FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to___________
Commission File Number 1-4471
XEROX CORPORATION
(Exact Name of Registrant as
specified in its charter)
New York 16-0468020 _
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
P.O. Box 1600
Stamford, Connecticut 06904-1600
(Address of principal executive offices)
(Zip Code)
(203) 968-3000 _
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at October 31, 1998
Common Stock 327,918,850 shares
This document consists of 33 pages.
Forward-Looking Statements
From time to time Xerox Corporation (the Registrant or the Company) and its
representatives may provide information, whether orally or in writing,
including certain statements in this Form 10-Q under "Management's Discussion
and Analysis of Results of Operations and Financial Condition ," which are
deemed to be "forward-looking" within the meaning of the Private Securities
Litigation Reform Act of 1995 ("Litigation Reform Act"). These forward-
looking statements and other information relating to the Company 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," "intend," "will," 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 Registrant 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 Registrant does not intend to update these forward-looking statements.
In accordance with the provisions of the Litigation Reform Act we are making
investors aware that such "forward-looking" statements, because they relate to
future events, are by their very nature subject to many important factors
which could cause actual results to differ materially from those contained in
the "forward-looking" statements. Such factors include but are not limited to
the following:
Competition - the Registrant operates in an environment of significant
competition, driven by rapid technological advances and the demands of
customers to become more efficient. There are a number of companies worldwide
with significant financial resources which compete with the Registrant to
provide document processing products and services in each of the markets
served by the Registrant, some of whom operate on a global basis. The
Registrant's success in its future performance is largely dependent upon its
ability to compete successfully in its currently-served markets and to expand
into additional market segments.
Transition to Digital - presently black and white light-lens copiers represent
approximately 40% of the Registrant's revenues. This segment of the general
office is mature with anticipated declining industry revenues as the market
transitions to digital technology. Some of the Registrant's new digital
products replace or compete with the Registrant's current light-lens
equipment. Changes in the mix of products from light-lens to digital, and the
pace of that change as well as competitive developments could cause actual
results to vary from those expected.
Pricing - the Registrant's ability to succeed is dependent upon its ability to
obtain adequate pricing for its products and services which provide a
reasonable return to shareholders. Depending on competitive market factors,
future prices the Registrant can obtain for its products and services may vary
from historical levels.
Financing Business - a significant portion of the Registrant's profits arise
from the financing of its customers' purchase of the Registrant's equipment.
On average, 75 to 80 percent of equipment sales are financed through the
Registrant. The Registrant's ability to provide such financing at competitive
rates and realize profitable spreads is highly dependent upon its own costs of
borrowing which, in turn, depend upon its credit ratings. Significant changes
in such ratings could reduce the profitability of such financing business
and/or make the Registrant's financing less attractive to customers thus
reducing the volume of financing business done. The Registrant's present
credit ratings permit ready access to the credit markets. There is no
assurance that these credit ratings can be maintained and/or ready access to
the credit markets can be assured.
Productivity - the Registrant's ability to sustain and improve its profit
margins is largely dependent on its ability to maintain an efficient, cost-
effective operation. Productivity improvements through process reengineering,
design efficiency and supplier cost improvements are required to offset labor
and materials cost inflation and competitive price pressures.
International Operations - the Registrant derives approximately half its
revenue from operations outside of the United States. In addition, the
Registrant manufactures many of its products and/or their components outside
the United States. The Registrant's future revenue, cost and profit results
could be adversely affected by a number of factors, including changes in
foreign currency exchange rates, changes in economic conditions from country
to country, changes in a country's political conditions, trade protection
measures, licensing requirements and local tax issues.
New Products/Research and Development - the process of developing new high
technology products and solutions is inherently complex and uncertain. It
requires accurate anticipation of customers' changing needs and emerging
technological trends. The Registrant must then make long-term investments and
commit significant resources before knowing whether these investments will
eventually result in products that achieve customer acceptance and revenues
required to provide anticipated returns from these investments.
Restructuring - the Registrant's ability to ultimately reduce pre-tax annual
expenditures by approximately $1 billion is dependent upon its ability to
successfully implement the 1998 restructuring program including the
elimination of 9,000 jobs worldwide, the closing and consolidation of
facilities, and the successful implementation of process and systems changes.
Year 2000 - the Registrant's ability to complete its Year 2000 plan is
dependent upon the availability of resources, the Registrant's ability to
discover and correct the potential Year 2000 sensitive problems which could
have a serious impact on the Registrant's information management systems,
facilities and products, and the ability of the Registrant's suppliers and
customers to bring their systems into Year 2000 compliance.
Xerox Corporation
Form 10-Q
September 30, 1998
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 12
Discontinued Operations 22
Capital Resources and Liquidity 25
Risk Management 27
Part II - Other Information
Item 1. Legal Proceedings 29
Item 2. Changes in Securities 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 31
Exhibit Index
Computation of Net Income per Common Share 32
Computation of Ratio of Earnings to Fixed Charges 33
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/investor
PART I - FINANCIAL INFORMATION
Item 1 Xerox Corporation
Consolidated Statements of Income (Unaudited)
Three months ended Nine months ended
September 30, September 30,
(In millions, except per-share data) 1998 1997 1998 1997
Revenues
Sales $ 2,448 $ 2,343 $ 7,243 $ 6,602
Service and rentals 1,894 1,784 5,611 5,387
Finance income 265 243 799 749
Total Revenues 4,607 4,370 13,653 12,738
Costs and Expenses
Cost of sales 1,296 1,271 3,963 3,620
Cost of service and rentals 1,034 939 3,037 2,758
Inventory charges - - 113 -
Equipment financing interest 147 128 426 386
Research and development expenses 271 270 770 806
Selling, administrative and general
expenses 1,278 1,287 3,770 3,744
Restructuring and asset impairments - - 1,531 -
Other, net 41 25 157 49
Total Costs and Expenses 4,067 3,920 13,767 11,363
Income (Loss) before Income Taxes
(Benefits), Equity Income and
Minorities' Interests 540 450 (114) 1,375
Income taxes (benefits) 173 153 (66) 478
Equity in net income of
unconsolidated affiliates (28) (37) (54) (105)
Minorities' interests in earnings of
subsidiaries 14 14 35 75
Income (Loss) from Continuing Operations 381 320 (29) 927
Discontinued Operations - - (190) -
Net Income (Loss) $ 381 $ 320 $ (219) $ 927
Basic Earnings (Loss) per Share
Continuing Operations $ 1.12 $ 0.94 $ (0.19) $ 2.74
Discontinued Operations - - (0.58) -
Basic Earnings per Share $ 1.12 $ 0.94 $ (0.77) $ 2.74
Diluted Earnings (Loss) per Share
Continuing Operations $ 1.05 $ 0.89 $ (0.19) $ 2.58
Discontinued Operations - - (0.58) -
Diluted Earnings per Share $ 1.05 $ 0.89 $ (0.77) $ 2.58
See accompanying notes.
Xerox Corporation
Consolidated Balance Sheets
September 30, December 31,
(In millions, except share data in thousands) 1998 1997
Assets (Unaudited)
Cash $ 106 $ 75
Accounts receivable, net 2,553 2,145
Finance receivables, net 4,926 4,599
Inventories 3,506 2,792
Deferred taxes and other current assets 1,130 1,155
Total Current Assets 12,221 10,766
Finance receivables due after one year, net 8,365 7,754
Land, buildings and equipment, net 2,274 2,377
Investments in affiliates, at equity 1,265 1,332
Goodwill, net 1,782 1,375
Other assets 1,822 1,103
Investment in discontinued operations 1,936 3,025
Total Assets $ 29,665 $ 27,732
Liabilities and Equity
Short-term debt and current portion of
long-term debt $ 4,102 $ 3,707
Accounts payable 662 776
Accrued compensation and benefit costs 728 811
Unearned income 217 205
Other current liabilities 3,212 2,193
Total Current Liabilities 8,921 7,692
Long-term debt 10,882 8,779
Postretirement medical benefits 1,090 1,079
Deferred taxes and other liabilities 2,363 2,469
Discontinued operations liabilities -
policyholders' deposits and other 1,157 1,693
Deferred ESOP benefits (434) (434)
Minorities' interests in equity of subsidiaries 126 127
Company-obligated, mandatorily redeemable
preferred securities of subsidiary trust
holding solely subordinated debentures of
the Company 638 637
Preferred stock 692 705
Common shareholders' equity 4,230 4,985
Total Liabilities and Equity $ 29,665 $ 27,732
Shares of common stock issued 328,598 326,241
Shares of common stock outstanding 327,724 326,241
See accompanying notes.
Xerox Corporation
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30, (In millions) 1998 1997
Cash Flows from Operating Activities
Income (Loss)from Continuing Operations $ (29) $ 927
Adjustments required to reconcile income to cash
flows from operating activities:
Depreciation and amortization 589 517
Provisions for doubtful accounts 173 176
Restructuring and other charges 1,644 -
Provision for postretirement medical
benefits, net of payments 26 30
Charges against 1998 restructuring reserve (197) -
Minorities' interests in earnings of subsidiaries 35 75
Undistributed equity in income of affiliated companies (49) (101)
Increase in inventories (1,173) (723)
Increase in finance receivables (892) (513)
Increase in accounts receivable (390) (166)
Decrease in accounts payable and accrued
compensation and benefit costs (256) (126)
Net change in current and deferred income taxes (551) 108
Other, net (468) (183)
Total (1,538) 21
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment (337) (311)
Proceeds from sales of land, buildings and equipment 67 25
Purchase of additional interest in Rank Xerox - (812)
Acquisition of XLConnect, net of cash acquired (380) -
Other, net 6 -
Total (644) (1,098)
Cash Flows from Financing Activities
Net change in debt 2,499 249
Dividends on common and preferred stock (398) (356)
Proceeds from sale of common stock 99 130
Repurchase of common and preferred stock (147) (116)
Dividends to minority shareholders (4) (5)
Net proceeds from issuance of mandatorily
redeemable preferred securities - 637
Total 2,049 539
Effect of Exchange Rate Changes on Cash 6 (7)
Cash (Used) by Continuing Operations (127) (545)
Cash Provided by Discontinued Operations 158 503
Increase (Decrease) in Cash 31 (42)
Cash at Beginning of Period 75 104
Cash at End of Period $ 106 $ 62
See accompanying notes.
1. The unaudited consolidated interim financial statements
presented herein have been prepared by Xerox Corporation ("the
Company") in accordance with the accounting policies described in
its 1997 Annual Report to Shareholders and should be read in
conjunction with the notes thereto.
Effective 1998, Fuji Xerox changed its reporting period from a
fiscal year ending December 20 to a fiscal year ending December
31. Our share of their results of operations during the period
between the end of the 1997 fiscal year and the beginning of the
new fiscal year (the stub period) amounted to a loss of $6
million. The loss was debited 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.
References herein to "we" or "our" refer to Xerox and
consolidated subsidiaries unless the context specifically
requires otherwise.
2. Inventories consist of (in millions):
September 30, December 31,
1998 1997
Finished products $ 2,051 $ 1,549
Work in process 162 97
Raw materials and supplies 570 406
Equipment on operating leases, net 723 740
Total $ 3,506 $ 2,792
3. On April 7, 1998, we announced a worldwide restructuring
program associated with enhancing our competitive position and
lowering our overall cost structure. In connection with this
program, we recorded a second-quarter, pretax provision of $1,644
million ($1,107 million after taxes and including our share, $18
million, of a restructuring charge recorded by Fuji Xerox). The
program will include the elimination of approximately 9,000 jobs
worldwide, the closing and consolidation of facilities, and the
write-down of certain assets to net realizable value. The
charges associated with this action include $113 million of
inventory charges recorded as cost of revenues. Key initiatives
of the restructuring will include:
1) Consolidating 56 European customer support centers into one
facility and implementing a shared services organization which
will generate order entry, invoicing, and other back-office
and sales operations.
2) Streamlining manufacturing, logistics, distribution and
service operations. This will include centralizing U.S. parts
depots and outsourcing storage and distribution.
3) Overhauling our internal processes and associated resources,
including closing one of four geographically-organized U.S.
customer administrative centers.
The reductions will occur primarily in administrative functions,
but will also impact service, research and manufacturing.
The following table summarizes the status of the restructuring
reserve (in millions):
Charges September 30,
Total Against 1998
Reserve Reserve Balance
Severance and related costs $1,017 $185 $ 832
Asset impairment 316 316 -
Lease cancellation and other costs 198 15 183
Inventory charges 113 113 -
Total $1,644 $629 $1,015
As of September 30, 1998, approximately 3,200 employees have left
the Company under the restructuring program.
4. In May 1998, we acquired XLConnect Solutions, Inc.
("XLConnect"), an information technology services company, and
its parent Company, Intelligent Electronics, Inc. ("Intelligent
Electronics") for $413 million in cash. The operating results of
these companies, which are immaterial, have been included in our
consolidated statement of income from the date of acquisition.
Based on the allocation of the purchase price, this transaction
resulted in goodwill of $395 million (including transaction
costs), which is being amortized over 25 years.
5. Common shareholders' equity consists of (in millions):
September 30, December 31,
1998 1997
Common stock $ 330 $ 327
Additional paid-in-capital 1,433 1,303
Retained earnings 3,404 4,060
Net unrealized gain (loss) on
investment securities (1) (1)
Translation adjustments (857) (704)
Treasury stock (79) -
Total $ 4,230 $ 4,985
Effective January 1, 1998, we adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income."
This Statement requires that companies disclose comprehensive
income, which includes net income, foreign currency translation
adjustments, minimum pension liability adjustments, and
unrealized gains and losses on marketable securities classified
as available-for-sale.
Comprehensive income is as follows (in millions):
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
Net income (loss) $ 381 $ 320 $ (219) $ 927
Fuji Xerox stub period income(loss) - - (6) 8
Translation adjustments 77 (82) (153) (265)
Unrealized appreciation of equity
investments - - - 6
Comprehensive income (loss) $ 458 $ 238 $ (378) $ 676
6. In April 1998, we issued convertible subordinated debentures
for net proceeds of $575 million. The proceeds were used to
reduce commercial paper. The amount due upon maturity in April
2018 is $1,012 million, resulting in an effective interest rate
of 3.625% per annum, including 1.003% payable in cash
semiannually beginning in October 1998. These debentures are
convertible at any time at the option of the holder into 3.904
shares of our stock per $1,000 principal amount at maturity of
debentures.
7. Interest expense totaled $553 million and $450 million for
the nine months ended September 30, 1998 and 1997, respectively.
8. On August 13, 1998, we closed on the previously announced sale
of Crum & Forster Holdings, Inc. (CFI) to Fairfax Financial
Holdings Limited of Toronto for $680 million, including the
repayment of $115 million in debt. We incurred approximately $75
million in transaction-related costs.
With the completion of the CFI transaction, we have effectively
completed our exit from insurance and financial services. An
additional write-down of $190 million after-tax was recorded in
the first quarter of 1998.
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. Subsequently, a single corporate entity,
CSU,L.L.C.("CSU") was substituted for the three affiliated
companies. CSU claims damages predominately resulting from the
Company's alleged refusal to sell parts for high volume copiers
and printers to CSU 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 CSU, were not included in
that class action. The Company has asserted counterclaims
against CSU alleging patent and copyright infringement relating
to the copying of diagnostic software and service manuals. On
April 8, 1997, the District Court granted partial summary
judgement in favor of the Company on CSU's 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 judgement 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 judgement in favor of the
Company with respect to some of its claims of copyright
infringement. On July 17, 1997 and December 22, 1997 the Court
denied CSU's motions for reconsideration. On June 16-17, 1998 a
trial was held to establish copyright infringement damages to be
awarded to Xerox for the unlawful copying of the Company's
diagnostic software. A settlement was reached with regard to the
Company's infringement claims relating to service manuals. The
Court has calculated damages due to the Company in the amount of
$1,039,282 for its diagnostic software copyright infringement
claims. The Company intends to move for summary judgement on
plaintiff's antitrust claims. In response to that motion
Plaintiff has indicated it will concede, in light of the Court's
prior rulings, that there are no issues of fact barring entry of
summary judgement on its antitrust claims in favor of the Company
but that it will argue for reversal on appeal.
On April 11, 1996, an action was commenced by Accuscan Corp.
(Accuscan), in the United States District Court for the Southern
District of New York, against the Company seeking unspecified
damages for infringement of a patent of Accuscan which expired in
1993. The suit, as amended, was directed to facsimile and
certain other products containing scanning functions and sought
damages for sales between 1990 and 1993. On April 1, 1998, the
jury entered a verdict in favor of Accuscan for $40,000,000. On
October 1, 1998, the court entered an order which gives plaintiff
the option of reducing the amount of damages to $8,000,000 or, in
the alternative, request a new trial on the issue of damages.
Separately, the Company has filed a notice of appeal to the Court
of Appeals for the Federal Circuit with respect to the issue of
whether the Company should be liable for any damages. The
Company believes that the liability verdict should be set aside.
Item 2 Xerox Corporation
Management's Discussion and Analysis of
Results of Operations and Financial Condition
Document Processing
Summary
Income from continuing operations increased 19 percent to $381
million in the 1998 third quarter from $320 million in the 1997
third quarter, primarily as a result of outstanding growth in
digital product revenues and improved operating profit margins,
including the initial benefits from the worldwide restructuring
program.
Third quarter 1998 revenues of $4.6 billion were affected by
weaker global economic conditions, growing 6 percent on a pre-
currency basis. Weakness in Brazil and Russia alone reduced pre-
currency revenue growth by 2 percentage points in the quarter.
Diluted earnings per share from continuing operations increased 18
percent to $1.05 in the third quarter.
For the first nine months of the year, excluding the restructuring
charge, diluted earnings per share from continuing operations
increased 16 percent to $2.98 and income from continuing
operations increased 16 percent to $1,078 million. Including the
restructuring charge and the loss from discontinued operations,
Xerox reported a net loss of $219 million for the first nine
months of 1998, or a net loss of $0.77 per share.
Pre-Currency Growth
To understand the trends in the business, we believe that it is
helpful to adjust revenue and expense growth (except for ratios)
to exclude the impact of changes in the translation of foreign
currencies into U.S. dollars. We refer to this adjusted growth as
"pre-currency 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. When compared with the average of the
major European currencies on a revenue-weighted basis, the U.S.
dollar was approximately 2 percent weaker in the 1998 third
quarter than in the 1997 third quarter. However, the 9 percent
strengthening of the U.S. dollar compared with the Canadian dollar
essentially offset this impact.
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 pre-currency revenue growth
rates are as follows:
1997 1998 _
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3
Total Revenues 5% 6% 9% 10% 7% 10% 10% 6%
Digital Products 18 24 26 31 25 35 41 38
Light Lens Copiers (2) (3) 1 (2) (2) (4) (8) (15)
Digital product revenues grew 38 percent in the 1998 third
quarter, reaching 47 percent of total revenues and again exceeding
light lens revenues. In the 1997 third quarter, digital revenues
represented 35 percent of total revenues. The outstanding growth
of our expanding Document Centre black and white digital copier
family revenues represented 25 percentage points of the year-over-
year digital revenue growth. Production printing grew 11 percent
in the 1998 third quarter and production publishing grew 12
percent following a strong 1997 third quarter. Color copying and
printing growth slowed to 8 percent in the 1998 third quarter,
with excellent growth in DocuColor 40 revenues but flat revenues
in color copying due to increased competitive activity and pricing
pressure. For the first nine months of 1998, digital product
revenues grew 38 percent with over half the growth driven by the
Document Centre digital copier family. Color copying and printing
grew 24 percent, production publishing grew 17 percent and
production printing grew 6 percent.
Black-and-white light lens copier revenues declined 15 percent in
the 1998 third quarter as a result of some weakness in worldwide
economic conditions and continued pricing pressures, as well as
customer transition to the company's digital copiers. These
revenues were 40 percent of total revenues in the 1998 third
quarter compared with 50 percent of total revenues in the 1997
third quarter. Black-and-white light lens copier revenue declined
9 percent for the first nine months of 1998.
Geographically, the pre-currency revenue growth rates are as
follows:
1997 1998 _
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3
Total Revenues 5% 6% 9% 10% 7% 10% 10% 6%
United States 6 3 7 11 7 7 13 10
Xerox Limited 3 6 11 10 7 13 10 5
Other Areas 3 11 11 7 8 11 6 (4)
Memo: Fuji Xerox 10 3 3 (2) 3 2 (4) (6)
Third quarter and year to date U.S. revenue growth was driven by
excellent digital equipment sales and document outsourcing.
Xerox Limited and related companies manufacture and market Xerox
products principally in Europe. Xerox Limited revenue growth in
the 1998 third quarter and the first nine months of 1998 was
driven by excellent digital equipment sales and document
outsourcing growth, and strong growth in supplies. The U.K. and
Italy had strong revenue growth in the third quarter, Spain had
good growth, France and Holland had essentially flat revenues,
while revenue in Germany declined. In the first nine months of
1998, Holland, Italy and Spain had strong revenue growth, the UK
had good growth, France had modest growth while revenue in Germany
was essentially flat.
Other Areas include operations principally in Latin America,
Canada, China and Russia. Revenue in Brazil declined by 10 percent
in the 1998 third quarter as customers deferred purchases due to
the weak economic environment, although there was modest growth in
digital product revenues. Although our operations in Russia are
relatively small, with full year 1997 revenues of less than $100
million, there was a very significant revenue decline in the 1998
third quarter. Canada and a number of the smaller Latin American
affiliates, including Argentina and Colombia, had good revenue
growth in the third quarter. Revenue in Other Areas grew 4
percent during the first nine months of 1998. Revenue growth in
Canada and Mexico was strong while revenue in Brazil declined
modestly.
Fuji Xerox Co., Ltd., an unconsolidated entity, jointly owned by
Xerox Limited and Fuji Photo Film Company Limited, develops,
manufactures and distributes document processing products in
Japan, Australia, New Zealand, and other areas of the Pacific Rim.
Fuji Xerox revenue declined by 6 percent in the 1998 third quarter
reflecting a mid-single-digit decline in Japan and a double-digit
decline in Fuji Xerox' other Asia Pacific territories. For the
first nine months, revenue declined by 3 percent due to a modest
decline in Japan and a double-digit-decline in Fuji Xerox' other
Asia Pacific territories.
The pre-currency growth rates by type of revenue are as follows:
1997 1998 _
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3
Total Revenues 5% 6% 9% 10% 7% 10% 10% 6%
Sales 5 6 12 13 10 15 14 5
Equipment 11 12 17 16 14 17 19 7
Supplies 1 2 2 5 2 8 10 4
Paper (9) (1) 8 9 2 15 4 -
Service/Rentals/
Outsourcing/Other 4 5 6 6 5 4 6 6
Service (2) 1 2 1 1 3 1 1
Rentals (11) (8) (10) (7) (9) (9) (14) (10)
Document Outsourcing * 41 36 31 33 35 24 25 26
Finance Income 2 5 - 3 2 8 7 9
Memo:
Revenues Excluding
Equipment Sales 2 3 5 5 4 6 6 5
Equipment (Excluding OEM) 10 11 21 16 15 17 19 5
*Excludes equipment in outsourcing contracts that are accounted
for as sales.
Equipment sales in the 1998 third quarter grew 7 percent as
revenues declined in Brazil and Russia due to their weak economies
and we experienced some softness in several European countries.
Excluding Brazil and Russia, equipment sales grew 12 percent.
Approximately 55 percent of 1998 third quarter equipment sales was
due to products introduced since 1997, including the company's
expanding line of black-and-white digital copiers, the DocuTech
6180, the DocuColor Office 6, and the N series of network printers
sold through indirect channels. Equipment sales in the first nine
months of 1998 grew 14 percent primarily due to excellent growth
in digital products.
Supplies sales growth slowed in the 1998 third quarter primarily
due to paring back of inventory by our indirect sales channels
customers. For the first nine months of 1998, supply sales
increased 7 percent primarily due to growth in indirect channels
and competitive supplies.
Paper sales: Our strategy is to charge a spread over mill
wholesale prices to cover our costs and value added as a
distributor. Flat revenue in the 1998 third quarter reflects
slight volume increases due to expanding distribution channels,
offset by moderating industry prices due to excess worldwide
inventory. Good revenue growth in the first nine months of 1998
is primarily due to volume increases due to expanding distribution
channels partially offset by moderating industry prices.
Combined service, rental, document outsourcing and other revenues
grew 6 percent in the 1998 third quarter and 5 percent in the
first nine months of 1998. Service revenues grew 1 percent as the
impact of higher machine populations resulting from higher
equipment sales was partially offset by customer preference for
document outsourcing and competitive price pressures. Rental
revenues continued to decline, due primarily to customers'
preference for purchase or document outsourcing rather than
rental.
Document Outsourcing revenues are split between Equipment Sales
and Document Outsourcing. 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, including service, equipment rental,
supplies, paper, and labor, are included in
Service/Rentals/Outsourcing/Other on the income statement. This
has the effect of diverting some revenues from supplies, paper,
service and rental. The continuing excellent Document Outsourcing
growth reflects the trend of customers to focus on their core
businesses and outsource their document processing requirements to
Xerox. The growth rate for total document outsourcing revenue is
substantially higher than the growth included in
Service/Rentals/Outsourcing/Other, reflecting an increase in the
proportion of equipment in outsourcing contracts accounted for as
sales.
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. Good growth in
finance income in the 1998 third quarter and the first nine months
of 1998 is the result of strong growth in the financing of
equipment sales in Latin America, good growth in the U.S., and
modest growth in Europe.
Key Ratios and Expenses
The trend in key ratios was as follows:
1997 1998 _
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3
Gross Margin 46.4% 47.8% 46.5% 47.0% 46.9% 45.0% 45.6% 46.2%
SAG % Revenue 29.2 29.5 29.5 27.1 28.7 27.9 27.3 27.7
The gross margin declined by 0.3 percentage points in the 1998
third quarter from the 1997 third quarter, significantly less
than the gross margin decline in the first half of the year. The
modest third quarter gross margin decline was due to the
increasing proportion of lower margin indirect channels and
Document Outsourcing business, continued competitive price
pressures, and unfavorable product mix, partially offset by
manufacturing and service productivity. The 45.6 percent gross
margin for the first nine months of 1998 was 1.3 percentage points
lower than the first nine months of 1997 primarily due to the
factors mentioned above and weaker results in Brazil. The gross
margin for the first nine months of 1998, including the
restructuring charge was 44.8 percent.
Selling, administrative and general expenses (SAG) declined 1
percent in the 1998 third quarter from the 1997 third quarter due
to significant declines in general and administrative expenses
partially offset by increased sales coverage and advertising
investments. SAG was 27.7 percent of revenue in the 1998 third
quarter and 27.6 percent of revenue for the first nine months of
1998, 1.8 percentage points better than the 1997 third quarter and
the first nine months of 1997 due to continuing productivity
initiatives and expense controls, including the initial benefits
from our worldwide restructuring program, as well as the
increasing proportion of our business conducted through indirect
channels and Document Outsourcing.
Research and development (R&D) expense in the 1998 third quarter
was essentially flat with the 1997 third quarter. We continue to
invest in technological development to maintain our premier
position in the rapidly changing document processing market with
an added focus on increasing the effectiveness of that investment
and time to market. We expect R&D spending will be relatively
flat for the full year. Xerox R&D is strategically coordinated
with that of Fuji Xerox which invested $612 million in R&D in the
1997 full year, for a combined total of $1.7 billion.
Worldwide employment declined by 500 in the 1998 third quarter to
92,900 as a result of 1,700 employees leaving the company under
the worldwide restructuring program partially offset by the net
hiring of 1,200 employees, primarily for the company's fast-
growing document outsourcing business and the acquisition of an
Eastern European dealer.
The increase in other expenses, net, from the 1997 third quarter
and the first nine months of 1997 was due primarily to increased
non-financing interest expense and the planned increase in year
2000 remediation expenses.
Income Taxes (Benefits), Equity in Net Income of Unconsolidated
Affiliates and Minorities' Interests in the Earnings of
Subsidiaries
Income before income taxes increased 20 percent to $540 million in
the 1998 third quarter from $450 million in the 1997 third
quarter.
We estimate that the impact of currency on third quarter earnings
was about neutral which follows an adverse impact of approximately
$0.20 per share in the first half. If mid-October spot rates
continue, we would expect currency to benefit our 1998 fourth
quarter results by somewhat less than $0.05 per share compared to
a year ago. Under this scenario, currency will adversely affect
our earnings by about $0.15 to $0.20 per share for the full year,
after an adverse impact of $0.35 per share in 1997. Assuming mid-
October spot rates hold through 1999, currency could benefit our
earnings by about $0.20 per share year-over-year representing the
first positive impact in the past several years.
The effective tax rate was 32 percent in the 1998 third quarter,
which is consistent with the first half and the full year
expectation. The 2.2 percentage point decline from the 1997 third
quarter is due to the worldwide mix of profits as well as a tax
refund in 1998.
Equity in the net income of unconsolidated affiliates is
principally the Xerox Limited share of Fuji Xerox income. Total
equity in net income decreased in the 1998 third quarter due to
lower Fuji Xerox income reflecting difficult economic conditions
in Japan and their Asia Pacific operations and adverse currency
translation. We expect the difficult economic conditions in Japan
and the Pacific Rim to continue to adversely affect Fuji Xerox'
operations and that their earnings, before currency translation,
will be lower than 1997 for the balance of the year.
Minorities' Interests were unchanged and primarily reflect the
dividends on $650 million of mandatorily redeemable preferred
stock issued through a trust in January 1997 to reduce debt.
On April 7, 1998, we announced a worldwide restructuring program
associated with enhancing our competitive position and lowering
our overall cost structure. In connection with this program, we
recorded a second-quarter pretax provision of $1,644 million
($1,107 million after taxes and including our share of the Fuji
Xerox restructuring charge). The program will include the
elimination of approximately 9,000 jobs worldwide, the closing and
consolidation of facilities, and the write-down of certain assets.
The pre-tax charges associated with this action include $113
million of inventory charges recorded as cost of revenues. Key
initiatives of the restructuring will include:
1) Consolidating 56 European customer support centers into one
facility and implementing a shared services organization which
will generate order entry, invoicing, and other back-office and
sales operations.
2) Streamlining manufacturing, logistics, distribution and service
operations. This will include centralizing U.S. parts depots
and outsourcing storage and distribution.
3) Overhauling our internal processes and associated resources,
including closing one of four geographically-organized U.S.
customer administrative centers.
The reductions will occur primarily in administrative functions,
but will also impact service, research and manufacturing.
The following table summarizes the status of the restructuring
reserve (in millions):
Charges September30,
Original Against 1998
Reserve Reserve Balance
Severance and related costs $1,017 $185 $ 832
Asset impairment 316 316 -
Lease cancellation and other costs 198 15 183
Inventory charges 113 113 -
Total $1,644 $629 $ 1,015
When fully implemented, the ongoing pre-tax savings from the
restructuring initiatives will be approximately $1 billion
annually. Initially, more than half of the savings will be
reinvested to implement process and systems changes in order to
enable the restructuring, and in ongoing efforts to broaden and
strengthen marketing programs and distribution channels to enhance
revenue growth.
Selling, administrative and general expenses as a percentage of
revenue will move from the high 20's to the low 20's over time,
driven primarily by large reductions in overhead costs.
Manufacturing and service productivity will also improve. These
benefits will be somewhat offset by lower gross margins overall
due to the increasing proportion of business conducted through
indirect sales channels and outsourcing.
As of September 30, 1998, approximately 3,200 employees had left
the company under the restructuring program. The restructuring
reserve balance at September 30, 1998 relates to cash expenditures
to be incurred primarily during the remainder of 1998 and in 1999.
In April 1998, we announced that we were reactivating our $1
billion stock repurchase program, which was suspended last year
when we acquired the remaining financial interest in Rank Xerox,
now Xerox Limited. During the third quarter, the company
repurchased 1.1 million shares at a cost of $100 million for an
average price of $88 per share. Since the program inception,
share repurchases total 10.1 million shares for $568 million.
In May 1998, the company completed the $413 million acquisition of
XLConnect Solutions, Inc., an information technology services
company, and its parent company, Intelligent Electronics, Inc.
The results of operations for these companies have been included
in our results of operations since the date of acquisition.
The Year 2000 (Y2K) problem is the result of computer programs
written in two digits, rather than four, to define the applicable
year. As a result, many information systems are unable to
properly recognize and process date-sensitive information beyond
December 31, 1999. As with all major companies, certain of our
information systems and products require remediation or
replacement over the next year in order to render these systems
Year 2000 compliant.
We have divided the Year 2000 project into five major sections:
Information Technology; and the non-Information Technology areas
of Facilities, Vendor Compliance, Product Compliance and
Facilities Management products and services. The general phases
common to all sections are: 1) Awareness - a strategic approach
was developed to address the Year 2000 problem. 2) Assessment -
detailed plans and target dates were developed. 3) Programming -
includes hardware and software upgrades, systems replacements,
vendor certification and other associated changes. 4) Testing -
includes testing and conversion of system applications. 5)
Implementation - includes compliance achievement and user
acceptance.
The Information Technology section includes applications
(software), compute (mainframe/smaller computer environments),
infrastructure (networks, servers, and workstations), and
telecommunications. The status of each section is as follows:
Applications - 60 percent of the mission critical applications are
Y2K compliant, with an additional 23 percent in the process of
compliance testing. The remaining balance is in the process of
remediation design. We estimate that 90-95 percent of our
applications will be compliant by December 31, 1998 with the
balance achieving compliance by early 1999.
Compute - 76 percent of our mainframe/smaller computer
environments have been upgraded to be Y2K compliant with the
remainder scheduled to be upgraded by December 31, 1998.
Infrastructure - 32 percent of networks, servers, and workstations
have been upgraded to be Y2K compliant with the remainder to be
upgraded by mid-1999.
Telecommunications - 23 percent of internal mission critical
components are Y2K compliant, 51 percent are in the implementation
stage while the remaining 26 percent are in the programming stage.
We anticipate achieving compliance in this area by mid-1999.
Our Y2K project requires a majority of application systems be
remediated by December 31, 1998, or one year earlier than the
recognized failure date of 2000. For the 90-95 percent of our
applications that will be compliant by December 31, 1998, no
contingency plan is necessary. In those instances where
completion by the end of 1998 is not assured, appropriate and
unique contingency plans are in place, in development, or yet to
be determined.
The Facilities section, which includes electrical systems,
elevators, access control, security systems, etc., is primarily in
the assessment phase. We anticipate achieving compliance by
August 1, 1999.
We began our efforts in the Vendor Compliance area in November
1997. A general awareness letter was sent to all external
suppliers, and an assessment survey was sent to all business
critical suppliers. However, the response rate to this survey was
poor. Due to the poor response rate and the low-level of
confidence gained from responses to surveys, we decided to focus
our efforts along two fronts. First, we have initiated efforts
to evaluate the status of sole source/key proprietary suppliers of
long lead components as well as non-production suppliers and to
determine alternatives and contingency plan requirements.
Secondly, it is our intent to acquire additional inventory by
December 31, 1999 to ensure continuity of service to our customers
should our vendors experience Y2K problems. A process is underway
to determine the right product mix of this additional inventory.
These procedures are intended to provide a means of managing risk;
however, no assurance can be given that they will eliminate the
potential disruption caused by third party failure.
Regarding Product Compliance, we have determined that
approximately 77% of our product offerings are currently Y2K
compliant. An additional 11% are not being assessed for
compliance as the product has reached its end of life. The
remaining 12% of our products will be made compliant by June 30,
1999.
In Facilities Management, we are currently performing an inventory
and assessment of all third party components (Xerox products are
being remediated as part of the Information Technology and Product
Compliance sections). We expect that the remediation effort will
continue through March 31, 1999.
We are also dependent upon our customers for sales and cash flows.
Y2K interruptions in our customers' operations could result in
reduced sales, increased inventory or receivable levels and cash
flow reductions. While these events are possible, our customer
base is sufficiently broad to minimize the effects.
Xerox had begun, in 1993, a project to replace the majority of its
legacy systems which in many cases date back to the 1960s. These
efforts continue today. As to remediation, we currently estimate
that costs, exclusive of software and systems that are being
replaced or upgraded in the normal course of business, will be
$85 million during 1998, of which $58 million has been expended as
of September 30, 1998, and $50 million in 1999. The increase from
prior estimates is primarily due to costs being incurred in the
product compliance area.
We believe that the remediation of our information systems and
products will occur in a timely fashion so that the Y2K problem
will not result in significant operating problems with our
operating systems, facilities and products. However, if such
remediations or replacements are not completed in a timely manner,
the Y2K problem could potentially have a material adverse impact
on our operations. Possible worst case consequences could include
an interruption in our ability to: bill and apply collections from
our customers; manufacture and deliver products to our customers,
or meet our cash requirement needs.
The Euro. On January 1, 1999, eleven of the fifteen member
countries of the European Union are scheduled to establish fixed
conversion rates between their existing currencies and one common
currency - the euro. The euro will then trade on currency
exchanges and may be used in business transactions. Xerox Limited
has processes in place to address the systems and business issues
raised by the euro currency conversion. These issues include
among others, 1) the need to adapt computer and other business
systems and equipment to accommodate euro-denominated
transactions, and 2) the competitive impact of cross-border price
transparency, which may make it more difficult for businesses to
price for local markets for the same products on a country-by-
country basis. We estimate that the euro conversion will not have
a material impact on our financial condition or results of
operations.
New Accounting Standards. In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 requires companies to recognize all
derivatives as assets or liabilities measured at their fair value.
Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. We do
not expect this Statement to have a material impact on our
consolidated financial statements. This Statement is effective for
fiscal years beginning after June 15, 1999. We will adopt this
accounting standard beginning January 1, 2000.
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 $779 million at
September 30, 1998 compared with $1,332 million at December 31,
1997. The decrease primarily reflects the sale of Westchester
Specialty Group, Inc. (WSG) and Crum & Forster Holdings, Inc.
(CFI) and a reserve increase recorded in the first quarter,
somewhat offset by scheduled funding of reinsurance coverage to
the present and former 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 Group, Inc. (Coregis),
CFI, Industrial Indemnity Holdings, Inc. (II), WSG, TRG and three
insurance-related service companies.
On September 11, 1996, those transactions were terminated. No
additional charges were 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 retained
investment bankers to assist us in the simultaneous disposition of
each of the Remaining insurance and service companies.
Significant progress was made during 1997 and 1998 in the
disposition of the remaining companies. Specifically:
- - In the first quarter of 1997, we sold certain assets of Apprise
Corp., one of Talegen's insurance related service companies. The
financial terms of this transaction were not material.
- - In the second quarter of 1997, we completed the sale of Coregis
for $375 million in cash and the assumption of $75 million in
debt.
- - In the third quarter of 1997, we completed the sale of II for
$365 million in cash and the assumption of $79 million in debt.
- - In the fourth quarter of 1997, we completed the sale of TRG for
$150 million in cash and a $462 million performance-based
instrument to an investor group. Ultimate recovery of the value
of this instrument will be dependent on TRG's future cash flows
available for dividends.
- - In the first quarter of 1998, we completed the sale of WSG for
$338 million in cash, less approximately $70 million in
transaction-related costs.
- - In the third quarter of 1998, we completed the sale of CFI for
$680 million, including the repayment of $115 million in debt. In
connection with the sale, we incurred approximately $75 million in
transaction-related costs.
With the completion of the CFI transaction, we have effectively
completed our disengagement strategy from insurance and financial
services. In the first quarter of 1998 an additional write-down
of $190 million after-tax was recorded.
Xerox Financial Services, Inc. (XFSI) continues to provide
aggregate excess of loss reinsurance coverage to certain of the
former Talegen and TRG units through Ridge Re, a wholly owned
subsidiary. As of October 1998, XFSI is obligated to pay four
remaining annual premium installments of $43 million, plus finance
charges for coverage totaling $982 million (which is net of 15
percent coinsurance). At September 30, 1998, Ridge Re had
recognized the discounted value of approximately $661 million of
the available coverage.
The net investment in Insurance at September 30, 1998 totaled $533
million compared with a balance of $1,076 million at December 31,
1997. The decrease primarily reflects the sale of WSG and CFI and
the reserve increase recorded in the first quarter of 1998,
somewhat offset by contractual payments to Ridge Re for annual
premium installments and associated finance charges and interest
on the assigned insurance debt.
Other Financial Services
The net investment in Other Financial Services at September 30,
1998 was $130 million compared with $125 million at December 31,
1997.
On June 1, 1995, 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 September 30, 1998,
OakRe retained approximately $1.0 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 September 30, 1998. 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 September 30, 1998
totaled $265 million compared with a balance of $298 million at
December 31, 1997. The $33 million reduction from the December
31, 1997 level primarily relates to scheduled run-off in third
party financing and sales of certain real estate and other
investments. Debt associated with these assets totaled $149
million at September 30, 1998 and $167 million at December 31,
1997.
Capital Resources and Liquidity
Total debt, including ESOP and discontinued operations debt not
shown separately in our consolidated balance sheets, was $15,134
million at September 30, 1998 or $2,231 million more than at
December 31, 1997. The changes in consolidated indebtedness since
year-end and versus the first nine months of 1997 are summarized
as follows (in millions):
1998 1997
Total Debt as of January 1 $12,903 $12,448
Non-Financing Businesses:
Document Processing operations 1,115 173
Discontinued Businesses (388) (506)
Total Non-Financing 727 (333)
Financing Businesses 647 (106)
Total Operations 1,374 (439)
Shareholder dividends 398 356
Purchase of The Rank Group's interests
in Rank Xerox (now Xerox Limited) - 1,534
Purchase of XLConnect , net of
cash acquired 380 -
Mandatorily redeemable preferred stock (1) (637)
Equity redemption and other changes 80 (56)
Total Debt as of September 30 $15,134 $13,206
For analytical purposes, total equity includes common equity; ESOP
preferred stock; mandatorily redeemable preferred securities; and
minorities' interests. The following table summarizes the changes
in total equity during the first nine months of 1998 and 1997 (in
millions):
1998 1997
Total equity as of January 1 $6,454 $5,931
Income (loss)from continuing operations (29) 927
Loss from discontinued operations (190) -
Shareholder dividends paid (398) (356)
Exercise of stock options 99 130
Repurchase of common and preferred stock (147) (116)
Purchase of minority interest - (723)
Mandatorily redeemable preferred securities 1 637
Translation adjustment (153) (265)
All other, net 49 63
Balance as of September 30 $5,686 $6,228
Non-Financing Operations
Non-financing cash usage during the first nine months of 1998 has
increased significantly compared with the first nine months of
1997 as explained below. It should be noted, however, that our
non-financing operations have historically generated significant
amounts of cash in the fourth quarter of the year.
The following table summarizes Document Processing non-financing
operations cash generation and borrowing for the nine months ended
September 30, 1998 and 1997 (in millions):
Cash Generated/(Borrowed)
September 30, September 30,
1998 1997
Document Processing
Non-Financing:
Income / (Loss) $(140) $ 763
Depreciation and amortization 589 517
Restructuring charges 1,644 -
Charges against 1998 restructuring
reserve (197) -
Net change in current
and deferred income taxes (551) 108
Increase in inventories (1,173) (723)
Increase in accounts receivable (390) (166)
Decrease in payables and accrued
compensation (256) (126)
Capital investment, net (270) (286)
All other, net (371) (260)
Total $(1,115) $(173)
Cash usage was $1,115 million and $173 million during the first
nine months of 1998 and 1997, respectively. Net income before
depreciation and amortization, restructuring charges, and the
change in deferred income taxes increased $154 million to $1,542
million for the first nine months of 1998. However, this was more
than offset by cash expenditures against the 1998 restructuring
reserve, increased inventory investment in support of accelerated
digital product sales growth, higher accounts receivable due to
stronger equipment sales growth and some increase in days sales
outstanding due to the temporary effects from the reorganization
and consolidation of U.S. customer administrative centers, and
settlement in 1998 of compensation obligations.
Financing Businesses
Financing business debt growth of $647 million during the first
nine months of 1998 contrasts with a $106 million reduction during
the first nine months of 1997. The $753 million period over
period change reflects strong growth in equipment sales, an
increase in the length of the average contract originated in 1998
and currency translation effects due to a significant
strengthening of the U.S. dollar against most major European
currencies during the first nine months of 1997.
Risk Management
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 U.S. dollar
value of a foreign currency-denominated loan. In addition, when
cost-effective, currency derivatives are 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 cost-effective management of interest rate exposures. The
potential risk attendant to this strategy is the 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, and determining the
replacement cost, if any, of existing transactions.
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 10-11 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 September 30, 1998, 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 July 1, 1998, Registrant issued
1,077 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: B.R.
Inman, A.A.Johnson, V.E. Jordan, Jr., Y. Kobayashi, H.
Kopper, R.S. Larsen, J.D. Macomber, G.J. Mitchell, N.J.
Nicholas, Jr., J.E. Pepper, P. F. Russo, M.R. Seger and
T.C.Theobald.
(c) The shares were issued at a deemed purchase price of
$101.625 per share (aggregate price $108,875), 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 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
February 2, 1998. Incorporated by reference to Exhibit 3
(b)to Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
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) No current reports on Form 8-K 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: November 10, 1998 By Philip D. Fishbach
Vice President and Controller
(Principal Accounting Officer)
Exhibit 11
Xerox Corporation
Computation of Net Income Per Common Share
(Dollars in millions, except per-share data; shares in thousands)
Three months Nine Months
ended September 30, ended September 30,
1998 1997 1998 1997
I. Basic Net Income (Loss) Per Common Share
Income (loss) from
continuing operations $ 381 $ 320 $ (29) $ 927
Accrued dividends on ESOP preferred
stock, net (11) (11) (34) (33)
Adjusted income (loss)from
continuing operations 370 309 (63) 894
Discontinued operations - - (190) -
Adjusted net income (loss) $ 370 $ 309 $ (253) $ 894
Average common shares outstanding
during the period 327,655 325,237 327,738 324,430
Common shares issuable with respect
to exchangeable shares 1,650 1,908 1,650 1,908
Adjusted average shares outstanding
for the period 329,305 327,145 329,388 326,338
Basic earnings (loss) per share:
Continuing operations $ 1.12 $ 0.94 $ (0.19) $ 2.74
Discontinued operations - - (0.58) -
Basic earnings per share $ 1.12 $ 0.94 $ (0.77) $ 2.74
II. Diluted Net Income (Loss) Per Common Share
Income (loss) from
continuing operations $ 381 $ 320 $ (29) $ 927
ESOP expense adjustment, net of tax 1 - - -
Interest on convertible debt,
net of tax 4 1 - 2
Accrued dividends on ESOP preferred
stock, net - - (34) -
Adjusted income (loss) from
continuing operations 386 321 (63) 929
Discontinued operations - - (190) -
Adjusted net income (loss) $ 386 $ 321 $ (253) $ 929
Average common shares outstanding
during the period 327,655 325,237 327,738 324,430
Stock options, incentive and
exchangeable shares 6,535 5,841 1,650 5,841
Convertible debt 6,595 2,644 - 2,644
ESOP preferred stock 26,811 27,418 - 27,418
Adjusted average shares outstanding
for the period 367,596 361,140 329,388 360,333
Diluted earnings (loss) per share:
Continuing operations $ 1.05 $ 0.89 $ (0.19) $ 2.58
Discontinued operations - - (0.58) -
Diluted earnings per share $ 1.05 $ 0.89 $ (0.77) $ 2.58
Exhibit 12 Xerox Corporation
Computation of Ratio of Earnings to Fixed Charges
Nine months ended Year ended
September 30, December 31,
(In millions) 1998* 1997 1997 1996 1995 1994 1993**
Fixed charges:
Interest expense $ 553 $ 450 $ 617 $ 592 $ 603 $ 520 $ 540
Rental expense 104 92 140 140 142 170 180
Total fixed charges
before capitalized
interest and preferred
stock dividends of
subsidiaries 657 542 757 732 745 690 720
Preferred stock divi-
dends of subsidiaries 41 37 50 - - - -
Capitalized interest - - - - - 2 5
Total fixed charges $ 698 $ 579 $ 807 $ 732 $ 745 $ 692 $ 725
Earnings available for
fixed charges:
Earnings*** $ (60) $1,480 $2,268 $2,067 $1,980 $1,602 $ (193)
Less undistributed
income in minority
owned companies (49) (101) (84) (84) (90) (54) (51)
Add fixed charges before
capitalized interest
and preferred stock
dividends of
subsidiaries 657 542 757 732 745 690 720
Total earnings
available for
fixed charges $ 548 $1,921 $2,941 $2,715 $2,635 $2,238 $ 476
Ratio of earnings to
fixed charges (1)(2) 0.79 3.32 3.64 3.71 3.54 3.23 0.66
(1) The ratio of earnings to fixed charges has been computed based on the
Company's continuing operations by dividing total earnings available for
fixed charges, excluding capitalized interest and preferred stock
dividends of subsidiaries, by total fixed charges. Fixed charges consist
of interest, including capitalized interest and preferred stock dividends
of subsidiaries, and one-third of rent expense as representative of the
interest portion of rentals. Debt has been assigned to discontinued
operations based on historical levels assigned to the businesses when
they were continuing operations, adjusted for subsequent paydowns.
Discontinued operations consist of the Company's Insurance, Other
Financial Services, and Third Party Financing and Real Estate businesses.
(2) The Company's ratio of earnings to fixed charges includes the effect of
the Company's finance subsidiaries, which primarily finance Xerox
equipment. Financing businesses are more highly leveraged and,
therefore, tend to operate at lower earnings to fixed charges ratio
levels than do non-financial businesses.
* Earnings for the nine months of 1998 were inadequate to cover fixed
charges. The coverage deficiency was $150 million. Excluding the
restructuring charge, the ratio of earnings to fixed charges would be 3.14.
** 1993 earnings were inadequate to cover fixed charges. The coverage
deficiency was $249 million.
*** Sum of "Income (Loss) before Income Taxes (Benefits), Equity Income and
Minorities' Interests" and "Equity in Net Income of Unconsolidated
Affiliates."
5
1,000,000
9-MOS
DEC-31-1998
JAN-01-1998
SEP-30-1998
106
0
16,343
499
3,506
12,221
5,161
2,887
29,665
8,921
15,133
638
692
330
3,900
29,665
7,243
13,653
3,963
7,539
6,228
173
553
(114)
(66)
(29)
(190)
0
0
(219)
(0.77)
(0.77)
