FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to___________
Commission File Number 1-4471
XEROX CORPORATION
(Exact Name of Registrant as
specified in its charter)
New York 16-0468020 _
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
P.O. Box 1600
Stamford, Connecticut 06904-1600
(Address of principal executive offices)
(Zip Code)
(203) 968-3000 _
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at July 31,1997
Common Stock 325,137,709 shares
This document consists of 31 pages.
This Form 10-Q contains certain forward-looking statements and
information relating to the Company that are based on the beliefs
of management as well as assumptions made by and information
currently available to management. The words "anticipate",
"believe", "estimate", "expect", "intends", and similar
expressions, as they relate to the Company or the Company's
management, are intended to identify forward-looking statements.
Such statements reflect the current views of the Company with
respect to future events and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks
or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated or expected.
The Company does not intend to update these forward-looking
statements.
Xerox Corporation
Form 10-Q
June 30, 1997
Table of Contents
Page
Part I - Financial Information
Item 1. Financial Statements
Consolidated Statements of Income 5
Consolidated Balance Sheets 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Document Processing 13
Discontinued Operations 19
Capital Resources and Liquidity 23
Hedging Instruments 25
Part II - Other Information
Item 1. Legal Proceedings 26
Item 2. Changes in Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 29
Exhibit Index
Computation of Net Income per Common Share 30
Computation of Ratio of Earnings to Fixed Charges 31
Letter Agreement dated June 4, 1997 between Registrant and
G. Richard Thoman, President and Chief Operating Officer of
Registrant (filed in electronic form only)
Financial Data Schedule (filed in electronic form only)
For additional information about The Document Company Xerox,
please visit our World-wide Web site at www.xerox.com and select
"Investor Information."
PART I - FINANCIAL INFORMATION
Item I Xerox Corporation
Consolidated Statements of Income
Three months ended Six months ended
June 30, June 30,
(In millions, except per-share data) 1997 1996 1997 1996
Revenues
Sales $ 2,286 $ 2,192 $ 4,265 $ 4,102
Service and rentals 1,817 1,778 3,607 3,540
Finance income 253 247 506 503
Total Revenues 4,356 4,217 8,378 8,145
Costs and Expenses
Cost of sales 1,230 1,191 2,354 2,282
Cost of service and rentals 913 882 1,811 1,781
Equipment financing interest 129 125 258 255
Research and development expenses 281 264 543 518
Selling, administrative and general
expenses 1,288 1,269 2,468 2,435
Other, net 18 27 19 31
Total Costs and Expenses 3,859 3,758 7,453 7,302
Income before Income Taxes, Equity Income
and Minorities' Interests 497 459 925 843
Income taxes 175 164 325 303
Equity in net income of unconsolidated
affiliates 46 42 68 62
Minorities' interests in earnings of
subsidiaries 31 44 61 72
Income from Continuing Operations 337 293 607 530
Discontinued Operations - - - -
Net Income $ 337 $ 293 $ 607 $ 530
Primary Earnings per Share
Continuing Operations $ 1.00 $ 0.85 $ 1.78 $ 1.53
Discontinued Operations - - - -
Primary Earnings per Share $ 1.00 $ 0.85 $ 1.78 $ 1.53
Fully Diluted Earnings per Share
Continuing Operations $ 0.94 $ 0.81 $ 1.69 $ 1.46
Discontinued Operations - - - -
Fully Diluted Earnings per Share $ 0.94 $ 0.81 $ 1.69 $ 1.46
See accompanying notes.
Xerox Corporation
Consolidated Balance Sheets
June 30, December 31,
(In millions, except share data in thousands) 1997 1996
Assets
Cash $ 118 $ 104
Accounts receivable, net 2,135 2,022
Finance receivables, net 4,232 4,386
Inventories 3,046 2,676
Deferred taxes and other current assets 1,014 964
Total Current Assets 10,545 10,152
Finance receivables due after one year, net 6,973 6,986
Land, buildings and equipment, net 2,264 2,256
Investments in affiliates, at equity 1,474 1,282
Goodwill 1,368 623
Other assets 1,232 1,121
Investment in discontinued operations 3,977 4,398
Total Assets $ 27,833 $ 26,818
Liabilities and Equity
Short-term debt and current portion of
long-term debt $ 3,412 $ 3,536
Accounts payable 525 577
Accrued compensation and benefit costs 605 761
Unearned income 210 208
Other current liabilities 2,202 2,122
Total Current Liabilities 6,954 7,204
Long-term debt 9,797 8,424
Postretirement medical benefits 1,074 1,050
Deferred taxes and other liabilities 2,344 2,429
Discontinued operations liabilities -
policyholders' deposits and other 2,090 2,274
Deferred ESOP benefits (494) (494)
Minorities' interests in equity of subsidiaries 121 843
Company obligated, mandatorily redeemable
preferred securities of subsidiary trust
holding solely subordinated debentures
of the Company 637 -
Preferred stock 713 721
Common shareholders' equity 4,597 4,367
Total Liabilities and Equity $ 27,833 $ 26,818
Shares of common stock issued 325,902 325,902
Shares of common stock outstanding 324,777 323,681
See accompanying notes.
Xerox Corporation
Consolidated Statements of Cash Flows
Six months ended June 30 (in millions) 1997 1996
Cash Flows from Operating Activities
Income from Continuing Operations $ 607 $ 530
Adjustments required to reconcile income to cash
flows from operating activities:
Depreciation and amortization 334 357
Provisions for doubtful accounts 114 88
Provision for postretirement medical
benefits, net of payments 20 23
Minorities' interests in earnings of subsidiaries 61 72
Undistributed equity in income of affiliated companies(65) (62)
Increase in inventories (568) (543)
Increase in finance receivables (247) (187)
Increase in accounts receivable (148) (282)
Decrease in accounts payable and accrued
compensation and benefit costs (204) (177)
Net change in current and deferred income taxes 71 124
Other, net (184) (444)
Total (209) (501)
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment (193) (241)
Proceeds from sales of land, buildings and equipment 19 30
Purchase of additional interest in Rank Xerox (812) -
Net change in payables to Discontinued Operations (26) -
Total (1,012) (211)
Cash Flows from Financing Activities
Net change in debt 617 1,079
Dividends on common and preferred stock (237) (220)
Proceeds from sale of common stock 108 66
Repurchase of common and preferred stock (116) (207)
Dividends to minority shareholders (3) (1)
Net proceeds from issuance of mandatorily
redeemable preferred stock 637 -
Total 1,006 717
Effect of Exchange Rate Changes on Cash (8) (2)
Cash Provided (Used) by Continuing Operations (223) 3
Cash Provided (Used) by Discontinued Operations 237 (121)
Increase (Decrease) in Cash 14 (118)
Cash at Beginning of Period 104 136
Cash at End of Period $ 118 $ 18
See accompanying notes.
Xerox Corporation
Notes to Consolidated Financial Statements
1. The consolidated financial statements presented herein have
been prepared by Xerox Corporation ("the Company") in accordance
with the accounting policies described in its 1996 Annual Report
to Shareholders and should be read in conjunction with the notes
thereto.
Effective 1997, Fuji Xerox changed its reporting period from a
fiscal year ending October 20 to a fiscal year ending December
20. The results of operations during the period between the end
of the 1996 fiscal year and the beginning of the new fiscal year
(the stub period) amounted to a gain of $8 million. The gain was
credited to retained earnings.
In the opinion of management, all adjustments (consisting only of
normal recurring adjustments) which are necessary for a fair
statement of operating results for the interim periods presented
have been made. Interim financial data presented herein are
unaudited.
References herein to "we" or "our" refer to Xerox and
consolidated subsidiaries unless the context specifically
requires otherwise.
2. Inventories consist of (in millions):
June 30, December 31,
1997 1996
Finished products $ 1,779 $ 1,570
Work in process 110 80
Raw materials and supplies 419 322
Equipment on operating leases, net 738 704
Total $ 3,046 $ 2,676
3. In June, 1997, we acquired the remaining 20 percent of Rank
Xerox Limited (Rank Xerox) from The Rank Group Plc (Rank) in a
transaction valued at 940 million pounds sterling, or
approximately $1.5 billion. As a result of this transaction, we
now own 100 percent of Rank Xerox. The transaction was funded
entirely by debt consisting of 500 million pounds sterling of
third party debt and 440 million pounds sterling of notes payable
issued to Rank, which will be paid in deferred installments, half
within one year and the other half at the end of two years. An
additional payment of up to 60 million pounds sterling would be
made in 2000 based upon achievement of certain Rank Xerox
earnings growth targets by 1999. The purchase price was
allocated such that goodwill increased by $737 million, minority
interest in equity of subsidiaries was reduced by approximately
$720 million, with the balance of $70 million applied to other
assets and liabilities, primarily investment in affiliates, at
equity.
4. In January 1997, a trust sponsored and wholly owned by the
Company issued 650,000 shares of 8% Capital Securities (the
Preferred Securities) with an aggregate liquidation amount of
$650 million to the public for net proceeds, after discount and
fees, of $637 million. The trust also issued 20,103 shares of
common securities to the Company. The proceeds from these
offerings were invested by the trust in $650 million aggregate
principal amount of the Company's newly-issued 8% Junior
Subordinated Debentures due 2027 (the Debentures). The
Debentures represent all of the assets of the trust. The
proceeds from the issuance of the Debentures were used by the
Company for general corporate purposes. The Debentures and
related income statement effects are eliminated in the Company's
consolidated financial statements.
The Preferred Securities accrue and pay cash distributions semi-
annually at a rate of 8% per annum of the stated liquidation
amount of $1,000 per Preferred Security. The Company has
guaranteed, on a subordinated basis, distributions and other
payments due on the Preferred Securities (the Guarantee). The
Guarantee, when taken together with the Company's obligations
under the Debentures and in the indenture pursuant to which the
Debentures were issued and the Company's obligations under the
Amended and Restated Declaration of Trust governing the trust,
provides a full and unconditional guarantee of amounts due on the
Preferred Securities.
The Preferred Securities are mandatorily redeemable upon the
maturity of the Debentures on February 1, 2027, or earlier to the
extent of any redemption by the Company of any Debentures. The
redemption price on February 1, 2027 will be $1,000 per share
plus accrued and unpaid distributions to the date fixed for
redemption.
5. Common shareholders' equity consists of (in millions):
June 30, December 31,
1997 1996
Common stock $ 327 $ 327
Additional paid-in-capital 1,349 1,353
Retained earnings 3,459 3,090
Net unrealized gain (loss) on
investment securities 5 (1)
Translation adjustments (424) (241)
Treasury stock (119) (161)
Total $ 4,597 $ 4,367
6. Interest expense totaled $288 million and $295 million for
the six months ended June 30, 1997 and 1996, respectively.
7. In 1996, the Board of Directors authorized the Company to
repurchase up to $1 billion of Xerox common stock. The stock
would be purchased from time to time on the open market depending
on market conditions. Through June 30, 1997, 8.5 million shares
had been repurchased for $422 million, some of which had been
reissued to satisfy the exercise of stock options. In the second
quarter of 1997, the repurchase program was suspended in
connection with the acquisition of the remaining interest in Rank
Xerox, as described above.
8. Summarized operating results of Insurance follow (in
millions):
Three months ended Six months ended
June 30, June 30,
1997 1996 1997 1996
Revenues
Insurance premiums earned $ 381 $ 436 $ 805 $ 854
Investment and other income 112 107 223 213
Total Revenues 493 543 1,028 1,067
Costs and Expenses
Insurance losses and loss expenses 556 362 921 705
Insurance acquisition costs and
other operating expenses 129 141 277 283
Interest expense 49 48 98 102
Administrative and general expenses (39) 3 (28) 9
Total Costs and Expenses 695 554 1,268 1,099
Realized Capital Gains 1 - 7 2
Gain on Sale of Subsidiary 63 - 63 -
Income (Loss) Before Income Taxes (138) (11) (170) (30)
Income Tax Benefits 49 5 65 14
Income (Loss) From Insurance * $ (89) $ (6) $ (105) $ (16)
* The total Insurance after-tax losses were charged to reserves established
for this purpose and, therefore, did not impact our earnings.
The net assets at June 30, 1997 and December 31, 1996 of the
Insurance businesses included in our consolidated balance sheets
as discontinued operations are as follows (in millions):
June 30, December 31,
1997 1996
Insurance Assets
Investments $ 6,888 $ 7,889
Reinsurance recoverable 2,111 2,458
Premiums and other receivables 1,003 1,082
Deferred taxes and other assets 987 1,201
Total Insurance Assets $10,989 $12,630
Insurance Liabilities
Unpaid losses and loss expenses $ 7,538 $ 8,572
Unearned income 609 812
Notes payable 265 215
Other liabilities 979 1,185
Total Insurance Liabilities $ 9,391 $10,784
Investment in Insurance, net $ 1,598 $ 1,846
9. 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 has
indicated that he plans to testify at trial that, allegedly as a
result of Xerox' conduct, plaintiffs have lost profits of
approximately $75 million. The Company has asserted counterclaims
against the plaintiffs alleging patent and copyright
infringement, misappropriation of Xerox trade secrets and
conversion. On December 11, 1995, the District Court issued a
preliminary injunction against the parent company for copyright
infringement. On April 8, 1997, the District Court granted
partial summary judgment in favor of the Company on plaintiffs'
antitrust claims, ruling that the Company's unilateral refusal to
sell or license its patented parts cannot give rise to antitrust
liability. The Court's ruling did not preclude a finding of
antitrust liability based upon other allegations of exclusionary
conduct, including the refusal to sell unpatented parts. The
District Court also granted summary judgment in favor of the
Company on its patent infringement claim, leaving open with
respect to patent infringement only the issues of willfulness and
the amount of damages, and granted partial summary judgment in
favor of the Company with respect to some of its claims of
copyright infringement. On July 17, 1997 the District Court,
pursuant to 28 U.S.C. Section 1292(b), certified its April 8,
1997 Order for interlocutory appeal to the United States Court of
Appeals for the Federal Circuit and stayed trial of the matter
pending remand.
Discontinued Operations
Farm & Home Savings Association, now known as Roosevelt Bank,
(Farm & Home) and certain Talegen Holdings, Inc. 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, former
residents of, or students attending school within, a residential
subdivision known as Southbend, 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. In February 1997, the Insurance Companies
reached an agreement in principle to settle all of the claims
brought by plaintiffs who have or had a pertinent nexus to the
Southbend subdivision, with the exception of a group of 53
plaintiffs. In addition, Farm & Home intends to press its pending
motions for summary judgment which, if granted, would provide a
legal basis for dismissal of any claims asserted in the future.
If the settlement is not consummated, and the claims are not
resolved by summary judgment, one or more of these cases can be
expected to be tried in 1997. The Southbend subdivision has
since been acquired by the Insurance Companies and all of the
structures have been demolished.
Item II Xerox Corporation
Management's Discussion and Analysis of
Results of Operations and Financial Condition
Document Processing
Summary
Income from continuing operations increased 15 percent from $293
million in the 1996 second quarter to $337 million in the 1997
second quarter, including $13 million as a result of the
acquisition of the Rank Group's remaining interest in Rank Xerox
in June.
Revenues of $4.4 billion in the quarter represented 6 percent
growth on a pre-currency basis. After the adverse effect of
currency, revenue growth was 3 percent. The pre-currency revenue
growth was driven by strong growth in equipment sales (excluding
OEM sales) and continued excellent growth in document
outsourcing.
Fully diluted earnings per share increased 16 percent to $0.94 in
the second quarter including $0.04 as a result of the Rank Xerox
transaction.
Underlying Growth
To understand the trends in the business, we believe that it is
helpful to adjust revenue and expense growth (except for ratios)
to exclude the impact of changes in the translation of foreign
currencies into U.S. dollars. We refer to this adjusted growth
as "underlying growth."
A substantial portion of our consolidated revenues is derived
from operations outside of the United States where the U.S.
dollar is not the functional currency, primarily in Europe. When
compared with most of the major European currencies, the U.S.
dollar was approximately 11 percent stronger in the 1997 second
quarter than in the 1996 second quarter; only the pound sterling
was stronger. As a result, foreign currency translation had an
unfavorable impact of approximately 2 percentage points on total
revenues in the 1997 second quarter.
Revenues denominated in currencies where the local currency is
the functional currency are not hedged for purposes of
translation into U.S. dollars.
Revenues
For the major product categories, the underlying revenue growth
rates are as follows:
1996 1997
Q1 Q2 Q3 Q4 FY Q1 Q2
Total Revenues 4% 6% 5% 8% 6% 5% 6%
Digital Products 19 21 23 26 23 18 24
Light Lens Copiers - - (4) - (1) (2) (3)
Digital product revenues were 34 percent of total revenues in the
1997 second quarter compared with 29 percent in the 1996 second
quarter. Growth of 24 percent in the second quarter follows 18
percent growth in the first quarter. Color copying and printing
grew 62 percent with continued excellent growth from the
DocuColor 40, the company's 40 page-per-minute color document
production system. Computer printing grew 15 percent and
production publishing grew 9 percent despite some slowdown due
to customer anticipation of the new 180 page-per-minute DocuTech
Production Publisher, introduced in May and widely available
beginning in July.
Black-and-white light lens copier revenues were 52 percent of
total revenues in the 1997 second quarter compared with 57
percent in the 1996 second quarter. Revenues declined 3 percent
in the second quarter reflecting increased competitive pricing
pressures and the impact of customers transitioning to Xerox
digital technology, including the new black-and-white digital
copiers introduced in April and production publishing products.
Geographically, the underlying revenue growth rates are as
follows:
1996 1997 _
Q1 Q2 Q3 Q4 FY Q1 Q2
Total Revenues 4% 6% 5% 8% 6% 5% 6%
United States 5 6 5 9 6 6 3
Rank Xerox (2) 2 2 2 1 3 6
Other Areas 11 10 6 14 10 3 11
Memo: Fuji Xerox 13 15 11 11 12 11 4
Revenues from the U.S. sales and service operations grew 5
percent in the second quarter. However, total U.S. revenue
growth was 3 percent primarily due to lower shipments to Fuji
Xerox in the 1997 second quarter compared with a year ago.
Rank Xerox Limited and related companies manufacture and market
Xerox products principally in Europe. Overall, the European
economies remain soft. However, the U.K., Germany, and Holland
had good revenue growth in the second quarter. France, Italy, and
Spain had modest growth. Consolidation of the South African
operations in 1997 accounted for one percentage point of the Rank
Xerox growth in the 1997 second quarter.
Other Areas include operations principally in Latin America,
Canada and China. Brazil had strong revenue growth in the 1997
second quarter reflecting excellent growth in equipment sales and
document outsourcing. Revenue growth was also excellent in
Mexico, but the smaller Latin American countries such as Chile,
Venezuela and Colombia continue to be impacted by difficult
economic conditions. Revenue growth in Canada and China was good
in the second quarter.
Fuji Xerox Co., Ltd., an unconsolidated entity, jointly owned by
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 modest revenue growth in the 1997 second quarter
following strong revenue growth in the previous quarters is
primarily the result of calendarization due to the 1997 change in
the Fuji Xerox fiscal year from October 20 to December 20. The
1997 second quarter reflects modest growth in Japan and excellent
growth in the Asia Pacific countries.
The underlying growth rates by type of revenue are as follows:
1996 1997
Q1 Q2 Q3 Q4 FY Q1 Q2
Total Revenues 4% 6% 5% 8% 6% 5% 6%
Sales 3 6 7 12 7 5 6
Equipment (Excluding OEM) 7 9 6 14 10 10 11
Supplies 1 8 11 11 8 1 2
Paper (2) (7) (12) (7) (7) (9) (1)
Service/Rentals/
Outsourcing/Other 5 4 4 4 4 4 5
Service 1 (2) (3) (1) (1) (2) 1
Rentals 2 2 1 (4) - (11) (8)
Document Outsourcing * 48 51 51 41 47 41 36
Finance Income 1 - 4 1 1 2 5
Memo: Revenues Excluding
Equipment Sales 3 4 2 3 3 2 3
*Excludes equipment in outsourcing contracts that are accounted
for as sales.
Equipment sales in the 1997 second quarter grew 11 percent
reflecting excellent growth in digital products partially offset
by declines in black-and-white light lens copiers.
Supplies sales: The decline in growth in the 1997 first and
second quarters from the 1996 third and fourth quarters is due
principally to a reduction in sales of OEM printer cartridges
following the buildup of inventory for new products at OEM
customers.
Paper sales: Our strategy is to charge a spread over mill
wholesale prices to cover our costs and value added as a
distributor. The modest revenue decline in the 1997 second
quarter from the 1996 second quarter is the result of lower
industry-wide price declines which were offset by volume
increases.
Combined service, rental and document outsourcing and other
revenue growth improved to 5 percent in the 1997 second quarter.
The 36 percent growth in document outsourcing (excluding
equipment in outsourcing contracts accounted for as sales)
continued to divert revenues from service, rentals, finance
income and supplies. Service revenues grew 1 percent as the
impact of higher machine populations resulting from recent higher
equipment sales was partially offset by competitive price
pressures. Rental revenues continued to decline due to continuing
customer preference for purchase, primarily in Latin America, or
document outsourcing rather than rental.
Document Outsourcing revenues are included in Equipment Sales as
well as in Service/Rental/Document Outsourcing/Other. Where
document outsourcing contracts include revenue accounted for as
equipment sales, this revenue is included as Equipment Sales on
the Income Statement. All other document outsourcing revenue
which includes service, equipment not treated as sales, supplies,
paper, and labor, are included in the
Service/Rentals/Outsourcing/Other line item. When equipment in
document outsourcing contracts recognized as equipment sales is
included, total document outsourcing business revenue growth
accelerated in the 1997 first and second quarters from earlier
quarters.
Finance income: Our strategy for financing equipment sales in the
industrialized economies 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. Continuing
strong growth in the financing of equipment sales in Latin
America has been partially offset by lower average interest rates
in North America and Europe.
Gross Profit and Expenses
The gross margins by revenue stream were as follows:
1996 1997
Q1 Q2 Q3 Q4 FY Q1 Q2
Total Gross Margin 46.0% 47.9% 46.2% 47.1% 46.9% 46.5% 47.8%
Sales 42.9 45.7 43.9 45.4 44.6 43.2 46.2
Service/Rent/DocOut 49.0 50.4 48.8 49.3 49.4 49.9 49.7
Financing 49.0 49.5 48.3 51.0 49.5 48.9 49.2
The total gross margin declined by 0.1 percentage point in the
1997 second quarter from the 1996 second quarter.
The sales gross margin improved by 0.5 percentage points from the
1996 second quarter principally due to productivity, partially
offset by competitive pricing pressures. The service, rentals and
document outsourcing gross margin declined by 0.7 percentage
points from an unusually high 1996 second quarter but was in line
with the last several quarters.
Research and development (R&D) expense increased 6 percent in the
1997 second quarter as we continue to invest in technological
development to maintain our premier position in the rapidly
changing document processing market. Xerox R&D is strategically
coordinated with that of Fuji Xerox which invested $537 million
in R&D in the 1996 full year, for a combined total of $1.6
billion.
Selling, administrative and general expenses (SAG) increased 3
percent in the 1997 second quarter, or only half the revenue
increase. SAG was 29.6 percent of revenue in the second quarter,
a decrease of 0.5 percentage points from the 1996 second quarter.
The decline was due to productivity initiatives and expense
controls.
Worldwide employment increased by 900 in the 1997 second quarter
to 89,100, largely as a result of the net hiring of 500 employees
in the company's fast-growing document outsourcing business.
The $9 million decrease in other expenses, net, from the 1996
second quarter was due to the non-recurrence of several one-time
charges in 1996 partially offset by increased currency losses
from balance sheet translation due to currency devaluations in
our Latin American operations. In January 1997, we issued $650
million of mandatorily redeemable preferred stock through a trust
and paid down debt, which resulted in reduced interest expense.
The after tax impact of the dividend on these securities is
included in the income statement in the line item: minorities'
interests in the earnings of subsidiaries.
Income Taxes, Equity in Net Income of Unconsolidated Affiliates
and Minorities' Interests in the Earnings of Subsidiaries
Income before income taxes increased 8 percent to $497 million in
the 1997 second quarter from $459 million in the 1996 second
quarter.
The effective tax rate was 35.1 percent in the 1997 second
quarter compared with 35.7 percent in the 1996 second quarter.
We expect the second quarter rate to be maintained during the
balance of 1997.
Equity in the net income of unconsolidated affiliates is
principally the Rank Xerox share of Fuji Xerox income. Although
there was a lower 1997 second quarter profit contribution from
Fuji Xerox, largely because of unfavorable currency translation
and calendarization relating to the 1997 fiscal year change,
total equity in net income increased modestly, as a result of
increases from a number of smaller investments.
Minorities' interests reduction in the second quarter was
primarily due to our acquisition of the remaining interest in
Rank Xerox, effective in June, and lower Rank Xerox profits,
partially offset by the after tax impact of the dividend on the
mandatorily redeemable preferred stock discussed above.
In June 1997, the company completed the acquisition of The Rank
Group's remaining 20 percent financial interest in Rank Xerox
Limited and related companies (Rank Xerox Companies) for 940
million pounds sterling, or approximately $1.5 billion.
The transaction was funded entirely by debt consisting of
500 million pounds sterling of third party debt and
440 million pounds sterling of notes payable issued to The Rank Group.
The purchase price was allocated such that goodwill increased by
$737 million, minority interest in equity of subsidiaries was
reduced by approximately $720 million, with the balance of $70
million applied to other assets and liabilities, primarily
investments in affiliates at equity.
This acquisition increased second quarter net income by $13
million and fully diluted earnings per share by $0.04 and we
estimate that it will have a positive impact on earnings per
share and cash flow going forward.
In February 1996, the board of directors authorized the
repurchase of up to $1 billion of Xerox common stock. Through the
1997 second quarter, the company had repurchased 8.5 million
shares for $422 million, including $16 million in April. As a
result of the Rank Xerox transaction, the repurchase program was
suspended during the second quarter as use of the company's
financial resources to fund the $1.5 billion acquisition of The
Rank Group's remaining interest in Rank Xerox produces greater
value for Xerox shareholders.
Effective 1997, Fuji Xerox changed its reporting period from a
fiscal year ending October 20 to a fiscal year ending December
20. The results of operations during the period between the end
of the 1996 fiscal year and the beginning of the new fiscal year
(the stub period) amounted to a gain of $8 million. The gain was
credited directly to retained earnings.
In February 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 128
"Earnings Per Share." Commencing with our fourth quarter
reporting, SFAS No. 128 will require us to present basic and
diluted earnings per share (EPS) on the face of the income
statement. The computation of basic EPS replaces primary EPS.
If we had implemented SFAS No. 128 during the second quarter, we
would have reported basic EPS of $1.01 and $1.80 for the quarter
and year to date, respectively, and diluted EPS of $0.94 and
$1.69 for the quarter and year to date, respectively.
In June 1997, the FASB issued SFAS No. 130, "Reporting
Comprehensive Income" and No. 131, "Disclosures about Segments of
an Enterprise and Related Information." Commencing in 1998, SFAS
No. 130 will require companies to report comprehensive income and
SFAS No. 131 will require companies to report segment performance
as it is used internally to evaluate segment performance. These
statements merely add additional disclosure requirements.
Discontinued Operations
The net investment in the discontinued financial services
businesses which includes Insurance, Other Financial Services and
Third-Party Financing and Real Estate totaled $1,887 million at
June 30, 1997 compared with $2,124 million at December 31, 1996.
The decrease primarily reflects the sale of Coregis Group, Inc.
(Coregis) somewhat offset by scheduled funding of reinsurance
coverage to the Talegen Holdings, Inc. (Talegen) companies and
The Resolution Group, Inc. (TRG) by Ridge Reinsurance Limited
(Ridge Re) and interest for the period on the assigned debt. A
discussion of the discontinued businesses follows.
Insurance
In 1995, we recorded a $1,546 million after-tax charge in
connection with agreements to sell all of our "Remaining"
insurance companies, which included Coregis, Crum & Forster
Holdings, Inc., Industrial Indemnity Holdings, Inc. (II),
Westchester Specialty Group, Inc. (WSG), TRG and three insurance-
related service companies.
On September 11, 1996, those transactions were terminated. No
additional charges are considered necessary as a result of the
termination. 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 simultaneous disposition
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 these insurance businesses.
Although we believe that the disposal of the Remaining insurance
companies should be substantially completed by the end of 1997,
and that the value 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, level of interest rates, and
relative value of insurance properties.
On May 30, 1997, Coregis was sold to a subsidiary of GE Capital
Corporation for $375 million in cash and the assumption of $75
million of debt. The selling price was in excess of book value
and was consistent with the estimated value for the unit when we
discontinued the insurance operations in 1995. As per the sales
agreement, the 1997 results of Coregis accrued to the buyer.
In an unrelated transaction, Andersen Consulting LLP agreed to
acquire certain assets of Apprise Corp. (Apprise), one of
Talegen's insurance-related service companies. The financial
terms of this transaction, which closed in the first quarter,
were not material.
In May, 1997 we announced an agreement to sell II to Fremont
Indemnity Company, a unit of Fremont General Corporation for $365
million in cash and the assumption of $79 million of debt. The
selling price is in excess of book value and is consistent with
the estimated value of the unit when we discontinued the
insurance operations in 1995. As per the sales agreement, the
1997 earnings of II will accrue to the buyer. This transaction
was completed on August 1, 1997.
Insurance Operating Results
Operating results for the discontinued Insurance segment (the
Remaining insurance companies, Ridge Re and Xerox Financial
Services, Inc. holding company expenses, primarily assigned
interest) for the second quarter follow:
Second Quarter Six Months
(In millions) 1997 1996 1997 1996
Total Insurance Revenue $ 340 $ 359 $ 686 $ 707
Insurance Pre-Tax Income
(Loss):
Underwriting $ (268) $ (54) $ (332) $ (108)
Investment income 84 74 164 148
Net realized capital gains 1 - 1 2
Interest expense (49) (49) (98) (103)
Other 40 (1) 44 (6)
Insurance Pre-Tax
Income (Loss) $ (192) $ (30) $ (221) $ (67)
After-Tax Income
(Loss):
Insurance $ (151) $ (18) $ (160) $ (40)
Disposed companies 62 12 55 24
Total After-Tax
Income (Loss)* $ (89) $ (6) $ (105) $ (16)
* The total Insurance after-tax loss was charged to reserves
established for this purpose and, therefore, does not impact
our earnings.
The preceding table's revenue and pre-tax loss excludes the
results of Coregis, II and Apprise. The 1997 results of Apprise
and the 1996 results of Coregis, II and Apprise are shown on an
after-tax basis under the caption "Disposed companies."
Revenues from Insurance totaled $340 million in the second
quarter of 1997 compared with $359 million in the second quarter
of 1996, reflecting a slight reduction of earned premiums
somewhat offset by an improvement in investment income.
The increase in the 1997 second quarter Insurance pre-tax loss,
compared with 1996, primarily reflects reserve strengthening at
WSG offset partially by an improvement in investment income.
The investment in Insurance at June 30, 1997 totaled $1,598
million compared with a balance of $1,846 million at December 31,
1996. The decrease primarily reflects the sale of Coregis,
somewhat offset by 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
closing of the sales of the Remaining insurance companies.
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 to affect
the size of losses). The Remaining insurance companies'
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.
Other Financial Services
The net investment in Other Financial Services (OFS) at June 30,
1997 was $122 million compared with $101 million at December 31,
1996. The increase in the investment primarily reflects the
effect of a transfer from Insurance which had no effect on the
total net investment in the discontinued financial services
businesses.
On June 1, 1995, Xerox Financial Services, Inc. (XFSI) completed
the sale of Xerox Financial Services Life Insurance Company and
related companies (Xerox Life). In connection with the
transaction, OakRe Life Insurance Company (OakRe), a wholly-owned
XFSI subsidiary, has assumed responsibility, via Coinsurance
Agreements, for existing Single Premium Deferred Annuity (SPDA)
policies issued by Xerox Life. The Coinsurance Agreements
include a provision for the assumption (at their election) by the
purchaser's 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. 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 purchaser's companies.
As a result of the Coinsurance Agreements, at June 30, 1997,
OakRe retained approximately $1.9 billion of investment portfolio
assets (transferred from Xerox Life) 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. Xerox Life's 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 June 30, 1997. 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 June 30, 1997
totaled $395 million, a $55 million reduction from the December
31, 1996 level due primarily to the continued run-off of third-
party assets. The run-off proceeds were used to reduce assigned
debt to $178 million at June 30, 1997, a $45 million decrease
from the year-end 1996 level.
Capital Resources and Liquidity
Total debt, including ESOP and discontinued operations debt not
shown separately in our consolidated balance sheets, was $13,702
million at June 30, 1997 or $1,254 million more than at December
31, 1996. The changes in consolidated indebtedness since year-
end and versus the first six months of 1996 are summarized as
follows:
(In millions) 1997 1996
Total Debt as of January 1 $12,448 $11,794
Non-Financing Businesses
Document Processing operations 419 648
Discontinued Businesses (151) 109
Total Non-Financing 268 757
Financing Businesses (201) (14)
Total Operations 67 743
Shareholder dividends 237 220
Acquisition of Additional Interest in RX 1,530 -
Mandatorily redeemable preferred stock (637) -
Equity redemption and other changes 57 5
Total Debt as of June 30 $13,702 $12,762
The following table summarizes the changes in total equity during
the first six months of 1997 and 1996:
(In millions) 1997 1996
Total equity as of January 1 $5,931 $5,396
Income from Continuing Operations 607 530
Shareholder dividends paid (237) (220)
Proceeds from Sale of Common Stock 108 66
Repurchase of common and preferred stock (116) (207)
Purchase of Minority Interest (723) -
Net proceeds from issuance of mandatorily
redeemable preferred stock 637 -
All other, net (139) (56)
Balance as of June 30 $6,068 $5,509
Non-Financing Operations
Operational cash flows are highly seasonal. Due primarily to
profit sharing payments and inventory build up, historically our
operations have used cash in the first half and generated cash
later in the year.
The following table summarizes Document Processing non-financing
operations cash generation and borrowing for the six months ended
June 30, 1997 and 1996:
Cash Generated/(Borrowed)
Six Months Ended June 30
(In millions) 1997 1996
Document Processing
Non-Financing:
Income $ 505 $ 429
Depreciation and amortization 334 357
Capital expenditures, net (174) (211)
Working capital/other (1,084) (1,223)
Total $ (419) $ (648)
Six-month cash usage of $419 million was $229 million less than
in the first six months of 1996 due primarily to higher net
income, lower capital spending due to an unusually high level of
facilities infrastructure investments in the first half of 1996,
and reduced working capital growth resulting from improved
billing and collection performance.
Financing Businesses
Financing businesses debt was reduced by $201 million and $14
million during the first six months of 1997 and 1996,
respectively. This larger decline in 1997 reflects currency
translation effects related to the strength of the U.S. dollar
compared with the major European currencies which were only
partially offset by volume growth.
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 we employ long-standing
policies prescribing that derivative instruments only 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 U.S. dollar
value of a foreign currency-denominated loan. In addition, when
cost-effective, currency derivatives may be 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. 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 both the
risk of a major compression in interest margins if interest rates
increase and the opportunity for margin expansion if interest
rates decline.
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-rate
obligations. The transactions performed within each of these
three categories enable cost-effective management of interest
rate exposures. The potential risk attendant to this strategy is
non-performance of a swap counterparty. We address this risk by
arranging swaps exclusively with a diverse group of strong-credit
counterparties, regularly monitoring their credit ratings,
determining the replacement cost, if any, of existing
transactions, and internally capping related exposures.
Our currency and interest rate hedging is typically unaffected by
changes in market conditions as forward contracts, options and
swaps are normally held to maturity consistent with our objective
to lock in currency rates and interest rate spreads on the
underlying transactions.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth under Note 9 contained in the "Notes to
Consolidated Financial Statements" on pages 11-12 of this
Quarterly Report, on Form 10-Q, is incorporated by reference in
answer to this item.
Item 2. Changes in Securities
During the quarter ended June 30, 1997, Registrant issued the
following securities in transactions which were not registered
under the Securities Act of 1933, as amended (the Act):
(a) Securities Sold: on April 1, 1997, Registrant issued 1,798
shares of Common stock, par value $1 per share.
(b) No underwriters participated. The shares were issued to
each of the non-employee Directors of Registrant: A.A.
Johnson, B.R. Inman, V.E. Jordan, Jr., Y. Kobayashi,
H. Kopper, R.S. Larsen, J.D. Macomber, G.J. Mitchell,
N.J. Nicholas, Jr., J.E. Pepper, M.R. Seger and T.C.
Theobald.
(c) The shares were issued at a deemed purchase price of $56.875
per share (aggregate price $102,261.26), based upon the
market value on the date of issuance, in payment of the
quarterly Directors' fees pursuant to Registrant's
Restricted Stock Plan for Directors.
(d) Exemption from registration under the Act was claimed based
upon Section 4(2) as a sale by an issuer not involving a
public offering.
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of Xerox Corporation was duly
called and held on May 15, 1997 at the Sutton Place Hotel, 955
Bay Street, Toronto, Ontario, Canada.
Proxies for the meeting were solicited on behalf of the Board of
Directors of the Registrant pursuant to Regulation 14A of the
General Rules and Regulations of the Commission. There was no
solicitation in opposition to the Board of Directors' nominees
for election as directors as listed in the Proxy Statement, and
all nominees were elected.
At the meeting, votes were cast upon the Proposals described in
the Proxy Statement for the meeting (filed with the Commission
pursuant to Regulation 14A and incorporated herein by reference)
as follows:
Proposal 1 - Election of directors for the ensuing year.
Name For Withheld Vote
Paul A. Allaire 288,098,645 1,594,838
B. R. Inman 288,192,852 1,500,631
Antonia Ax:son Johnson 288,238,146 1,455,337
Vernon E. Jordan, Jr. 288,093,982 1,599,501
Yotaro Kobayashi 288,441,237 1,252,246
Hilmar Kopper 254,937,711 34,755,772
Ralph S. Larsen 288,455,665 1,237,818
John D. Macomber 288,389,761 1,303,721
George J. Mitchell 288,245,098 1,448,385
N. J. Nicholas, Jr. 288,439,212 1,254,271
John E. Pepper 288,408,014 1,285,469
Martha R. Seger 288,327,631 1,365,852
Thomas C. Theobald 288,358,443 1,335,040
Proposal 2 - To elect KPMG Peat Marwick LLP as independent
auditors for the year 1997.
For - 288,390,447
Against - 547,723
Abstain - 755,313
Proposal 3 - To approve the amendments to the 1991 Long-Term
Incentive Plan
For - 275,981,729
Against - 8,556,033
Abstain - 2,149,186
Broker Non-vote 3,006,535
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 3(a)(1) Restated Certificate of Incorporation of
Registrant filed by the Department of State of the State of
New York on October 29, 1996. Incorporated by reference to
Exhibit 3(a)(1) to Registrant's Quarterly Report on Form
10-Q for the Quarter Ended September 30, 1996.
Exhibit 3(b) By-Laws of Registrant, as amended through
May 29, 1991. Incorporated by reference to Exhibit 3(b)(2)
to Registrant's Quarterly Report for the Quarter Ended
June 30, 1991.
Exhibit 10(b) Registrant's 1991 Long-Term Incentive Plan,
as amended through May 15, 1997. Incorporated by reference
to Registrant's Notice of the 1997 Annual Meeting of
Shareholders and Proxy Statement pursuant to Regulation 14A.
Exhibit 10(n) Letter Agreement dated June 4, 1997 between
Registrant and G. Richard Thoman, President and Chief
Operating Officer of Registrant.
Exhibit 11 Computation of Net Income per Common Share.
Exhibit 12 Computation of Ratio of Earnings to Fixed
Charges.
Exhibit 27 Financial Data Schedule (in electronic form
only).
(b) Current reports on Form 8-K dated April 7, 1997, May 19,
1997, June 6, 1997 and June 30, 1997 reporting Item 5 "Other
Events" were filed during the quarter for which this Quarterly
Report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
XEROX CORPORATION
(Registrant)
_____________________________
Date: August 7, 1997 By Philip D. Fishbach
Vice President and Controller
(Principal Accounting Officer)