 and 1995, in total and for each latent
exposure area are summarized in the following table:
Unpaid Losses and Loss Expenses
Gross Net
(In millions) Reserves Reserves
- --------------------------------------------------------------------------------
December 31, 1996 in total: $8,496 $5,619
================================================================================
Latent exposure areas1
Asbestos $ 710 $ 235
Environmental 690 381
Other latent exposures 296 106
- --------------------------------------------------------------------------------
Total $1,696 $ 722
================================================================================
December 31, 1995 in total: $8,478 $5,650
================================================================================
Latent exposure areas1
Asbestos $ 498 $ 224
Environmental 530 253
Other latent exposures 211 48
- --------------------------------------------------------------------------------
Total $1,239 $ 525
================================================================================
1 Net latent exposure reserves have not been reduced for recoverables from Ridge
Re because the Ridge Re contract is an aggregate excess of loss contract
covering all lines of business for the Remaining insurance companies.
Additionally, the net latent exposure reserves presented do not include reserves
for uncollectible reinsurance.
46
Gross loss and loss expense reserves attributable to prior accident year
losses for the Remaining insurance companies were strengthened by $421 million
and $913 million in 1996 and 1995, respectively. After consideration of losses
ceded to reinsurers, other than Ridge Re, and uncollectible reinsurance, net
unpaid loss and loss expense reserves were strengthened by $334 million and $769
million in 1996 and 1995, respectively. The aggregate 1996 and 1995 net
strengthening was comprised of additions to latent exposure reserves, non-latent
exposure reserves and the reserve for uncollectible reinsurance of $647 million,
$113 million and $343 million, respectively. The strengthening of net reserves
excludes pre-tax cessions to Ridge Re of $103 million and $476 million in 1996
and 1995, respectively, which, while beneficial to Talegen and TRG, cessions to
Ridge Re do not result in a benefit to the consolidated Xerox accounts.
Other Financial Services
Other Financial Services (OFS), which were discontinued in 1993, had no
after-tax income in the full year 1996, 1995 and 1994. The net investment in OFS
at December 31, 1996 was $101 million compared to $114 million and $232 million
at December 31, 1995 and 1994, respectively. The decrease in 1996 over 1995
primarily reflects the sale of the remaining portion of First Quadrant Corp.
On June 1, 1995, 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 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 policies (of Immediate, Whole Life, and Variable
annuities as well as a minor amount of SPDAs) were sold and are now the
responsibility of the Cova Companies.
As a result of the Coinsurance Agreements, at December 31, 1996, OakRe
retained approximately $2.0 billion of investment portfolio assets ($3.2 billion
transferred from the Xerox Life Companies at June 1, 1995) 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 through
the year 2000 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 December 31, 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 Financing and Real-Estate
Third-Party Financing and Real-Estate assets at December 31, 1996, 1995 and 1994
totaled $450 million, $489 million and $547 million, respectively. The proceeds
from the asset sales and run-off activity were consistent with the amounts
contemplated in the formal disposal plan.
47
Notes to Consolidated Financial Statements
(Dollars in millions, except per-share data and unless otherwise indicated)
1 Summary of Significant
Accounting Policies
Basis of Consolidation. The consolidated financial statements include the
accounts of Xerox Corporation and all majority owned subsidiaries (the Company).
All significant intercompany accounts and transactions have been eliminated.
References herein to "we"or "our" refer to Xerox and consolidated subsidiaries
unless the context specifically requires otherwise.
Rank Xerox Limited, Rank Xerox Holding BV, Rank Xerox Investment Limited, R-X
Holdings Limited and their respective subsidiaries, and the other subsidiaries
owned by the Company and The Rank Group Plc are referred to as Rank Xerox.
Investments in which we have a 20 to 50 percent ownership interest are
accounted for on the equity method.
Upon the sale of stock by a subsidiary, we recognize a gain or loss equal
to our proportionate share of the increase or decrease in the subsidiary's
equity. During 1996, we recognized a pre-tax net gain of $11 from such
transactions.
Effective January 1, 1995, we changed the reporting periods of Rank Xerox
and the Latin American operations from fiscal years ending October 31 and
November 30, respectively, to a calendar year ending December 31. The results of
these operations during the period between the end of the 1994 fiscal year and
the beginning of the new calendar year (the stub period) amounted to a loss of
$21. The loss was charged to retained earnings to avoid reporting more than 12
months results of operations in one year. Accordingly, 1995 worldwide operations
include the results for all consolidated subsidiaries beginning January 1, 1995.
The cash activity for the stub period is included in Other, net in the 1995
consolidated statement of cash flows.
Business Segment Information. As a result of our decision to sell our Insurance
operations, see Note 10 on Page 52, we now operate in a single industry segment
that consists of the worldwide development, manufacturing, marketing, financing
and servicing of document processing products and services. This business is
unitary from both a company and a customer perspective in that the marketing,
financing and servicing of our products represent an integrated document
services solution.
Earnings Per Share. Primary earnings per share are based on net income less
preferred stock dividend requirements divided by the average common shares
outstanding during the period and common equivalent shares related to dilutive
stock options and Xerox Canada Inc. exchangeable Class B stock. Fully diluted
earnings per share assume full conversion of convertible debt and convertible
preferred stock into common stock at the beginning of the year or date of
issuance, unless they are antidilutive.
Use of Estimates. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Goodwill. Goodwill represents the cost of acquired businesses in excess of the
net assets purchased and is amortized on a straight-line basis, generally over
40 years. Goodwill is reported net of accumulated amortization and the
recoverability of the carrying value is evaluated on a periodic basis.
Accumulated amortization at December 31, 1996 and 1995 was $41 and $25,
respectively.
Accounting Changes. Effective January 1, 1996, we adopted Statement of Financial
Accounting Standards (SFAS) No. 121 - "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 121
requires companies to review assets for possible impairment and provides
guidelines for recognition of impairment losses related to long-lived assets,
certain intangibles and assets to be disposed of. The impact of the adoption of
SFAS No. 121 was immaterial.
Effective January 1, 1996, we adopted SFAS No. 123 - "Accounting for
Stock-Based Compensation." SFAS No. 123 allows companies to elect to recognize
compensation cost for stock-based employee compensation arrangements or to
disclose in the notes to the consolidated financial statements the impact on net
income and earnings per share as if the fair value based compensation cost had
been recognized. See Note 17 on Page 66 for such disclosures.
48
Revenue Recognition. Revenues from the sale of equipment under installment
contracts and from sales-type leases are recognized at the time of sale or at
the inception of the lease, respectively. Associated finance income is earned on
an accrual basis under an effective annual yield method. Revenues from equipment
under other leases are accounted for by the operating lease method and are
recognized over the lease term. Service revenues are derived primarily from
maintenance contracts on our equipment sold to customers and are recognized over
the term of the contracts.
Provisions for Losses on Uncollectible Receivables. The provisions for losses on
uncollectible trade and finance receivables are determined principally on the
basis of past collection experience.
Inventories. Inventories are carried at the lower of average cost or market.
Buildings and Equipment. Our fixed assets are depreciated over their estimated
useful lives. Depreciation is computed using principally the straight-line
method. Significant improvements are capitalized; maintenance and repairs are
expensed. See Note 7 on Page 51.
Classification of Commercial Paper and Bank Notes Payable. It is our policy to
classify as long-term debt that portion of commercial paper and bank notes
payable that is intended to match fund finance receivables due after one year to
the extent that we have the ability under our revolving credit agreement to
refinance such commercial paper and notes payable on a long-term basis. See Note
11 on Page 56.
Foreign Currency Translation. The functional currency for most foreign
operations is the local currency. Net assets are translated at current rates of
exchange and income and expense items are translated at the average exchange
rate for the year. The resulting translation adjustments are recorded as a
separate component of shareholders' equity. The U.S. dollar is used as the
functional currency for our subsidiaries, primarily those in Latin America,
which conduct their business in U.S. dollars or operate in hyperinfla-tionary
economies. A combination of current and historical exchange rates are used in
remeasuring the local currency transactions of these subsidiaries and the
resulting exchange adjustments are included in income. Aggregate foreign
currency losses were $27, $18, and $136 in 1996, 1995, and 1994, respectively,
and are included in Other, net in the consolidated statements of income. The
decline in currency losses in 1996 and 1995 from prior years is primarily due to
the relative stabilization of exchange rates in Brazil commencing after July 1,
1994.
Reclassifications. Effective with 1996 reporting, our China operations are fully
consolidated. Prior years' financial statements have been restated to reflect
this change and several other accounting reclassifications were made to conform
with the 1996 presentation. The impact of these changes is not material and did
not affect net income.
2 Common Stock Split
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 stock split was
June 6 for shareholders of record as of May 23. Shareholders'~ equity has been
restated to give retroactive recognition to the stock split in prior periods by
reclassifying from additional paid-in capital to common stock the par value of
the additional shares arising from the split. In addition, all references in the
financial statements to number of shares and per share amounts have been
restated.
3 Acquisition
On February 28, 1995, we paid The Rank Group Plc (RO) (pound)620 million, or
approximately $972, for 40 percent of RO's financial interest in Rank Xerox. The
transaction increased our financial interest in Rank Xerox to 80 percent from 67
percent. Our additional interest in the operating results of Rank Xerox is
included in the consolidated statement of income from the date of acquisition.
Based on the allocation of the purchase price, this transaction resulted in
goodwill of $574 (including transaction costs), a decline in minorities'
interests in equity of subsidiaries of approximately $400 and an increase in
long-term debt of $972.
49
4 1993 Restructuring Charge
In 1993, we recorded a restructuring charge which aggregated $1,195 relating to
a restructuring program aimed at significantly reducing our cost base and at
improving 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.
Charges to the reserve for the three years ending December 31, 1996 follow:
1996 1995 1994
- --------------------------------------------------------------------------------
Net charges to
restructuring reserve $222 $370* $430
================================================================================
Reserve balance:
Current $131 $298 $429
Non-current 42 97 336
- --------------------------------------------------------------------------------
Total reserve balance $173 $395 $765
================================================================================
* Includes $30 charged to the reserve during the stub period.
Management believes that the aggregate reserve balance of $173 at December 31,
1996 is adequate for completion of the restructuring program.
5 Finance Receivables, net
Finance receivables represent installment sales and sales-type leases resulting
from the marketing of our business equipment products. These receivables
generally mature over two to five years and are typically collateralized by a
security interest in the underlying assets. The components of finance
receivables, net at December 31, 1996, 1995 and 1994 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Gross receivables $ 13,916 $ 12,721 $ 12,135
Unearned income (2,551) (2,207) (2,074)
Unguaranteed residual values 354 283 206
Allowance for doubtful accounts (347) (322) (319)
- -------------------------------------------------------------------------------
Finance receivables, net 11,372 10,475 9,948
Less current portion 4,386 4,069 3,910
- -------------------------------------------------------------------------------
Amounts due after one year, net $ 6,986 $ 6,406 $ 6,038
===============================================================================
Contractual maturities of our gross finance receivables subsequent to
December 31, 1996 follow:
1997 1998 1999 2000 2001 Thereafter
- --------------------------------------------------------------------------------
$5,492 $3,708 $2,626 $1,493 $507 $90
================================================================================
Experience has shown that a portion of these finance receivables will be prepaid
prior to maturity. Accordingly, the preceding schedule of contractual maturities
should not be considered a forecast of future cash collections.
6 Inventories
The components of inventories at December 31, 1996, 1995 and 1994 follow:
1996 1995 1994
- --------------------------------------------------------------------------------
Finished goods $1,570 $1,646 $1,458
Work in process 80 88 88
Raw materials 322 295 268
Equipment on operating leases, net 704 627 480
- --------------------------------------------------------------------------------
Inventories $2,676 $2,656 $2,294
================================================================================
Equipment on operating leases consists of our business equipment products that
are rented to customers and are depreciated to estimated residual value.
Depreciable lives vary from two to four years. In order to more precisely match
depreciable lives to the duration of lease contracts with customers, during
1996, we increased the depreciable lives of certain equipment on operating
leases such that the equipment is now predominately depreciated over three to
four years. The effect of this change was not material. Our business equipment
operating lease terms vary, generally from 12 to 36 months. Accumulated
depreciation on equipment on operating leases for the years ended December 31,
1996, 1995 and 1994 amounted to $1,259, $1,065 and $824, respectively. Scheduled
minimum future rental revenues on operating leases with original terms of one
year or longer are:
1997 1998 1999 Thereafter
- --------------------------------------------------------------------------------
$446 $202 $101 $48
================================================================================
Total contingent rentals, principally usage charges in excess of minimum
allowances relating to operating leases, for the years ended December 31, 1996,
1995 and 1994 amounted to $199, $190 and $197, respectively.
50
7 Land, Buildings and Equipment, net
The components of land, buildings and equipment, net at December 31, 1996, 1995
and 1994 follow:
Estimated
Useful Lives
(Years) 1996 1995 1994
- --------------------------------------------------------------------------------
Land $ 89 $ 85 $ 87
Buildings and building
equipment 20 to 40 991 941 876
Leasehold improvements Lease term 378 347 339
Plant machinery 4 to 12 1,862 1,907 1,843
Office furniture and
equipment 3 to 10 1,231 1,161 1,245
Other 3 to 20 218 201 139
Construction in progress 250 231 227
- --------------------------------------------------------------------------------
Subtotal 5,019 4,873 4,756
Less accumulated depreciation 2,763 2,768 2,648
- --------------------------------------------------------------------------------
Land, buildings and equipment, net $2,256 $2,105 $2,108
================================================================================
We lease certain land, buildings and equipment, substantially all of which are
accounted for as operating leases. Total rent expense under operating leases for
the years ended December 31, 1996, 1995 and 1994 amounted to $421, $425 and
$502, respectively. Future minimum operating lease commitments that have
remaining non-cancelable lease terms in excess of one year at December 31, 1996
follow:
1997 1998 1999 2000 2001 Thereafter
- --------------------------------------------------------------------------------
$311 $241 $179 $144 $119 $406
================================================================================
In certain circumstances, we sublease space not currently required in
operations. Future minimum sublease income under leases with non-cancelable
terms in excess of one year amounted to $27 at December 31, 1996.
In 1994, we awarded a contract to Electronic Data Systems Corp. (EDS) to
operate our worldwide data processing and telecommunications network through the
year 2004. Minimum payments due EDS under the contract follow:
1997 1998 1999 2000 2001 Thereafter
- --------------------------------------------------------------------------------
$336 $300 $261 $233 $222 $485
================================================================================
8 Investments in Affiliates, at Equity
Investments in corporate joint ventures and other companies in which we have a
20 to 50 percent ownership interest at December 31, 1996, 1995 and 1994 follow:
1996 1995 1994
- --------------------------------------------------------------------------------
Fuji Xerox $1,173 $1,223 $1,183
Other investments 109 91 95
- --------------------------------------------------------------------------------
Investments in affiliates, at equity $1,282 $1,314 $1,278
================================================================================
Rank Xerox, a consolidated subsidiary, owns 50 percent of the outstanding stock
of Fuji Xerox, a corporate joint venture with Fuji Photo Film Co., Ltd. Fuji
Xerox is headquartered in Tokyo and operates in Japan and other areas of the
Pacific Rim, Australia and New Zealand, except for China. Condensed financial
data of Fuji Xerox for its last three fiscal years ended October 20, follow:
1996 1995 1994
- --------------------------------------------------------------------------------
Summary of Operations
Revenues $8,091 $8,500 $7,235
Costs and expenses 7,546 7,989 6,829
- --------------------------------------------------------------------------------
Income before income taxes 545 511 406
Income taxes 313 287 235
- --------------------------------------------------------------------------------
Net income $ 232 $ 224 $ 171
================================================================================
Rank Xerox' equity in net income $ 116 $ 112 $ 86
================================================================================
Xerox' equity in net income $ 93 $ 88 $ 57
================================================================================
Balance Sheet Data
Assets
Current assets $3,008 $3,518 $3,428
Non-current assets 3,168 3,085 3,038
- --------------------------------------------------------------------------------
Total assets $6,176 $6,603 $6,466
================================================================================
Liabilities and Shareholders' Equity
Current liabilities $2,546 $2,675 $2,567
Long-term debt 427 594 658
Other non-current liabilities 850 884 871
Shareholders' equity 2,353 2,450 2,370
- --------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $6,176 $6,603 $6,466
================================================================================
51
9 Geographic Area Data
Revenues and assets of Rank Xerox are substantially attributable to European
operations; their consolidated operations in Africa, Asia and the Middle East
together comprise less than two percent of our consolidated amounts. The Other
Areas classification includes operations principally in Latin America and
Canada.
Intercompany revenues are generally based on manufacturing cost plus a
markup to recover other operating costs and to provide a profit margin to the
selling company.
Geographic area data for our continuing operations follow:
Year ended December 31,
-----------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------
Revenues from Unrelated Entities:
United States $ 8,583 $ 8,068 $ 7,822
Rank Xerox 5,501 5,495 4,566
Other Areas 3,294 3,025 2,696
- -------------------------------------------------------------------------------
Total $ 17,378 $ 16,588 $ 15,084
===============================================================================
Intercompany Revenues:
United States $ 1,377 $ 1,376 $ 1,291
Rank Xerox 230 226 262
Other Areas 425 463 362
- -------------------------------------------------------------------------------
Total $ 2,032 $ 2,065 $ 1,915
===============================================================================
Total Revenues:
United States $ 9,960 $ 9,444 $ 9,113
Rank Xerox 5,731 5,721 4,828
Other Areas 3,719 3,488 3,058
Less intercompany revenues (2,032) (2,065) (1,915)
- -------------------------------------------------------------------------------
Total $ 17,378 $ 16,588 $ 15,084
===============================================================================
Net Income (Before
Intercompany Eliminations):
United States $ 444 $ 370 $ 436
Rank Xerox 432 409 218
Other Areas 375 364 193
- -------------------------------------------------------------------------------
Total $ 1,251 $ 1,143 $ 847
===============================================================================
Net Income (After
Intercompany Eliminations):
United States $ 414 $ 418 $ 386
Rank Xerox 431 408 215
Other Areas 361 348 193
- -------------------------------------------------------------------------------
Total $ 1,206 $ 1,174 $ 794
===============================================================================
Assets:
United States $ 10,354 $ 9,876 $ 9,133
Rank Xerox 7,844 7,566 7,171
Other Areas 4,222 3,756 3,070
- -------------------------------------------------------------------------------
Subtotal 22,420 21,198 19,374
Investment in
discontinued operations 4,398 4,810 7,904
- -------------------------------------------------------------------------------
Total $ 26,818 $ 26,008 $ 27,278
===============================================================================
10 Discontinued Operations
In January 1993, we announced our intent to sell or otherwise disengage from our
Insurance and Other Financial Services businesses. Since that time, we have
disposed of a number of these businesses through sale and run-off collection
activities. At December 31, 1996, our sole remaining non-Document Processing
operation is the Insurance business, which excludes our other discontinued
businesses consisting of Other Financial Services, and Third-Party Financing and
Real-Estate which are primarily in asset run-off. The Insurance business
consists of Talegen Holdings, Inc. (Talegen), The Resolution Group, Inc. (TRG),
Ridge Reinsurance Limited (Ridge Re) and headquarters costs and interest expense
associated with the insurance activities of Xerox Financial Services, Inc.
(XFSI).
In January 1996, we announced agreements to sell all of the remaining
insurance and insurance-related service companies of Talegen and TRG (the
Remaining companies), for approximately $2.7 billion, to investor groups led by
Kohlberg Kravis Roberts & Co. (KKR) and Talegen/TRG management. However, in
September 1996, KKR and the Company mutually agreed to terminate these
agreements. As a result, the Board of Directors formally approved a plan of
disposal under which we have retained investment bankers to assist us in
simultaneously marketing each of the Remaining companies. We expect our strategy
of exiting the Insurance business to be either fully or substantially completed
by the end of 1997.
In connection with the announced sale of the Remaining companies to KKR, we
recorded a $1,546 loss on disposal in the fourth quarter of 1995. Based on
current estimates of the value of the Remaining companies, no additional charges
are required as a result of the terminated agreements.
Insurance. In 1993, Talegen completed a restructuring which established and
capitalized seven insurance operating groups as independent legal entities:
Constitution Re Corporation (CRC), Coregis Group, Inc. (Coregis), Crum & Forster
Holdings, Inc., Industrial Indemnity Insurance Holdings, Inc., TRG, Viking
Insurance Holdings, Inc. (Viking) and Westchester Specialty Group, Inc.
In connection with the restructuring of Talegen, XFSI agreed that support
would be provided in the form of aggregate excess of loss reinsurance. This
reinsurance protection
52
is provided through XFSI's single purpose, wholly owned reinsurance company
Ridge Re, which was established in 1992. Commencing in 1993, XFSI became
obligated to pay Ridge Re annual premium installments of $49, plus finance
charges, for 10 years, for coverage totaling $1,245, which is net of 15 percent
coinsurance. The XFSI premium payments have been guaranteed by us. We have also
guaranteed Ridge Re's performance under a $400 letter of credit facility
required to provide security with respect to aggregate excess of loss
reinsurance obligations under contracts with the Remaining companies. At
December 31, 1996, Ridge Re recognized approximately $650 of the $1,245 excess
of loss reinsurance coverage estimated to be required based on actuarial
projections.
XFSI may also be required, under certain circumstances, to purchase up to
$301 in redeemable preferred stock of Ridge Re. In addition, XFSI has guaranteed
to the Remaining companies that Ridge Re will meet all of its financial
obligations under all of the foregoing excess of loss reinsurance issued to
them.
Sales of Talegen Insurance Operating Groups. In April 1995, CRC was sold for a
purchase price of $421 in cash, which approximated book value. In July 1995,
Viking was sold for approximately $103 in cash plus future upward price
adjustments based on loss reserve development. The transaction approximated book
value. The proceeds of both transactions were used to retire debt.
In January 1997, we announced the sale of the Coregis insurance unit to a
subsidiary of GE Capital Corporation for $450. The consideration, which is
comprised of $375 in cash and $75 assumed debt, is in excess of book value and
is consistent with the estimated value for the unit when we discontinued the
Insurance operations in 1995. The transaction is subject to regulatory approvals
and customary closing conditions and is expected to close in the second quarter
of 1997. In 1996, Coregis had gross written premiums of $423 and a year-end
policyholders surplus of $271.
Insurance Financial Information. Summarized operating results of Insurance for
the three years ended December 31, 1996 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Revenues
Insurance premiums earned $ 1,708 $ 1,888 $ 2,312
Investment and other income 435 464 437
- -------------------------------------------------------------------------------
Total Revenues 2,143 2,352 2,749
- --------------------------------------------------------------------------------
Costs and Expenses
Insurance losses and loss expenses 1,667 2,031 1,769
Insurance acquisition costs and
other operating expenses 557 619 777
Interest expense 203 231 212
Administrative and
general expenses (48) 556 47
- -------------------------------------------------------------------------------
Total costs and expenses 2,379 3,437 2,805
Realized capital gains 4 60 12
- -------------------------------------------------------------------------------
Income (loss) before income taxes (232) (1,025) (44)
Income tax benefits 97 357 44
- -------------------------------------------------------------------------------
Net income (loss) from
operations* (135) (668) --
Loss on disposal -- (978) --
- -------------------------------------------------------------------------------
Income (loss) from Insurance $ (135) $(1,646) $ --
===============================================================================
* The 1995 amount includes $568 of after-tax reserves.
The 1996 total insurance after-tax loss of $135 was charged to reserves
established for this purpose and, therefore, did not impact our earnings.
The net assets at December 31, 1996, 1995 and 1994 of the Insurance
businesses included in our consolidated balance sheets as discontinued
operations are summarized as follow:
1996 1995 1994
- --------------------------------------------------------------------------------
Insurance Assets
Investments $ 7,889 $ 7,871 $ 8,384
Reinsurance recoverable 2,458 2,616 3,063
Premiums and other receivables 1,082 1,191 1,276
Deferred taxes and other assets 1,201 1,450 1,743
- --------------------------------------------------------------------------------
Total Insurance assets $12,630 $13,128 $14,466
- --------------------------------------------------------------------------------
Insurance Liabilities
Unpaid losses and loss expenses $ 8,572 $ 8,761 $ 8,809
Unearned income 812 859 1,066
Notes payable 215 372 425
Other liabilities 1,185 1,458 954
- --------------------------------------------------------------------------------
Total Insurance liabilities 10,784 11,450 11,254
- --------------------------------------------------------------------------------
Investment in Insurance, net $ 1,846 $ 1,678 $ 3,212
================================================================================
53
At December 31,1996 and 1995, intercompany receivables aggregating
approximately $414 and $465, respectively, have been included as assets in
Investment in discontinued operations in the consolidated balance sheets. The
corresponding obligations are included in Deferred taxes and other liabilities
in the consolidated balance sheets and represent funding commitments by XFSI
guaranteed by us. Substantially all of these funding commitments will be paid at
the time the remaining Talegen and TRG sales are completed.
The Investments caption consists mainly of short-term investments as shown
below. At December 31, 1996, approximately 96 percent of the fixed maturity
investments are investment grade securities. The amortized cost and fair value
of the investment portfolio at December 31, 1996 follow:
Amortized Fair
Cost Value
- --------------------------------------------------------------------------------
Fixed maturities $3,097 $3,121
Equity securities 2 3
Short-term investments 4,765 4,765
- --------------------------------------------------------------------------------
Total investments $7,864 $7,889
================================================================================
Activity related to unpaid losses and loss expenses for the three years ended
December 31, 1996 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Unpaid Losses and Loss Expenses
Gross unpaid losses and loss
expenses, January 1 $ 8,761 $ 8,809 $ 9,684
Reinsurance recoverable 2,290 2,391 2,935
- -------------------------------------------------------------------------------
Net unpaid losses and loss
expenses, January 1 6,471 6,418 6,749
- -------------------------------------------------------------------------------
Incurred related to:
Current year accident losses 1,364 1,461 1,748
Prior year accident losses 303 570 21
- -------------------------------------------------------------------------------
Total incurred 1,667 2,031 1,769
- -------------------------------------------------------------------------------
Paid related to:
Current year accident losses 407 427 486
Prior year accident losses 1,215 1,203 1,577
- -------------------------------------------------------------------------------
Total paid 1,622 1,630 2,063
- -------------------------------------------------------------------------------
Sale of CRC and Viking -- (769) --
- -------------------------------------------------------------------------------
Other adjustments (189) 421 (37)
- -------------------------------------------------------------------------------
Net unpaid losses and loss
expenses, December 31 6,327 6,471 6,418
Reinsurance recoverable 2,245 2,290 2,391
- -------------------------------------------------------------------------------
Gross unpaid losses and loss
expenses, December 31 $ 8,572 $ 8,761 $ 8,809
===============================================================================
The increase in 1995 incurred prior year accident losses compared to prior years
relates to reserve strengthening including the recording of Ridge Re aggregate
excess loss reserves.
Other Financial Services. In 1995, we completed the sale of Xerox Financial
Services Life Insurance Company (Xerox Life) for approximately $104 before
settlement costs and capital funding of OakRe Life Insurance Company (OakRe), a
single-purpose XFSI subsidiary formed in 1994. OakRe assumed responsibility for
the Single Premium Deferred Annuity (SPDA) policies issued by Xerox Life's
Missouri and California companies via coinsurance agreements. As a result of
these coinsurance agreements, at December 31, 1996 and 1995, we have retained on
our consolidated balance sheet approximately $2.0 and $2.5 billion, respectively
of investment portfolio assets and reinsurance reserves related to Xerox Life's
former SPDA policies. These amounts will decrease through the year 2000 as the
SPDA policies are either terminated by the policyholder or renewed and
transferred to the buyer.
In connection with the aforementioned sale, XFSI established a $500 letter
of credit and line of credit with a group of banks to support OakRe's
coinsurance obligations. This letter of credit expires in 2000 and it is unused
and available at December 31, 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.
54
Third-Party Financing and Real-Estate. During the last six years, we made
substantial progress in disengaging from the Third-Party Financing and
Real-Estate businesses that were discontinued in 1990. During the three years
ended December 31, 1996, we received net cash proceeds of $359 ($36 in 1996, $64
in 1995 and $259 in 1994) from the sale of individual assets and from run-off
collection activities. The amounts received were consistent with our estimates
in the disposal plan and were used primarily to retire debt.
The remaining assets primarily represent direct financing leases, many with
long-duration contractual maturities and unique tax attributes. Accordingly, we
expect that the wind-down of the portfolio will be slower during 1997 and in
future years, as it was in 1995 and 1996, compared with prior years.
Total Discontinued Operations. The consolidated financial statements present the
Insurance, Other Financial Services and Third-Party Financing and Real-Estate
businesses as discontinued operations. Debt has been assigned to discontinued
operations based on historical levels assigned to the businesses when they were
continuing operations adjusted for subsequent paydowns. Interest expense thereon
is primarily determined based on our annual average domestic borrowing costs.
Assigned interest expense for the discontinued businesses for the years ended
December 31, 1996, 1995 and 1994 was $226, $255 and $246, respectively.
Summarized information of discontinued operations for the three years ended
December 31, 1996 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Summary of Operations
Income (loss) before income taxes $ -- $(1,025) $ (44)
Income tax benefits -- 357 44
(Loss) on disposal -- (978) --
- -------------------------------------------------------------------------------
Net income (loss) $ -- $(1,646) $ --
===============================================================================
Balance Sheet Data
Assets
- ------
Insurance
Investment, net $ 1,846 $ 1,678 $ 3,212
- -------------------------------------------------------------------------------
Other Financial Services
Investments 1,991 2,508 3,604
Other assets, net 111 135 541
- -------------------------------------------------------------------------------
OFS assets 2,102 2,643 4,145
- -------------------------------------------------------------------------------
Third-Party Financing and
Real-Estate
Gross finance receivables 401 472 538
Unearned income and other 49 17 9
- -------------------------------------------------------------------------------
Investment, net 450 489 547
- --------------------------------------------------------------------------------
Investment in
discontinued operations $ 4,398 $ 4,810 $ 7,904
- -------------------------------------------------------------------------------
Liabilities
- -----------
OFS policyholders' deposits $ 1,998 $ 2,528 $ 3,576
Other OFS liabilities 3 1 337
Assigned debt 273 281 281
- -------------------------------------------------------------------------------
Discontinued operations liabilities $ 2,274 $ 2,810 $ 4,194
===============================================================================
At December 31, 1996 and 1995, approximately $2.5 billion and $2.3 billion,
respectively, of third-party indebtedness assigned to the Insurance operations
is included in the consolidated balance sheet caption Long-term debt.
Our net investment in discontinued operations is approximately $2,124 and
$2,000 at December 31, 1996 and 1995, respectively. Based on current estimates,
we believe that the proceeds received from disposal of the remaining net
discontinued assets will be consistent with our net carrying value of these
businesses.
55
11 Debt
Short-Term Debt. Short-term borrowings data at December 31, 1996 and 1995
follow:
Weighted average
interest rates at
December 31, 1996 1996 1995
- --------------------------------------------------------------------------------
Bank notes payable 6.92% $ 762 $ 893
Foreign commercial paper 4.88 864 --
- --------------------------------------------------------------------------------
Total short-term debt 1,626 893
Current maturities of
long-term debt 1,910 2,381
- --------------------------------------------------------------------------------
Total $3,536 $3,274
================================================================================
Bank notes payable generally represent foreign currency denominated borrowings
of non-U.S. subsidiaries.
Long-Term Debt. A summary of long-term debt, by final maturity date, at December
31, 1996 and 1995 follow:
Weighted average
interest rates at
December 31, 1996 1996 1995
- --------------------------------------------------------------------------------
U.S. Operations:
Xerox Corporation (parent company)
Guaranteed ESOP notes
due 1999-2004 7.63% $ 494 $ 547
Notes due 1996 -- -- 420
Notes due 1997 8.97 275 200
Notes due 1999 5.35 454 484
Notes due 2000 7.33 600 600
Notes due 2001 6.85 212 62
Notes due 2002 8.00 225 200
Notes due 2004 7.15 200 200
Notes due 2005 -- -- 50
Notes due 2006 7.13 50 --
Notes due 2007 7.38 25 25
Notes due 2011 7.94 205 --
Notes due 2016 7.20 250 --
Notes due 2026 6.25 350 --
Other debt due 1996-2014 7.05 128 97
Capital lease obligations 6.85 4 5
- --------------------------------------------------------------------------------
Subtotal 3,472 2,890
- --------------------------------------------------------------------------------
Xerox Credit Corporation
Notes due 1996 -- -- 850
Notes due 1997 6.48 877 677
Notes due 1998 5.93 420 220
Notes due 1999 8.25 300 150
Notes due 2000 6.40 153 303
Notes due 2001 6.78 100 --
Notes due 2011 7.68 200 --
Floating rate notes due 2048 5.80 65 61
Other debt due 1997 10.00 9 18
- --------------------------------------------------------------------------------
Subtotal 2,124 2,279
- --------------------------------------------------------------------------------
XFSI Notes due 1996 -- -- 135
- --------------------------------------------------------------------------------
Total U.S. operations $5,596 $5,304
- --------------------------------------------------------------------------------
Weighted average
interest rates at
December 31, 1996 1996 1995
- --------------------------------------------------------------------------------
International Operations:
Various obligations, payable in:
Canadian dollars due 1996-2007 10.83% $ 192 $ 263
Dutch guilders due 1996-2000 5.33 108 216
French francs due 1996-1999 5.73 47 76
German marks due 1996-1999 6.47 146 280
Pounds sterling due 1996-2003 8.31 257 283
Swiss francs due 1996-2000 3.80 57 81
Italian lira due 1996-1998 8.70 113 99
U.S. dollars due 1996-1999 6.09 133 268
Other currencies due 1996-2001 6.70 274 363
Capital lease obligations -- -- 9
- --------------------------------------------------------------------------------
Total international operations 1,327 1,938
- --------------------------------------------------------------------------------
Other borrowings deemed
long-term 3,684 3,287
- --------------------------------------------------------------------------------
Subtotal 10,607 10,529
Less current maturities 1,910 2,381
- --------------------------------------------------------------------------------
Total long-term debt $ 8,697 $ 8,148
================================================================================
Consolidated Long-Term Debt Maturities. Payments due on long-term debt for the
next five years follow:
1997 1998 1999 2000 2001 Thereafter
- --------------------------------------------------------------------------------
$1,910 $803 $924 $873 $416 $1,997
================================================================================
These payments do not include amounts relating to domestic commercial paper and
foreign bank notes payable which have been classified as long-term debt under
the caption Other borrowings deemed long-term. These borrowings are classified
as long-term because we have the intent to refinance them on a long-term basis,
and the ability to do so under our revolving credit agreement.
Certain of our debt agreements allow us to redeem outstanding debt prior to
scheduled maturity. Outstanding debt issues with these call features are
classified in the preceding five-year maturity table in accordance with
management's current expectations. The actual decision as to early redemption
will be made at the time the early redemption option becomes exercisable and
will be based on prevailing economic and business conditions.
Lines of Credit. Our domestic operations have a revolving credit agreement
totaling $5.0 billion with a group of banks, which expires in 2000. This
agreement is unused and is available to back commercial paper borrowings of our
domestic operations, which amounted to $3.1 billion and $2.8 billion at December
31, 1996 and 1995, respectively. In addition, our foreign subsidiaries had
unused committed long-term lines of credit used to back short-term indebtedness
that aggregate $2.1 billion in various currencies at prevailing interest rates.
56
Match Funding of Finance Receivables and Indebtedness. We employ a match
funding policy for customer financing assets and related liabilities. Under this
policy, which is more fully discussed in the accompanying Financial Review on
Page 41, the interest and currency characteristics of the indebtedness are, in
most cases, matched to the interest and currency characteristics of the finance
receivables. At December 31, 1996, these operations had approximately $11.6
billion of net finance receivables, which will service approximately $9.5
billion of assigned short- and long-term debt, including $0.2 billion of debt
assigned to discontinued third-party financing businesses.
Guarantees. At December 31, 1996, we have guaranteed the borrowings of our ESOP
and $1,309 of indebtedness of our foreign subsidiaries.
Interest. Interest paid by us on our short- and long-term debt, including
amounts relating to debt assigned to discontinued operations, amounted to $871,
$817 and $751, respectively, for the years ended December 31, 1996, 1995 and
1994.
Total Short- and Long-Term Debt. Our total indebtedness, excluding the direct
indebtedness of Talegen, at December 31, 1996 and 1995 is reflected in the
consolidated balance sheet captions as follows:
1996 1995
- --------------------------------------------------------------------------------
Short-term debt and current portion
of long-term debt $ 3,536 $ 3,274
Long-term debt 8,424 7,867
Discontinued operations liabilities-
policyholders' deposits and other 273 281
- --------------------------------------------------------------------------------
Total debt $12,233 $11,422
================================================================================
A summary of changes in consolidated indebtedness for the three years ended
December 31, 1996 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Increase (decrease) in short-term
debt, net $ 989 $ 94 $ (146)
Proceeds from long-term debt 2,998 3,169 2,058
Principal payments on
long-term debt (2,989) (2,497) (1,555)
- -------------------------------------------------------------------------------
Subtotal 998 766 357
Less discontinued operations 8 -- (193)
- -------------------------------------------------------------------------------
Total change in debt of
continuing operations $ 990 $ 766 $ 550
===============================================================================
12 Financial Instruments
Derivative Financial Instruments. Certain financial instruments with
off-balance-sheet risk have been entered into by us to manage our interest rate
and foreign currency exposures. These instruments are held solely for hedging
purposes and include interest rate swap agreements, forward exchange contracts
and foreign currency swap agreements. We do not enter into derivative instrument
transactions for trading or other speculative purposes.
We typically enter into simple, unleveraged derivative transactions which,
by their nature, have low credit and market risk. Our policies on the use of
derivative instruments prescribe an investment grade counterparty credit floor
and at least quarterly monitoring of market risk on a counterparty-by-
counterparty basis. We utilize numerous counterparties to ensure that there are
no significant concentrations of credit risk with any individual counterparty or
groups of counterparties. Based upon our ongoing evaluation of the replacement
cost of our derivative transactions and counterparty creditworthiness, we
consider the risk of credit default significantly affecting our financial
position or results of operations to be remote.
We employ the use of hedges to reduce the risks that rapidly changing
market conditions may have on the underlying transactions. Typically, our
currency and interest rate hedging activities are not affected by changes in
market conditions as forward contracts and swaps are arranged and normally held
to maturity in order to lock in currency rates and interest rate spreads related
to underlying transactions.
None of our hedging activities involve exchange traded instruments.
Interest Rate Swaps. We enter into interest rate swap agreements to manage
interest rate exposure. An interest rate swap is an agreement to exchange
interest rate payment streams based on a notional principal amount. We follow
settlement accounting principles for interest rate swaps whereby the net
interest rate differentials to be paid or received are recorded currently as
adjustments to interest expense.
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
57
underlying assets. Additionally, customer financing assets are consistently
funded with liabilities denominated in the same currency. We refer to the
effects of these conservative practices as "match funding" our customer
financing 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 does effectively eliminate 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. During 1996, two such agreements were cancelled in
connection with the early retirement of two medium-term notes. The transactions
performed within each of these three categories enable the cost-effective
management of interest rate exposures. During 1996, the average notional amount
of an interest rate swap agreement was $32.
At December 31, 1996 and 1995, the total notional amounts of these
transactions, based on contract maturity, follow:
1996 1995
- --------------------------------------------------------------------------------
Commercial paper/bank borrowings $1,822 $1,784
Medium-term debt 4,000 3,906
Long-term debt 3,444 1,394
- --------------------------------------------------------------------------------
Total $9,266 $7,084
================================================================================
For the three years ended December 31, 1996, no pay fixed/receive variable
interest rate swap agreements were terminated prior to maturity.
The aggregate notional amounts of interest rate swaps by maturity date and type
at December 31, 1996 and 1995 follow:
1996 1997 1998-2000 2001-2016 Total
- ------------------------------------------------------------------------------------------------------------------------------------
1996 Pay fixed/receive variable $ -- $1,224 $3,117 $1,750 $6,091
Pay variable/receive variable -- 455 373 37 865
Pay variable/receive fixed -- 143 510 1,657 2,310
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ -- $1,822 $4,000 $3,444 $9,266
- ------------------------------------------------------------------------------------------------------------------------------------
Memo:
Interest rate paid -- 6.21% 6.73% 5.98% 6.35%
Interest rate received -- 5.90% 5.72% 6.49% 6.04%
====================================================================================================================================
1995 Pay fixed/receive variable $1,466 $1,339 $2,196 $ -- $5,001
Pay variable/receive variable 150 505 323 70 1,048
Pay variable/receive fixed 168 37 150 680 1,035
- ------------------------------------------------------------------------------------------------------------------------------------
Total $1,784 $1,881 $2,669 $ 750 $7,084
- ------------------------------------------------------------------------------------------------------------------------------------
Memo:
Interest rate paid 6.61% 6.39% 7.19% 6.44% 6.75%
Interest rate received 6.69% 6.00% 5.99% 7.74% 6.35%
====================================================================================================================================
Forward Exchange Contracts. We utilize forward exchange contracts to hedge
against the potentially adverse impacts of foreign currency fluctuations on
foreign currency denominated receivables and payables; firm foreign currency
commitments; and investments in foreign operations. Firm foreign currency
commitments generally represent committed purchase orders for foreign sourced
inventory. These contracts generally mature in six months or less. At December
31, 1996 and 1995, we had outstanding forward exchange contracts of $2,259 and
$1,474, respectively. Of the outstanding contracts at December 31, 1996, the
largest single currency represented was the Japanese yen. Contracts denominated
in Japanese yen, Brazilian reais, U.S.
58
dollars, French francs, Italian lira and Swiss francs accounted for over 75
percent of our forward exchange contracts. On contracts that hedge foreign
currency denominated receivables and payables, gains or losses are reported
currently in income and premiums or discounts are amortized to income and
included in Other, net in the consolidated statements of income. Gains or
losses, as well as premiums or discounts, on contracts that hedge firm
commitments are deferred and subsequently recognized as part of the underlying
transaction. At December 31, 1996, we had a net deferred loss of $26. Gains or
losses on contracts that hedge an investment in a foreign operation are reported
currently in the balance sheet as a component of cumulative translation
adjustments. The premium or discount on contracts that hedge an investment in a
foreign operation are amortized to income and included in Other, net in the
consolidated statements of income. During 1996, the average notional amount of a
forward exchange contract amounted to $8.
Foreign Currency Swap Agreements. During 1996, we entered into cross currency
interest rate swap agreements, whereby we issued foreign currency denominated
debt and swapped the proceeds with a counterparty. In return, we received and
effectively denominated the debt in local currencies. Currency swaps are
utilized as hedges of the underlying foreign currency borrowings, and exchange
gains or losses are recognized currently in Other, net in the consolidated
statements of income. At December 31, 1996, cross currency interest rate swap
agreements with an aggregate notional amount of $511 remained outstanding.
Fair Value of Financial Instruments. The estimated fair values of our financial
instruments at December 31, 1996 and 1995 follow:
1996 1995
------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------
Cash $ 104 $ 104 $ 136 $ 136
Accounts receivable, net 2,022 2,022 1,914 1,914
Short-term debt 1,626 1,626 893 893
Long-term debt 10,607 10,766 10,529 10,864
Interest rate and currency
swap agreements -- (61) -- (73)
Forward exchange
contracts -- 19 -- (29)
===============================================================================
The fair value amounts for Cash, Accounts receivable, net and Short-term debt
approximate carrying amounts due to the short maturities of these instruments.
The fair value of Long-term debt was estimated based on quoted market
prices for these or similar issues or on the current rates offered to us for
debt of the same remaining maturities. The difference between the fair value and
the carrying value represents the theoretical net premium we would have to pay
to retire all debt at such date. We have no plans to retire significant portions
of our long-term debt prior to scheduled maturity. We are not required to
determine the fair value of our finance receivables, the match funding of which
is the source of much of our interest rate swap activity.
The fair values for interest rate and cross currency swap agreements and
forward exchange contracts were calculated by us based on market conditions at
year-end and supplemented with quotes from brokers. They represent amounts we
would receive (pay) to terminate/replace these contracts. We have no present
plans to terminate/replace significant portions of these contracts.
13 Employee Benefit Plans
Retirement Income Guarantee Plan (RIGP). Approximately 51,000 salaried and union
employees participate in the RIGP plans. The RIGP plans are defined benefit
plans, which provide employees with the greater of (i) the benefit calculated
under a highest average pay and years of service formula, (ii) the benefit
calculated under a formula that provides for the accumulation of salary and
interest credits during an employee's work life, or (iii) the individual account
balance from our prior defined contribution plan (Transitional Retirement
Accounts or TRA).
At December 31, 1996, these domestic plans accounted for approximately 64
percent of our total pension assets and were invested as follows: domestic and
international equity securities - 71 percent; fixed-income investments - 27
percent; and real estate - 2 percent. No plan assets are invested in our stock.
The RIGP plans are in compliance with the minimum funding standards of the
Employee Retirement Income Security Act of 1974 (ERISA).
The transition asset and prior service cost are amortized over 15 years.
Pension costs are determined using assumptions as of the beginning of the year
while the funded status
59
is determined using assumptions as of the end of the year. The assumptions used
in the accounting for the U.S. defined benefit plans follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Assumed discount rates 7.75% 7.25% 8.75%
Assumed rates for compensation
increases 4.50 4.25 5.75
Expected return on plan assets 9.50 9.50 9.50
===============================================================================
Our discount rate considers, among other items, the aggregate effects of a
relatively young work force and, because pension benefits are settled at
retirement, the absence of retirees receiving pension benefits from plan assets.
Accordingly, the duration of our pension obligation tends to be relatively
longer in comparison to other companies. Changes in the assumed discount rates
and rates of compensation increases primarily reflect changes in the underlying
rates of long-term inflation.
Other Plans. We maintain various supplemental executive retirement plans (SERPs)
that are not tax-qualified and are unfunded.
We sponsor numerous pension plans for our international operating units in
Europe, Canada and Latin America, which generally provide pay- and
service-related benefits. Plan benefits are provided through a combination of
funded trusteed arrangements or through book reserves. The Rank Xerox pension
plan in the United Kingdom is the largest international plan and accounted for
approximately 24 percent of our total pension assets at December 31, 1996. It is
primarily invested in marketable equity securities.
Financial Information. Our disclosures about the funded status and components of
pension cost are in accordance with U.S. accounting principles. Such principles
recognize the long-term nature of pension plan obligations and the need to make
assumptions about events many years into the future. In any year there may be
significant differences between a plan's actual experience and its actuarially
assumed experience. Such differences are deferred and do not generally affect
current net pension cost. The objective of deferring such differences is to
allow actuarial gains and losses an opportunity to offset over time. These
deferrals are included in the captions Unrecognized net gain (loss) and Net
amortization and deferrals in the accompanying tables. Due to variations in
investment results, the effect of revising actuarial assumptions, and actual
plan experience which differs from assumed experience, certain of our plans may
be classified as overfunded in one year and underfunded in another year. Under
ERISA and other laws, the excess assets of overfunded plans are not available to
fund deficits in other plans.
The non-funded plans are the SERPs and the Rank Xerox pension plans in
Germany and Austria. For tax reasons, these plans are most efficiently and
customarily funded on a pay-as-you-go basis.
A reconciliation of the funded status of our retirement plans to the amounts
accrued in our consolidated balance sheets at December 31, 1996 and 1995 follow:
1996 1995
---------------------------------- ---------------------------------------
Over- Under- Non- Over- Under- Non-
funded funded funded Total funded funded funded Total
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation $5,549 $ 70 $ 252 $5,871 $5,066 $ 41 $ 240 $ 5,347
Effect of projected compensation increases 471 51 48 570 440 37 53 530
- ------------------------------------------------------------------------------------------------------------------------------------
Projected benefit obligation (PBO) 6,020 121 300 6,441 5,506 78 293 5,877
Plan assets at fair value 6,706 65 -- 6,771 5,830 38 -- 5,868
- ------------------------------------------------------------------------------------------------------------------------------------
Excess (deficit) of plan assets over PBO 686 (56) (300) 330 324 (40) (293) (9)
Items not yet reflected in the financial statements:
Unamortized transition obligations (assets) (116) 17 10 (89) (137) 19 12 (106)
Unrecognized prior service cost 40 -- (9) 31 48 -- (12) 36
Unrecognized net (gain) loss (268) 30 29 (209) 49 (14) 31 66
- ------------------------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) pension cost recognized
in the consolidated balance sheets at
December 31 $ 342 $ (9) $(270) $ 63 $ 284 $ (35) $ (262) $ (13)
====================================================================================================================================
60
The components of pension cost for the three years ended December 31, 1996
follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Defined benefit plans
Service cost $ 164 $ 143 $ 150
- -------------------------------------------------------------------------------
Interest cost - change in PBO due to:
Passage of time 201 186 171
Net investment income (loss)
allocated to TRA accounts 586 624 (45)
- -------------------------------------------------------------------------------
Subtotal 787 810 126
- -------------------------------------------------------------------------------
Net investment (income) loss on:
TRA assets (586) (624) 45
Other plan assets (417) (372) (96)
- -------------------------------------------------------------------------------
Subtotal (1,003) (996) (51)
- -------------------------------------------------------------------------------
Net amortization and deferrals 150 120 (144)
- -------------------------------------------------------------------------------
Settlement ad curtailment gains (7) (32) (12)
- -------------------------------------------------------------------------------
Defined benefit plans
- net pension cost 91 45 69
Defined contribution plans
- pension cost 17 13 13
- -------------------------------------------------------------------------------
Total pension cost $ 108 $ 58 $ 82
===============================================================================
Plan assets consist of both defined benefit plan assets and assets legally
allocated to the TRA accounts. The combined investment results of the assets are
shown above in the Net investment income caption. To the extent investment
results relate to TRA, such results are credited to these accounts as a
component of interest cost. The TRA account assets were $4.0 billion and $3.4
billion at December 31, 1996 and 1995, respectively. Our pension plans' funding
surplus tends to be less than that of comparable companies because a substantial
portion of plan assets are TRA-related and are equal to TRA-related liabilities.
Other Postretirement Benefits. The primary plan for U.S. salaried employees
retiring on or after January 1, 1995, provides retirees an annual allowance that
can be used to purchase medical and other benefits. The allowance available to
each eligible employee is partially service related and, for financial
accounting purposes, is projected to increase at an annual rate of 7.5 percent
until it reaches the plan's annual maximum coverage of approximately 2 times the
1995 level, the transition date to the new plan.
We also have other postretirement benefit plans that cover employees who
retired prior to January 1, 1995 and certain grandfathered employees. These
other plans are generally indemnity arrangements that provide varying levels of
benefit coverage. The medical inflation assumption for these plans is 8.0
percent in 1996 and declines to 5.25 percent in 2002 and thereafter. A one
percentage point increase in the medical inflation assumptions would increase
the service and interest cost for these plans by $4 and the accumulated
postretirement benefit obligation by $53.
The discount rate used to determine the funded status was 7.75 percent,
7.25 percent and 8.75 percent at December 31, 1996, 1995 and 1994, respectively.
A reconciliation of the financial status of the plans as of December 31
follows:
1996 1995 1994
- --------------------------------------------------------------------------------
Accumulated Postretirement
Benefit Obligation:
Retirees $ 501 $ 506 $ 470
Fully eligible employees 183 251 205
Other employees 208 219 247
- --------------------------------------------------------------------------------
Total 892 976 922
Unrecognized net gain 158 42 84
- --------------------------------------------------------------------------------
Accrued cost recognized in the
consolidated balance sheets $1,050 $1,018 $1,006
================================================================================
The components of postretirement benefit cost for the three years ended December
31, 1996 follow:
1996 1995 1994
- -------------------------------------------------------------------------------
Service cost $ 26 $ 19 $ 27
Interest cost 63 70 66
Net amortization (1) (4) --
Settlement gain -- (8) (25)
- -------------------------------------------------------------------------------
Total $ 88 $ 77 $ 68
===============================================================================
These plans are most efficiently and customarily funded on a pay-as-you-go
basis.
Employee Stock Ownership Plan (ESOP) Benefits. In 1989, we established an ESOP
and sold to it 10 million shares of Series B Convertible Preferred Stock
(Convertible Preferred) of the Company for a purchase price of $785. Each ESOP
share is convertible into 3 common shares of the Company. The Convertible
Preferred has a $1 par value, a guaranteed minimum value of $78.25 per share and
accrues annual dividends of $6.25 per share. The ESOP borrowed the purchase
price from a group of lenders. The ESOP debt is included in our consolidated
balance sheets because we guarantee the ESOP borrowings. A corresponding amount
classified as Deferred ESOP benefits represents our commitment to future
compensation expense related to the ESOP benefits.
61
The ESOP will repay its borrowings from dividends on the Convertible
Preferred and from our contributions. The ESOP's debt service is structured such
that our annual contributions (in excess of dividends) essentially correspond to
a specified level percentage of participant compensation. As the borrowings are
repaid, the Convertible Preferred is allocated to ESOP participants and Deferred
ESOP benefits are reduced by principal payments on the borrowings. Most of our
domestic employees are eligible to participate in the ESOP.
Information relating to the ESOP for the three years ended December 31,
1996 follows:
1996 1995 1994
- --------------------------------------------------------------------------------
Interest on ESOP Borrowings $42 $45 $49
================================================================================
Dividends declared on Convertible
Preferred Stock $58 $59 $61
================================================================================
Cash contribution to the ESOP $36 $34 $32
================================================================================
Compensation expense $37 $35 $32
================================================================================
We recognize ESOP costs based on the amount committed to be contributed to the
ESOP plus related trustee, finance and other charges.
14 Income Taxes
The parent company and its domestic subsidiaries file consolidated U.S. income
tax returns. Generally, pursuant to tax allocation arrangements, domestic
subsidiaries record their tax provisions and make payments to the parent company
for taxes due or receive payments from the parent company for tax benefits
utilized.
Income before income taxes from continuing operations for the three years
ended December 31, 1996 consists of the following:
1996 1995 1994
- --------------------------------------------------------------------------------
Domestic income $ 781 $ 747 $ 713
Foreign income 1,163 1,102 801
- --------------------------------------------------------------------------------
Income before income taxes $1,944 $1,849 $1,514
================================================================================
Provisions for income taxes from continuing operations for the three years
ended December 31, 1996 consist of the following:
1996 1995 1994
- --------------------------------------------------------------------------------
Federal income taxes
Current $ 210 $ 285 $ 160
Deferred 50 (21) 100
Foreign income taxes
Current 205 178 88
Deferred 166 110 182
State income taxes
Current 62 57 46
Deferred 7 6 19
- --------------------------------------------------------------------------------
Income taxes $ 700 $ 615 $ 595
================================================================================
A reconciliation of the U.S. Federal statutory income tax rate to the effective
income tax rate for continuing operations for the three years ended December 31,
1996 follow:
1996 1995 1994
- ------------------------------------------------------------------------------
U.S. Federal statutory income
tax rate 35.0% 35.0% 35.0%
Foreign earnings and dividends
taxed at different rates .5 2.2 2.1
Goodwill amortization .3 .3 --
Tax-exempt income (.5) (.6) (.7)
Effect of tax rate changes on
deferred tax assets and liabilities -- (5.3) --
State taxes 2.3 2.2 2.7
Change in valuation allowance
for deferred tax assets (1.0) (.8) --
Other (.6) .3 .2
- ------------------------------------------------------------------------------
Effective income tax rate 36.0% 33.3% 39.3%
==============================================================================
The 1996 effective tax rate of 36.0 percent is 2.7 percentage points higher than
1995. After excluding the 1995 Brazilian deferred tax benefit, the 1996
effective tax rate is 2.6 percentage points lower than 1995. This lower
effective tax rate is primarily due to the lower statutory tax rate in Brazil
and the mix of profits from our worldwide operations.
The 1995 effective tax rate of 33.3 percent is 6 percentage points lower
than the 1994 rate. This lower 1995 rate is primarily caused by a decrease in
Brazilian corporate tax rates, which created a deferred tax benefit. This
benefit increased 1995 fourth quarter and full year net income by $98. Excluding
the Brazilian tax benefit, the 1995 effective tax rate was 38.6 percent.
On a consolidated basis, including the effects of discontinued operations,
we paid a total of $252, $182 and $163 in income taxes to federal, foreign and
state income-taxing authorities in 1996, 1995 and 1994, respectively.
62
Total income tax expense (benefit) for the three years ended December 31,
1996 was allocated as follows:
1996 1995 1994
- -------------------------------------------------------------------------------
Income from continuing operations $ 700 $ 615 $ 595
Discontinued operations (84) (374) (135)
Common shareholders' equity* (15) (15) (19)
- -------------------------------------------------------------------------------
Total $ 601 $ 226 $ 441
===============================================================================
* For dividends paid on shares held by the ESOP; cumulative translation adjust-
ments; tax benefit on non-qualified stock options; and unrealized gains and
losses on investment securities.
Deferred income taxes have not been provided on the undistributed earnings of
foreign subsidiaries and other foreign investments carried at equity. The amount
of such earnings included in consolidated retained earnings at December 31, 1996
was approximately $3.9 billion. These earnings have been substantially
reinvested and we do not plan to initiate any action that would precipitate the
payment of income taxes thereon. It is not practicable to estimate the amount of
additional tax that might be payable on the foreign earnings.
The tax effects of temporary differences that give rise to significant
portions of the eferred taxes at December 31, 1996 and 1995 follow:
1996 1995
- -------------------------------------------------------------------------------
Tax effect of future tax deductions:
Depreciation $ 397 $ 537
Postretirement medical benefits 405 393
Restructuring reserves 70 194
Other operating reserves 296 337
Deferred intercompany profit 83 109
Allowance for doubtful accounts 69 73
Deferred compensation 138 132
Tax credit carryforwards 122 101
Research and development 158 87
Other 108 75
- -------------------------------------------------------------------------------
Subtotal 1,846 2,038
Less valuation allowance -- 20
- -------------------------------------------------------------------------------
Total $ 1,846 $ 2,018
===============================================================================
Tax effect of future taxable income:
Installment sales and leases $(1,287) $(1,309)
Leverage leases (31) (35)
Deferred income (205) (146)
Other (163) (189)
- -------------------------------------------------------------------------------
Total $(1,686) $(1,679)
===============================================================================
The above amounts are classified as current or long-term in the consolidated
balance sheets in accordance with the asset or liability to which they relate.
Current deferred tax assets at December 31, 1996, 1995 and 1994 amounted to
$473, $608 and $709, respectively.
We conclude 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.
At December 31, 1996, we have tax credit carryforwards for federal income
tax purposes of $29 available to offset future federal income taxes through 2000
and $93 available to offset future federal income taxes indefinitely.
15 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 for high volume copiers and printers to plaintiffs prior
to 1994. 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. In their complaint plaintiffs allege monetary
damages in the form of lost profits in excess of $10 million (to be trebled) and
injunctive relief. In a report prepared, pursuant to Rule 26(a)2)B)of the
Federal Rules of Civil Procedure, an accountant retained by plaintiffs as an
expert indicated that he plans to testify at trial that, allegedly as a result
of Xerox' conduct, plaintiffs have lost profits of approximately $137 million.
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 March 31, 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 had no
material effect on the Company.
63
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.
16 Preferred Stock
We have 22 million authorized shares of cumulative preferred stock, $1 par
value. Outstanding preferred stock at December 31, 1996 and 1995 follow (shares
in thousands):
1996 1995
------------------ ------------------
Shares Amount Shares Amount
- --------------------------------------------------------------------------------
Redeemable
Preferred Stock -- -- 500 $ 25
Convertible
Preferred Stock 9,212 $ 721 9,435 738
- --------------------------------------------------------------------------------
Total 9,212 $ 721 9,935 $ 763
================================================================================
Redeemable Preferred Stock. During 1996, we redeemed the remaining 500,000
outstanding shares of our series of Ten-Year Preferred Stock at the sinking fund
redemption price of $50 per share. Dividends amounted to $0, $3 and $7 in 1996,
1995 and 1994, respectively.
Our former series of Twenty-Year Preferred Stock was redeemed in 1994 for
$184, including a premium of $11. Dividends amounted to $5 in 1994.
Convertible Preferred Stock. As more fully described in Note 13 on Page 61, we
sold, for $785, 10 million shares of our Series B Convertible Preferred Stock
(ESOP shares) in 1989 in connection with the establishment of our ESOP. As
employees with vested ESOP shares leave the Company, these shares are redeemed
by us. We have the option to settle such redemptions with either shares of
common stock or cash.
Preferred Stock Purchase Rights. We have a shareholder rights plan designed to
deter coercive or unfair takeover tactics and to prevent a person or persons
from gaining control of us without offering a fair price to all shareholders.
Under the terms of the plan, one-third of a preferred stock purchase right
(Right) accompanies each share of outstanding common stock. Each Right entitles
the holder to purchase from us one one-hundredth of a new series of preferred
stock at an exercise price of $225.
Within the time limits and under the circumstances specified in the plan,
the Rights entitle the holder to acquire either our common stock, the surviving
company in a business combination, or the purchaser of our assets, having a
value of two times the exercise price.
The rights may be redeemed prior to becoming exercisable by action of the
Board of Directors at a redemption price of $.05 per Right. The rights expire in
April 1997.
The rights are non-voting and, until they become exercisable, have no
dilutive effect on the earnings per share or book value per share of our common
stock.
Deferred Preferred Stock. In October 1996, a subsidiary of ours issued 2 million
deferred preferred shares for Canadian (Cdn.) $50 million. The U.S. dollar value
was $37 million and is included in Minorities' interests in equity of
subsidiaries in the consolidated balance sheet. These shares are mandatorily
redeemable on February 28, 2006 for Cdn. $90 million. The difference between the
redemption amount and the proceeds from the issue is being amortized, through
the redemption date, to minorities' interests in earnings of subsidiaries in the
consolidated statement of income. We have guaranteed the redemption value.
64
17 Common Shareholders' Equity
The components of common shareholders' equity and the changes therein for the
three years ended December 31, 1996 follow:
Net
Unrealized
Gain
Common Stock Additional (Loss) on Treasury Stock
----------------- Paid-In Retained Investment Translation ---------------
(Shares in thousands) Shares Amount Capital Earnings Securities Adjustments Shares Amount Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1993 312,366 $ 318 $ 1,100 $ 2,793 $ 6 $ (245) -- $ -- $3,972
Stock option and incentive plans 3,168 3 76 (3) 76
Xerox Canada Inc.
exchangeable stock 1,959
Convertible securities 486 16 16
Net income 794 794
Cash dividends declared
Common stock
($1.00 per share) (322) (322)
Preferred stock
(See Note 16 on Page 64) (73) (73)
Tax benefits on ESOP dividends 19 19
Call premium on preferred stock
(See Note 16 on Page 64) (11) (11)
Net unrealized loss on
investment securities (439) (439)
Translation adjustments -
net of minority
shareholders' interests of $93 145 145
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 317,979 321 1,192 3,197 (433) (100) -- -- 4,177
Stock option and incentive plans 4,962 6 114 (11) 109
Xerox Canada Inc.
exchangeable stock 1,365
Convertible securities 723 28 28
Net loss (472) (472)
Net loss during stub period (21) (21)
Cash dividends declared
Common stock
($1.00 per share) (327) (327)
Preferred stock
(See Note 16 on Page 64) (62) (62)
Tax benefits on ESOP dividends 17 17
Net unrealized gain on
investment securities 432 432
Translation adjustments -
net of minority
shareholders' interests of $17 (3) (3)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 325,029 327 1,334 2,321 (1) (103) -- -- 3,878
Purchase of treasury stock (6,493) (306) (306)
Stock option and incentive plans 596 (23) (15) 2,428 122 84
Xerox Canada Inc.
exchangeable stock 103 1,347
Convertible securities 174 10 497 23 33
Net Income 1,206 1,206
Cash dividends declared
Common stock
($1.12 per share) (379) (379)
Preferred stock
(See Note 16 on Page 64) (59) (59)
Tax benefits on ESOP dividends 16 16
Translation adjustments -
net of minority
shareholders' interests of $(24) (138) (138)
Premiums from sale of put options 11 11
Tax benefits on stock options 21 21
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 325,902 $ 327 $ 1,353 $ 3,090 $ (1) $ (241) (2,221) $ (161) $4,367
====================================================================================================================================
65
Common Stock. We have 1.05 billion authorized shares of common stock, $1 par
value. At December 31, 1996 and 1995, 20.9 and 7.8 million shares, respectively,
were reserved for issuance under our incentive compensation plans. In addition,
at December 31, 1996, 2.6 million common shares were reserved for the conversion
of $53 of convertible debt and 27.6 million common shares were reserved for
conversion of ESOP-related Convertible Preferred Stock.
Treasury Stock. The Board of Directors has authorized us to repurchase up to $1
billion of our common stock. The stock will be repurchased from time to time on
the open market depending on market conditions. As of December 31, 1996, we have
repurchased 6.5 million shares for $306. Common shares issued for stock option
exercises, conversion of convertible securities, and other exchanges are
satisfied by reissuances of treasury shares.
Put Options. In connection with the share repurchase program, during 1996, we
sold 2.8 million put options that entitle the holder to sell one share of our
common stock to us at a specified price. These put options are exercisable only
at maturity and can be settled in cash at our option. The put options have
maturities ranging from six months to two years.
At December 31, 1996, 2.4 million put options remain outstanding with a
weighted average strike price of $49.90 per share.
Stock Option and Long-Term Incentive Plans. We have a long-term incentive plan
whereby eligible employees may be granted nonqualified stock options and
performance unit rights. Subject to vesting and other requirements, performance
unit rights are typically paid in cash, and stock options and rights are settled
with newly issued or treasury shares of our common stock. Stock options granted
prior to December 31, 1995 normally vest in two years and normally expire five
years from the date of grant. Stock options granted subsequent to December 31,
1995 vest in three years and will expire eight years from the date of grant. The
exercise price of the options is equal to the market value of our common stock
on the date of grant. The value of each performance unit is typically based upon
the level of return on assets during the year in which granted. Performance
units ratably vest in the three years after the year awarded.
During 1995, Xerox Canada Inc. established an executive rights plan, which
grants participants at the executive level rights to acquire our common stock at
the participants' option. The vesting, expiration, and exercise price of each
right are the same as stock options in our long-term incentive plan.
At December 31, 1996 and 1995, 7.7 and 11.0 million shares, respectively,
were available for grant of options or rights. The following table provides
information relating to the status of, and changes in, options granted:
1996 1995
------------------ ------------------
Average Average
Stock Option Stock Option
(Options in thousands) Options Price Options Price
- --------------------------------------------------------------------------------
Outstanding at January 1 10,794 $ 33 9,726 $ 28
Granted 3,688 43 5,508 37
Canceled (365) 38 (228) 34
Exercised (2,939) 31 (4,092) 26
Surrendered for SARs (75) 15 (120) 16
------ ------
Outstanding at December 31 11,103 37 10,794 33
====== ======
Exercisable at
December 31, 1996 4,444
================================================
Becoming exercisable in 1997 3,446
================================================
The weighted average remaining life of outstanding options at December 31, 1996
is 4.2 years.
66
We do not recognize compensation expense relating to employee stock options
because the exercise price of the option equals the fair value of the stock on
the date of grant. If we had determined the compensation based on the fair value
of the options on the date of grant in accordance with SFAS No. 123, the pro
forma net income and earnings per share would be as follows:
1996 1995
- --------------------------------------------------------------------------------
Net income (loss) - as reported $ 1,206 $ (472)
Net income (loss) - pro forma 1,189 (482)
Primary Earnings (loss) per share -
as reported 3.49 (1.56)
Primary Earnings (loss) per share -
pro forma 3.44 (1.59)
Fully Diluted Earnings (loss) per share -
as reported 3.31 (1.75)
Fully Diluted Earnings (loss) per share -
pro forma 3.26 (1.78)
================================================================================
The pro forma effect on net income for 1996 and 1995 is not representative of
the pro forma effect on net income in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
1995, nor does it consider the effect of the change in the vesting schedule for
the Company's nonqualified stock options.
As reflected in the table above, the fair value of each option granted in
1996 and 1995 was $10.50 and $7.18, respectively. The fair value of each option
granted was estimated on the date of grant using the modified Black-Scholes
option pricing model using the following weighted average assumptions:
1996 1995
- -------------------------------------------------------------------------------
Risk-free interest rate 5.7% 6.9%
Expected life in years 5.5 3.7
Expected volatility 22.0% 18.5%
Expected dividend yield 2.6% 2.7%
===============================================================================
18 Subsequent Event
In January 1997, a subsidiary of ours issued 650,000 shares of 8% Capital
Securities for net proceeds of $643. The proceeds were used to reduce parent
company commercial paper. The principal will be included in minorities' interest
in equity of subsidiaries and the dividends will be included in minorities'
interests in earnings of subsidiaries in the consolidated financial statements.
This stock is mandatorily redeemable on February 1, 2027 for $650 and pays
dividends semiannually at the rate of 8% per annum. The redemption value is
guaranteed by us.
67
Quarterly Results of Operations
(Unaudited)
First Second Third Fourth
(In millions, except per-share data) Quarter Quarter Quarter Quarter Full Year
================================================================
1996
Revenues $ 3,928 $ 4,217 $ 4,158 $ 5,075 $ 17,378
Costs and Expenses 3,544 3,758 3,775 4,357 15,434
----------------------------------------------------------------
Income before Income Taxes,
Equity Income and Minorities' Interests 384 459 383 718 1,944
Income Taxes 139 164 138 259 700
Equity in Net Income of Unconsolidated Affiliates 20 42 30 31 123
Minorities' Interests in Earnings of Subsidiaries 28 44 25 64 161
----------------------------------------------------------------
Income from Continuing Operations 237 293 250 426 1,206
Discontinued Operations -- -- -- -- --
----------------------------------------------------------------
Net Income $ 237 $ 293 $ 250 $ 426 $ 1,206
================================================================
Primary Earnings per Share
Continuing Operations $ 0.68 $ 0.85 $ 0.71 $ 1.25 $ 3.49
Discontinued Operations -- -- -- -- --
----------------------------------------------------------------
Primary Earnings per Share $ 0.68 $ 0.85 $ 0.71 $ 1.25 $ 3.49
================================================================
Fully Diluted Earnings per Share
Continuing Operations $ 0.65 $ 0.81 $ 0.68 $ 1.17 $ 3.31
Discontinued Operations -- -- -- -- --
----------------------------------------------------------------
Fully Diluted Earnings per Share $ 0.65 $ 0.81 $ 0.68 $ 1.17 $ 3.31
----------------------------------------------------------------
================================================================
1995
Revenues $ 3,767 $ 4,054 $ 4,012 $ 4,755 $ 16,588
Costs and Expenses 3,400 3,642 3,597 4,100 14,739
-------- -------- -------- -------- --------
Income before Income Taxes,
Equity Income and Minorities' Interests 367 412 415 655 1,849
Income Taxes 142 160 160 153 615
Equity in Net Income of Unconsolidated Affiliates 13 51 38 29 131
Minorities' Interests in Earnings of Subsidiaries 51 49 37 54 191
-------- -------- -------- -------- --------
Income from Continuing Operations 187 254 256 477 1,174
Discontinued Operations (40) (16) (20) (1,570) (1,646)
-------- -------- -------- -------- --------
Net Income (Loss) $ 147 $ 238 $ 236 $ (1,093) $ (472)
======== ======== ======== ======== ========
Primary Earnings (Loss) per Share
Continuing Operations $ 0.53 $ 0.74 $ 0.74 $ 1.39 $ 3.40
Discontinued Operations (.12) (.05) (.06) (4.73) (4.96)
-------- -------- -------- -------- --------
Primary Earnings per Share $ 0.41 $ 0.69 $ 0.68 $ (3.34) $ (1.56)
======== ======== ======== ======== ========
Fully Diluted Earnings (Loss) per Share1
Continuing Operations $ 0.51 $ 0.70 $ 0.70 $ 1.30 $ 3.21
Discontinued Operations (.11) (.05) (.05) (4.73) (4.96)
-------- -------- -------- -------- --------
Fully Diluted Earnings per Share $ 0.40 $ 0.65 $ 0.65 $ (3.43) $ (1.75)
======== ======== ======== ======== ========
================================================================
1 The fully diluted earnings per share differs from full year amounts because of
changes in the number of shares outstanding during the year.
68
Notes
Reports of Management and Independent Auditors
Report of Management
Xerox Corporation management is responsible for the integrity and objectivity of
the financial data presented in this annual report. The consolidated financial
statements were prepared in conformity with generally accepted accounting
principles and include amounts based on management's best estimates and
judgments.
The Company maintains an internal control structure designed to provide
reasonable assurance that assets are safeguarded against loss or unauthorized
use and that financial records are adequate and can be relied upon to produce
financial statements in accordance with generally accepted accounting
principles. This structure includes the hiring and training of qualified people,
written accounting and control policies and procedures, clearly drawn lines of
accountability and delegations of authority. In a business ethics policy that is
communicated annually to all employees, the Company has established its intent
to adhere to the highest standards of ethical conduct in all of its business
activities.
The Company monitors its internal control structure with direct management
reviews and a comprehensive program of internal audits. In addition, KPMG Peat
Marwick LLP, independent auditors, have audited the consolidated financial
statements and have reviewed the internal control structure to the extent they
considered necessary to support their report, which follows.
The Audit Committee of the Board of Directors, which is composed solely of
outside directors, meets regularly with the independent auditors, the internal
auditors and representatives of management to review audits, financial reporting
and internal control matters, as well as the nature and extent of the audit
effort. The Audit Committee also recommends the engagement of independent
auditors, subject to shareholder approval. The independent auditors and internal
auditors have free access to the Audit Committee.
/s/ Paul A. Allaire
Paul A. Allaire
Chairman of the Board and
Chief Executive Officer
/s/Barry D. Romeril
Barry D. Romeril
Executive Vice President and
Chief Financial Officer
Report of Independent Auditors
To the Board of Directors and Shareholders of
Xerox Corporation
We have audited the consolidated balance sheets of Xerox Corporation and
consolidated subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income and cash flows for each of the years in the
three-year period ended December 31, 1996. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements appearing on Pages
26, 35, 42 and 48-67 present fairly, in all material respects, the financial
position of Xerox Corporation and consolidated subsidiaries as of December 31,
1996 and 1995, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 1996, in conformity
with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Stamford, Connecticut
January 23, 1997
69
Eleven Years In Review
(Dollars in millions, except per-share data) 1996 1995 1994 1993 1992 1991
==========================================================================
Per-Share Data
- ------------------------------------------------------------------
Earnings (loss) from continuing operations
Primary $ 3.49 $ 3.40 $ 2.24 $ (0.83) $ 1.72 $ 1.24
Fully diluted 3.31 3.21 2.15 (0.83) 1.53 1.23
Dividends declared 1.12 1.00 1.00 1.00 1.00 1.00
==========================================================================
Operations
- ------------------------------------------------------------------
Revenues $ 17,378 $ 16,588 $ 15,084 $ 14,229 $ 14,298 $ 13,438
Research and development expenses 1,044 949 895 883 922 890
Income (loss) from continuing operations 1,206 1,174 794 (193) 562 436
Net income (loss) 1,206 (472) 794 (126) (1,020) 454
==========================================================================
Financial Position
- ------------------------------------------------------------------
Accounts and finance receivables, net $ 13,394 $ 12,389 $ 11,759 $ 10,565 $ 10,250 $ 8,952
Inventories 2,676 2,656 2,294 2,162 2,257 2,091
Land, buildings and equipment, net 2,256 2,105 2,108 2,219 2,150 1,950
Investment in discontinued operations 4,398 4,810 7,904 8,841 8,652 9,164
Total assets 26,818 26,008 27,278 26,999 25,792 24,342
Consolidated capitalization
Short-term debt 3,536 3,274 3,159 2,698 2,533 2,038
Long-term debt 8,697 8,148 7,355 7,386 8,105 7,825
Total debt 12,233 11,422 10,514 10,084 10,638 9,863
Deferred ESOP benefits (494) (547) (596) (641) (681) (720)
Minorities' interests in equity of subsidiaries 843 755 1,021 844 885 818
Preferred stock 721 763 832 1,066 1,072 1,078
Common shareholders' equity 4,367 3,878 4,177 3,972 3,875 5,140
Total capitalization 17,670 16,271 15,948 15,325 15,789 16,179
==========================================================================
Selected Data and Ratios
- ------------------------------------------------------------------
Common shareholders of record at year-end 55,908 54,262 56,414 65,820 68,877 71,213
Book value per common share1 $ 13.42 $ 11.83 $ 12.95 $ 12.56 $ 13.40 $ 18.14
Year-end common share market price $ 52.63 $ 45.67 $ 33.00 $ 29.38 $ 26.42 $ 22.83
Employees at year-end 86,700 85,900 87,600 97,000 99,300 100,900
Working capital $ 2,948 $ 2,843 $ 2,411 $ 2,357 $ 2,578 $ 2,282
Current ratio 1.4 1.4 1.4 1.4 1.5 1.5
Additions to land, buildings and equipment $ 510 $ 438 $ 389 $ 470 $ 582 $ 467
Depreciation on land, buildings and equipment $ 372 $ 376 $ 446 $ 437 $ 418 $ 397
==========================================================================
* Data that conforms with the 1996 basis of presentation were not available.
1 Book value per common share is computed by dividing common shareholders'
equity by outstanding common shares plus common shares reserved for the
conversion of the Xerox Canada Inc. Exchangeable Class B stock.
70
Notes
1990 1989 1988 1987 1986
================================================================================
$ 1.81 $ 1.46 $ 0.38 $ 1.02 $ 0.91
1.74 1.45 0.38 1.02 0.91
1.00 1.00 1.00 1.00 1.00
================================================================================
$ 13,210 $ 12,095 $ 11,354 $ 10,537 $ 9,493
848 809 794 722 650
599 488 148 353 316
243 704 388 578 465
================================================================================
$ 8,016 $ 7,272 $ 6,109 $ 4,948 $ 3,887
2,148 2,413 2,558 2,286 2,459
1,851 1,781 1,803 1,639 1,491
9,695 * * * *
24,116 * * * *
1,828 1,482 1,174 * *
8,726 9,247 6,675 * *
10,554 10,729 7,849 5,771 4,343
(756) (785) -- -- --
832 715 806 655 565
1,081 1,081 296 442 442
5,051 5,035 5,371 5,105 4,687
16,762 16,775 14,322 11,973 10,037
================================================================================
74,994 78,876 84,864 86,388 90,437
$ 17.91 $ 17.86 $ 17.41 $ 17.00 $ 16.00
$ 11.83 $ 19.08 $ 19.46 $ 18.88 $ 20.00
99,000 99,000 100,000 99,200 100,400
$ 2,537 * * * *
1.6 * * * *
$ 405 $ 390 $ 418 $ 347 $ 328
$ 372 $ 370 $ 369 $ 320 $ 283
================================================================================
Dividends and Stock Prices
Consecutive Dividends Paid to Shareholders
The Company's Board of Directors, at a special meeting held January 22, 1997,
declared a 10 percent increase in the Xerox common stock quarterly dividend to
$.32 per share effective April 1, 1997. Xerox has declared dividends to its
shareholders for 67 consecutive years and has paid consecutive quarterly
dividends since 1948.
At its February 3, 1997 meeting, the Company's Board of Directors declared
the regular quarterly $1.5625 per share dividend on the Company's preferred
stock. The Series B Convertible Preferred stock was issued in July 1989 in
connection with the formation of a Xerox Employee Stock Ownership Plan.
Both the common and preferred stock dividends are payable April 1 to
shareholders of record March 7.
On April 1, 1996, the Company redeemed all outstanding shares of the
$3.6875 Ten-Year Sinking Fund Preferred stock at a price of $50. Dividends on
the stock ceased to accrue on April 1, 1996. Notices of redemption were mailed
to holders of the stock on February 26, 1996.
Xerox Common Stock Prices and Dividends
New York Stock Exchange First Second Third Fourth
Composite Prices Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
1996 High $ 47.33 $ 54.75 $ 58.25 $ 57.13
Low 39.79 42.08 46.25 44.63
Dividends Paid .25 .29 .29 .29
1995 High $ 40.17 $ 41.96 $ 44.92 $ 48.21
Low 32.17 36.58 36.46 42.00
Dividends Paid .25 .25 .25 .25
================================================================================
Note: A three-for-one split of the Company's common stock became effective on
June 6, 1996. Stock prices and dividends prior to that date have been adjusted
to reflect the split.
Stock Listed and Traded
Xerox common stock (XRX) is listed on the New York Stock Exchange and the
Chicago Stock Exchange. It is also traded on the Boston, Cincinnati, Pacific
Coast and Philadelphia exchanges and in London, Basel, Berne, Geneva, Lausanne
and Zurich.
71