UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
_______________
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: March 31, 2018
OR
o | 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 001-04471
XEROX CORPORATION
(Exact Name of Registrant as specified in its charter)
New York | 16-0468020 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
P.O. Box 4505, 201 Merritt 7 Norwalk, Connecticut | 06851-1056 | |
(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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | o | Non-accelerated filer (Do not check if smaller reporting company) | o | Smaller reporting company | o | Emerging growth company | o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Class | Outstanding at March 31, 2018 | |
Common Stock, $1 par value | 254,679,473 shares | |
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q and any exhibits to this Report contain “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “will”, “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements. These statements reflect management’s current beliefs, assumptions and expectations and are subject to a number of factors that may cause actual results to differ materially. Such factors include but are not limited to: our ability to address our business challenges in order to reverse revenue declines, reduce costs and increase productivity so that we can invest in and grow our business; changes in economic and political conditions, trade protection measures, licensing requirements and tax laws in the United States and in the foreign countries in which we do business; changes in foreign currency exchange rates; our ability to successfully develop new products, technologies and service offerings and to protect our intellectual property rights; the risk that multi-year contracts with governmental entities could be terminated prior to the end of the contract term and that civil or criminal penalties and administrative sanctions could be imposed on us if we fail to comply with the terms of such contracts and applicable law; the risk that partners, subcontractors and software vendors will not perform in a timely, quality manner; actions of competitors and our ability to promptly and effectively react to changing technologies and customer expectations; our ability to obtain adequate pricing for our products and services and to maintain and improve cost efficiency of operations, including savings from restructuring actions; the risk that individually identifiable information of customers, clients and employees could be inadvertently disclosed or disclosed as a result of a breach of our security systems; reliance on third parties, including subcontractors, for manufacturing of products and provision of services; our ability to manage changes in the printing environment and expand equipment placements; interest rates, cost of borrowing and access to credit markets; funding requirements associated with our employee pension and retiree health benefit plans; the risk that our operations and products may not comply with applicable worldwide regulatory requirements, particularly environmental regulations and directives and anti-corruption laws; the outcome of litigation and regulatory proceedings to which we may be a party; the effects on our business resulting from actions of activist shareholders; and other factors that are set forth in the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of this Quarterly Report on Form 10-Q and our 2017 Annual Report on Form 10-K, as well as our Current Reports on Form 8-K filed with the Securities and Exchange Commission (SEC). Furthermore, the actual results of the proposed transaction with FUJIFILM Holdings Corporation ("Transaction") could vary materially as a result of a number of factors, including, but not limited to: (i) the risk that the Transaction may not be completed in a timely manner or at all, which may adversely affect Xerox’s business and the price of Xerox’s common stock, (ii) the failure to satisfy the conditions to the consummation of the Transaction, including the receipt of certain approvals from Xerox’s shareholders and certain governmental and regulatory approvals, (iii) the parties may be unable to achieve expected synergies and operating efficiencies in the Transaction within the expected time frames or at all, (iv) the Transaction may not result in the accretion to Xerox’s earnings or other benefits, (v) the occurrence of any event, change or other circumstance that could give rise to the termination of the Transaction agreements, (vi) the effect of the announcement or pendency of the Transaction on Xerox’s and/or Fujifilm’s business relationships, operating results, and business generally, risks related to the proposed Transaction disrupting Xerox’s current plans and operations and potential difficulties in Xerox’s employee retention as a result of the Transaction, (vii) risks related to diverting management’s attention from Xerox’s ongoing business operations, (viii) the outcome of any legal proceedings that may be instituted against Xerox, its officers or directors related to the Transaction agreements or the Transaction and (ix) the possibility that competing offers or acquisition proposals for Xerox will be made. Xerox assumes no obligation to update any forward-looking statements as a result of new information or future events or developments, except as required by law.
Fuji Xerox Co., Ltd. (“Fuji Xerox”) is a joint venture between Xerox and Fujifilm in which Xerox holds a noncontrolling 25% equity interest and Fujifilm holds the remaining equity interest. Given our status as a minority investor, we have limited contractual and other rights to information with respect to Fuji Xerox matters. In April 2017, Fujifilm formed an independent investigation committee (the “IIC”) to primarily conduct a review of the appropriateness of the accounting practices at Fuji Xerox’s New Zealand subsidiary and at other subsidiaries. The IIC completed its review during the second quarter 2017 and identified aggregate adjustments to Fuji Xerox’s financial statements of approximately JPY 40 billion (approximately $360 million) primarily related to misstatements at Fuji Xerox’s New Zealand and Australian subsidiaries. We determined that our share of the total adjustments identified as part of the investigation was approximately $90 million and impacted our fiscal years 2009 through 2017. We revised our previously issued annual and interim consolidated financial statements for 2014, 2015 and 2016 and the first quarter of 2017. Fujifilm and Fuji Xerox continue to review Fujifilm’s oversight and governance of Fuji Xerox as well as Fuji Xerox’s oversight and governance over its businesses in light of the findings of the IIC.
In 2018, in connection with the completion of audits of Fuji Xerox’s fiscal year-end financial statements as of and for the years ended March 31, 2016 and 2017, as well as the review of Fuji Xerox’s unaudited interim financial statements
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as of and for the nine months ended December 31, 2017 and 2016, additional adjustments and misstatements were identified. These additional adjustments and misstatements were to the net income of Fuji Xerox for the period from 2010 through 2017 previously revised for the items identified by the IIC noted above. At this time, we can provide no assurances relative to the outcome of any potential governmental investigations or any consequences thereof that may happen as a result of this matter.
Xerox 2018 Form 10-Q
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XEROX CORPORATION
FORM 10-Q
March 31, 2018
TABLE OF CONTENTS
Page | ||
For additional information about Xerox Corporation and access to our Annual Reports to Shareholders and SEC filings, free of charge, please visit our website at www.xerox.com/investor. Any information on or linked from the website is not incorporated by reference into this Form 10-Q.
Xerox 2018 Form 10-Q
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ITEM 1 — FINANCIAL STATEMENTS
XEROX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended March 31, | ||||||||
(in millions, except per-share data) | 2018 | 2017 | ||||||
Revenues | ||||||||
Sales | $ | 933 | $ | 936 | ||||
Services, maintenance and rentals | 1,431 | 1,442 | ||||||
Financing | 71 | 76 | ||||||
Total Revenues | 2,435 | 2,454 | ||||||
Costs and Expenses | ||||||||
Cost of sales | 563 | 565 | ||||||
Cost of services, maintenance and rentals | 868 | 881 | ||||||
Cost of financing | 34 | 33 | ||||||
Research, development and engineering expenses | 100 | 111 | ||||||
Selling, administrative and general expenses | 628 | 634 | ||||||
Restructuring and related costs | 28 | 118 | ||||||
Amortization of intangible assets | 12 | 14 | ||||||
Transaction and related costs | 36 | — | ||||||
Other expenses, net | 32 | 114 | ||||||
Total Costs and Expenses | 2,301 | 2,470 | ||||||
Income (loss) before Income Taxes and Equity Income | 134 | (16 | ) | |||||
Income tax expense (benefit) | 40 | (24 | ) | |||||
Equity in net (loss) income of unconsolidated affiliates(1) | (68 | ) | 40 | |||||
Income from Continuing Operations | 26 | 48 | ||||||
Loss from discontinued operations, net of tax | — | (6 | ) | |||||
Net Income | 26 | 42 | ||||||
Less: Net income attributable to noncontrolling interests | 3 | 2 | ||||||
Net Income Attributable to Xerox | $ | 23 | $ | 40 | ||||
Amounts Attributable to Xerox: | ||||||||
Net income from continuing operations | $ | 23 | $ | 46 | ||||
Net loss from discontinued operations | — | (6 | ) | |||||
Net Income Attributable to Xerox | $ | 23 | $ | 40 | ||||
Basic Earnings (Loss) per Share: | ||||||||
Continuing operations | $ | 0.08 | $ | 0.17 | ||||
Discontinued operations | — | (0.03 | ) | |||||
Total Basic Earnings per Share | $ | 0.08 | $ | 0.14 | ||||
Diluted Earnings (Loss) per Share: | ||||||||
Continuing operations | $ | 0.08 | $ | 0.16 | ||||
Discontinued operations | — | (0.02 | ) | |||||
Total Diluted Earnings per Share | $ | 0.08 | $ | 0.14 | ||||
__________________________
(1) Equity in net income of unconsolidated affiliates has been revised for the prior year period presented throughout this document. Refer to Note 2 - Correction of Fuji Xerox Misstatement in Prior Period Financial Statements for additional information on this revision.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Xerox 2018 Form 10-Q
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XEROX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended March 31, | ||||||||
(in millions) | 2018 | 2017 | ||||||
Net Income | $ | 26 | $ | 42 | ||||
Less: Net income attributable to noncontrolling interests | 3 | 2 | ||||||
Net Income Attributable to Xerox | 23 | 40 | ||||||
Other Comprehensive Income, Net(1): | ||||||||
Translation adjustments, net | 176 | 133 | ||||||
Unrealized gains, net | 17 | 8 | ||||||
Changes in defined benefit plans, net | 18 | 26 | ||||||
Other Comprehensive Income, Net | 211 | 167 | ||||||
Less: Other comprehensive income, net attributable to noncontrolling interests | — | 1 | ||||||
Other Comprehensive Income, Net Attributable to Xerox | 211 | 166 | ||||||
Comprehensive Income, Net | 237 | 209 | ||||||
Less: Comprehensive income, net attributable to noncontrolling interests | 3 | 3 | ||||||
Comprehensive Income, Net Attributable to Xerox | $ | 234 | $ | 206 | ||||
__________________________
(1) Refer to Note 17 - Other Comprehensive Income for gross components of Other Comprehensive Income, reclassification adjustments out of Accumulated Other Comprehensive Loss and related tax effects.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Xerox 2018 Form 10-Q
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XEROX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in millions, except share data in thousands) | March 31, 2018 | December 31, 2017 | ||||||
Assets | ||||||||
Cash and cash equivalents | $ | 1,398 | $ | 1,293 | ||||
Accounts receivable, net | 1,326 | 1,357 | ||||||
Billed portion of finance receivables, net | 106 | 112 | ||||||
Finance receivables, net | 1,301 | 1,317 | ||||||
Inventories | 1,001 | 915 | ||||||
Other current assets | 254 | 236 | ||||||
Total current assets | 5,386 | 5,230 | ||||||
Finance receivables due after one year, net | 2,278 | 2,323 | ||||||
Equipment on operating leases, net | 448 | 454 | ||||||
Land, buildings and equipment, net | 602 | 629 | ||||||
Investments in affiliates, at equity | 1,378 | 1,404 | ||||||
Intangible assets, net | 257 | 268 | ||||||
Goodwill | 3,973 | 3,930 | ||||||
Deferred tax assets | 942 | 1,026 | ||||||
Other long-term assets | 911 | 682 | ||||||
Total Assets | $ | 16,175 | $ | 15,946 | ||||
Liabilities and Equity | ||||||||
Short-term debt and current portion of long-term debt | $ | 678 | $ | 282 | ||||
Accounts payable | 1,188 | 1,108 | ||||||
Accrued compensation and benefits costs | 427 | 444 | ||||||
Accrued expenses and other current liabilities | 859 | 907 | ||||||
Total current liabilities | 3,152 | 2,741 | ||||||
Long-term debt | 4,811 | 5,235 | ||||||
Pension and other benefit liabilities | 1,536 | 1,595 | ||||||
Post-retirement medical benefits | 651 | 662 | ||||||
Other long-term liabilities | 229 | 206 | ||||||
Total Liabilities | 10,379 | 10,439 | ||||||
Commitments and Contingencies (See Note 19) | ||||||||
Convertible Preferred Stock | 214 | 214 | ||||||
Common stock | 255 | 255 | ||||||
Additional paid-in capital | 3,908 | 3,893 | ||||||
Retained earnings | 4,927 | 4,856 | ||||||
Accumulated other comprehensive loss | (3,537 | ) | (3,748 | ) | ||||
Xerox shareholders’ equity | 5,553 | 5,256 | ||||||
Noncontrolling interests | 29 | 37 | ||||||
Total Equity | 5,582 | 5,293 | ||||||
Total Liabilities and Equity | $ | 16,175 | $ | 15,946 | ||||
Shares of common stock issued and outstanding | 254,679 | 254,613 | ||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Xerox 2018 Form 10-Q
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XEROX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31, | ||||||||
(in millions) | 2018 | 2017 | ||||||
Cash Flows from Operating Activities: | ||||||||
Net income | $ | 26 | $ | 42 | ||||
Loss from discontinued operations, net of tax | — | 6 | ||||||
Income from continuing operations | 26 | 48 | ||||||
Adjustments required to reconcile net income to cash flows from operating activities: | ||||||||
Depreciation and amortization | 163 | 133 | ||||||
Provision for receivables | 13 | 13 | ||||||
Provision for inventory | 4 | 5 | ||||||
Net gain on sales of businesses and assets | (16 | ) | — | |||||
Undistributed equity in net income of unconsolidated affiliates | 68 | (40 | ) | |||||
Stock-based compensation | 16 | 13 | ||||||
Restructuring and asset impairment charges | 28 | 108 | ||||||
Payments for restructurings | (54 | ) | (58 | ) | ||||
Defined benefit pension cost | 27 | 62 | ||||||
Contributions to defined benefit pension plans | (38 | ) | (23 | ) | ||||
Decrease (increase) in accounts receivable and billed portion of finance receivables | 46 | (77 | ) | |||||
Increase in inventories | (87 | ) | (58 | ) | ||||
Increase in equipment on operating leases | (56 | ) | (52 | ) | ||||
Decrease in finance receivables | 85 | 65 | ||||||
Increase in other current and long-term assets | (42 | ) | (57 | ) | ||||
Increase in accounts payable and accrued compensation | 12 | 21 | ||||||
Increase (decrease) in other current and long-term liabilities | 1 | (1 | ) | |||||
Net change in income tax assets and liabilities | 13 | (41 | ) | |||||
Net change in derivative assets and liabilities | (6 | ) | 55 | |||||
Other operating, net | 13 | 16 | ||||||
Net cash provided by operating activities of continuing operations | 216 | 132 | ||||||
Net cash used in operating activities of discontinued operations | — | (80 | ) | |||||
Net cash provided by operating activities | 216 | 52 | ||||||
Cash Flows from Investing Activities: | ||||||||
Cost of additions to land, buildings and equipment | (9 | ) | (17 | ) | ||||
Proceeds from sales of land, buildings and equipment | 16 | 1 | ||||||
Cost of additions to internal use software | (9 | ) | (9 | ) | ||||
Acquisitions, net of cash acquired | — | (11 | ) | |||||
Collections of deferred proceeds from sales of receivables | — | 48 | ||||||
Collections on beneficial interest from sales of finance receivables | — | 6 | ||||||
Other investing, net | — | (29 | ) | |||||
Net cash used in investing activities | (2 | ) | (11 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Net (payments) proceeds on short-term debt | (1 | ) | 1 | |||||
Proceeds from issuance of long-term debt | 2 | 3 | ||||||
Payments on long-term debt | (38 | ) | (1,328 | ) | ||||
Common stock dividends | (64 | ) | (81 | ) | ||||
Preferred stock dividends | (3 | ) | (6 | ) | ||||
Repurchases related to stock-based compensation | (1 | ) | (7 | ) | ||||
Payments to noncontrolling interests | (12 | ) | (1 | ) | ||||
Other financing | — | 161 | ||||||
Net cash used in financing activities | (117 | ) | (1,258 | ) | ||||
Effect of exchange rate changes on cash, cash equivalents and restricted cash | 9 | 9 | ||||||
Increase (decrease) in cash, cash equivalents and restricted cash | 106 | (1,208 | ) | |||||
Cash, cash equivalents and restricted cash at beginning of period | 1,368 | 2,402 | ||||||
Cash, Cash Equivalents and Restricted Cash at End of Period | $ | 1,474 | $ | 1,194 | ||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Xerox 2018 Form 10-Q
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XEROX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(in millions, except per-share data and where otherwise noted)
Note 1 – Basis of Presentation
References herein to “we,” “us,” “our,” the “company” and “Xerox” refer to Xerox Corporation and its consolidated subsidiaries unless the context suggests otherwise.
We have prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with the accounting policies described in our 2017 Annual Report on Form 10-K ("2017 Annual Report") except as noted herein, and the interim reporting requirements of Form 10-Q. Accordingly, certain information and note disclosures normally included in our annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our 2017 Annual Report.
In our opinion, all adjustments which are necessary for a fair statement of financial position, operating results and cash flows for the interim periods presented have been made. These adjustments consist of normal recurring items. Interim results of operations are not necessarily indicative of the results of the full year.
For convenience and ease of reference, we refer to the financial statement caption “Income (Loss) before Income Taxes and Equity Income” as “pre-tax income (loss).”
Note 2 – Correction of Fuji Xerox Misstatement in Prior Period Financial Statements
Fuji Xerox is a joint venture between Xerox Corporation and Fujifilm Holdings Corporation (“Fujifilm”) in which Xerox holds a noncontrolling 25% equity interest and Fujifilm holds the remaining equity interest. In 2017 Fujifilm publicly announced it had formed an independent investigation committee ("IIC") to conduct a review of the appropriateness of the accounting practices at Fuji Xerox’s New Zealand subsidiary related to the recovery of receivables associated with certain bundled leasing transactions that occurred in, or prior to, Fuji Xerox’s fiscal year ending March 31, 2016.
The IIC’s review, completed during the second quarter 2017, identified total aggregate adjustments to Fuji Xerox's financial statements of approximately JPY 40 billion (approximately $360 based on the Yen/U.S. Dollar spot exchange rate at March 31, 2017 of 111.89). The adjustments identified by the IIC primarily related to misstatements at Fuji Xerox's New Zealand subsidiary as well as their Australian subsidiary and certain other adjustments. We determined that our cumulative share of the total aggregate adjustments identified as part of the investigation was approximately $90 and impacted our fiscal years 2009 through 2017.
In the second quarter 2017, we determined that the misstatements to our Equity in net income of unconsolidated affiliates in prior years and the first quarter of 2017 identified through the IIC's review were immaterial to our previously issued financial statements. However, we concluded that the cumulative correction of these misstatements would have had a material effect on our 2017 consolidated financial statements. Accordingly, we revised our previously issued consolidated financial statements for the first quarter of 2017. The effect of the revision on our previously issued financial statements is provided in the tables below. Amounts throughout the consolidated financial statements and notes thereto have been adjusted to incorporate the revised amounts, where applicable.
Refer to Note 10 - Investment in Affiliates, at Equity for a discussion regarding the correction of incremental misstatements and adjustments identified in 2018 and corrected by Fuji Xerox as part of their reported results for the quarter ended March 31, 2018 (our first quarter).
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Revised Condensed Consolidated Statements of Income
The following tables reconcile selected lines from the company’s first quarter of 2017 Condensed Consolidated Statements of Income from the previously reported amounts to the revised amounts:
Three Months Ended March 31, 2017 | ||||||||||||
As Reported | Adjustment | As Revised | ||||||||||
Equity in net income of unconsolidated affiliates | $ | 16 | $ | 24 | $ | 40 | ||||||
Income from Continuing Operations | 24 | 24 | 48 | |||||||||
Net Income | 18 | 24 | 42 | |||||||||
Net Income Attributable to Xerox | 16 | 24 | 40 | |||||||||
Net income from continuing operations attributable to Xerox | $ | 22 | $ | 24 | $ | 46 | ||||||
Basic Earnings per Share: | ||||||||||||
Continuing operations | $ | 0.07 | $ | 0.10 | $ | 0.17 | ||||||
Total | $ | 0.05 | $ | 0.09 | $ | 0.14 | ||||||
Diluted Earnings per Share: | ||||||||||||
Continuing operations | $ | 0.07 | $ | 0.09 | $ | 0.16 | ||||||
Total | $ | 0.05 | $ | 0.09 | $ | 0.14 | ||||||
Revised Condensed Consolidated Statements of Comprehensive Income
The following tables reconcile selected lines from the company’s first quarter of 2017 Condensed Consolidated Statements of Comprehensive Income from the previously reported amounts to the revised amounts:
Three Months Ended March 31, 2017 | ||||||||||||
As Reported | Adjustment | As Revised | ||||||||||
Net Income | $ | 18 | $ | 24 | $ | 42 | ||||||
Net Income Attributable to Xerox | 16 | 24 | 40 | |||||||||
Translation adjustments, net | $ | 136 | $ | (3 | ) | $ | 133 | |||||
Other Comprehensive Income, Net | 170 | (3 | ) | 167 | ||||||||
Other Comprehensive Income, Net Attributable to Xerox | 169 | (3 | ) | 166 | ||||||||
Comprehensive Income, Net | $ | 188 | $ | 21 | $ | 209 | ||||||
Comprehensive Income, Net Attributable to Xerox | 185 | 21 | 206 | |||||||||
Revised Condensed Consolidated Statements of Cash Flows from Operations
The revision did not have an impact on the company’s operating cash flows. The following table reconciles selected lines from the company’s first quarter of 2017 Condensed Consolidated Statements of Cash Flows from the previously reported amounts to the revised amounts:
Three Months Ended March 31, 2017 | ||||||||||||
As Reported | Adjustment | As Revised | ||||||||||
Cash Flows from Operating Activities: | ||||||||||||
Net Income | $ | 18 | $ | 24 | $ | 42 | ||||||
Income from Continuing Operations | 24 | 24 | 48 | |||||||||
Undistributed equity in net income of unconsolidated affiliates | $ | (16 | ) | $ | (24 | ) | $ | (40 | ) | |||
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Note 3 – Adoption of New Revenue Recognition Standard
Adoption Summary:
On January 1, 2018 we adopted ASU 2014-09, Revenue from Contracts with Customers (ASC Topic 606), which superseded nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASC Topic 606 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASC Topic 606 defines a five step process to recognize revenue and requires more judgment and estimates within the revenue recognition process than required under previous U.S. GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.
We adopted this standard using the modified retrospective method of adoption. Under ASC Topic 606, based on the nature of our contracts and consistent with prior practice, we recognize revenue upon invoicing the customer for the large majority of our revenue. Additionally, the unit of accounting, that is, the identification of performance obligations, is consistent with prior revenue recognition practice. Accordingly, the adoption of this standard did not have a material impact for the large majority of our revenues. Lastly, a significant portion of our equipment sales are either recorded as sales-type leases or through direct sales to distributors and resellers and these revenue streams are not impacted by the adoption of ASC Topic 606. The only change of significance identified in our adoption involves a change in the classification of certain revenues that were previously reported in Services revenues. These revenues, which are approximately $50 annually, relate to certain analyst services performed in connection with the installation of equipment that are being considered part of the equipment sale performance obligation in 2018. Accordingly, in 2018 these revenues are now reported as part of Sales. In the first quarter of 2018, as result of this change, $9 of revenue was recorded as Sales, which would have been previously recorded as Services revenue in prior periods.
Another change identified upon adoption was with respect to deferred contract costs, which include incremental costs of obtaining a contract and costs to fulfill a contract. Deferred contract costs had been minimal under our prior practices as most costs to obtain a contract and fulfill a contract were expensed as incurred. However, as a result of the contract cost guidance included in ASC Topic 606 and ASC Topic 340-40 "Contracts with Customers", upon adoption, we recorded a transition asset of $153, and a net of tax increase of $117 to retained earnings, related to the incremental cost to obtain contracts. Substantially all of this adjustment is related to the deferral of sales commissions paid to sales people and agents in connection with the placement of equipment with post sale service arrangements.
The impacts of adopting ASC Topic 606 on our Condensed Consolidated Balance Sheets were as follows:
As of March 31, 2018 | ||||||||||||
Superseded Revenue Guidance(1) | Adjustments | As Reported | ||||||||||
Deferred tax assets | $ | 976 | $ | (34 | ) | $ | 942 | |||||
Other long-term assets | 764 | 147 | 911 | |||||||||
Retained earnings | 4,814 | 113 | 4,927 | |||||||||
____________
(1) | Reflects balance of account under revenue recognition guidance superseded by ASC Topic 606. |
Revenue Recognition Summary:
We generate revenue through the sale of equipment, supplies and maintenance and printing services. Revenue is measured based on consideration specified in a contract with a customer and is recognized when we satisfy a performance obligation by transferring control of a product to a customer or in the period the customer benefits from the service. With the exception of our sales-type lease arrangements, our invoices to the customer, which normally have short-term payment terms, are typically aligned to the transfer of goods or as services are rendered to our customers and therefore in most cases we recognize revenue based on our right to invoice customers. As a result of the application of this practical expedient for the substantial portion of our revenue, the disclosure of the value of unsatisfied performance obligations for our services is not required.
Significant judgments primarily include the identification of performance obligations in our Document management services arrangements as well the pattern of delivery for those services.
More specifically, revenue related to our products and services is generally recognized as follows:
Equipment: Revenues from the sale of equipment directly to end customers, including those from sales-type leases (see below), are recognized when obligations under the terms of a contract with our customer are satisfied and control has been transferred to the customer. For equipment placements that require us to install the product at the customer
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location, revenue is normally recognized when the equipment has been delivered and installed at the customer location. Sales of customer installable products are recognized upon shipment or receipt by the customer according to the customer's shipping terms. Revenue from the equipment performance obligation also includes certain analyst training services performed in connection with the installation or delivery of the equipment.
Maintenance services: We provide maintenance agreements on our equipment that include service and supplies for which the customer may pay a base minimum plus a price-per-page charge for usage. In arrangements that include minimums, those minimums are normally set below the customer’s estimated page volumes and are not considered substantive. These agreements are sold as part of a bundled lease arrangement or through distributors and resellers. We normally account for these maintenance agreements as a single performance obligation for printing services being delivered in a series with delivery being measured by usage as billed to the customer. Accordingly, revenue on these agreements are normally recognized as billed to the customer over the term of the agreements based on page volumes. A substantial portion of our products are sold with full service maintenance agreements, accordingly, other than the product warranty obligations associated with certain of our entry level products, we do not have any significant warranty obligations, including any obligations under customer satisfaction programs.
Document management services: Revenues associated with our document management services are generally recognized as printing services are rendered, which is generally on the basis of the number of images produced. Revenues on unit-price contracts are recognized at the contractual selling prices as work is completed by the customer. We account for these arrangements as a single performance obligation for printing services being delivered in a series with delivery being measured by usage as billed to the customer.
Our services contracts may also include the sale or lease of equipment and software. In these instances we follow the policies noted for Equipment or Software Revenues and separately report the revenue associated with these performance obligations. Certain document management services arrangements may also include an embedded lease of equipment. In these instances the revenues associated with the lease are recognized in accordance with the requirements for lease accounting.
Sales to distributors and resellers: We utilize distributors and resellers to sell our equipment, supplies and maintenance services to end-user customers. We refer to our distributor and reseller network as our two-tier distribution model. Revenues on sales to distributors and resellers are generally recognized when products are shipped to such distributors and resellers. However, revenue is only recognized when the distributor or reseller has economic substance apart from the company such that collectability is probable and we have no further obligations related to bringing about the resale, delivery or installation of the product that would impact transfer of control. Revenues associated with maintenance agreements sold through distributors and resellers to end customers are recognized in a consistent manner to maintenance services. Revenue that may be subject to a reversal of revenue due to contractual terms or uncertainties are not recorded as revenue until the contractual provisions lapse or the uncertainties are resolved.
Distributors and resellers participate in various rebate, price-protection, cooperative marketing and other programs, and we estimate the variable consideration associated with these programs and record those amounts as a reduction to revenue when the sales occur. Similarly, we account for our estimates of sales returns and other allowances when the sales occur based on our historical experience.
In certain instances, we may provide lease financing to end-user customers who purchased equipment we sold to distributors or resellers. We are not obligated to provide financing and we compete with other third-party leasing companies with respect to the lease financing provided to these end-user customers.
Bundled Lease Arrangements: A significant portion of our direct sales of equipment to end customers are made through bundled lease arrangements, which typically include equipment, maintenance and financing components for which the customer pays a single negotiated fixed minimum monthly payment for all elements over the contractual lease term. These arrangements also typically include an incremental, variable component for page volumes in excess of contractual page volume minimums, which are often expressed in terms of price-per-page. The fixed minimum monthly payments are multiplied by the number of months in the contract term to arrive at the total fixed minimum payments that the customer is obligated to make (fixed payments) over the lease term. In applying our lease accounting methodology, we only consider the fixed payments for purposes of allocating to the relative fair value elements of the contract.
Revenues under bundled arrangements are allocated considering the relative standalone selling prices of the lease and non-lease deliverables included in the bundled arrangement. Lease deliverables include the equipment, financing, maintenance and other executory costs, while non-lease deliverables generally consist of the supplies and non-maintenance services. The allocation for the lease deliverables begins by allocating revenues to the maintenance and other executory costs plus a profit thereon. These elements are generally recognized over the term of the lease as
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service revenue. The remaining amounts are allocated to the equipment and financing elements which are subjected to the accounting estimates noted below under “Leases”.
Leases: The two primary lease accounting provisions we assess for the classification of transactions as sales-type or operating leases are: (1) a review of the lease term to determine if it is equal to or greater than 75% of the economic life of the equipment and (2) a review of the present value of the minimum lease payments to determine if they are equal to or greater than 90% of the fair market value of the equipment at the inception of the lease. Equipment placements included in arrangements meeting these conditions are accounted for as sales-type leases and revenue is recognized as noted above for Equipment. Equipment placements included in arrangements that don’t meet these conditions are accounted for as operating leases and revenue is recognized over the term of the lease.
We consider the economic life of most of our products to be five years, since this represents the most frequent contractual lease term for our principal products and only a small percentage of our leases are for original terms longer than five years. There is no significant after-market for our used equipment. We believe five years is representative of the period during which the equipment is expected to be economically usable, with normal service, for the purpose for which it is intended. Residual values are not significant.
With respect to fair value, we perform an analysis of equipment fair value based on cash selling prices during the applicable period. The cash selling prices are compared to the range of values determined for our leases. The range of cash selling prices must be reasonably consistent with the lease selling prices in order for us to determine that such lease prices are indicative of fair value.
Our lease pricing interest rates, which are used in determining customer payments in a bundled lease arrangement, are developed based upon a variety of factors including local prevailing rates in the marketplace and the customer’s credit history, industry and credit class. We reassess our pricing interest rates quarterly based on changes in the local prevailing rates in the marketplace. These interest rates have generally been adjusted if the rates vary by 25 basis points or more, cumulatively, from the rate last in effect. The pricing interest rates generally equal the implicit rates within the leases, as corroborated by our comparisons of cash to lease selling prices.
Software: Most of our equipment has both software and non-software components that function together to deliver the equipment's essential functionality and therefore they are accounted for together as part of equipment sales revenues. Software accessories sold in connection with our equipment sales, as well as free-standing software sales are accounted for as separate performance obligations if determined to be material in relation to the overall arrangement. Revenue from software is not a significant component of our Total revenues.
Supplies: Supplies revenue is recognized upon transfer of control to the customer, generally upon utilization or shipment to the customer in accordance with the sales contract terms.
Financing: Finance income attributable to sales-type leases, direct financing leases and installment loans is recognized on the accrual basis using the effective interest method.
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Revenues disaggregated by primary geographic markets, major product lines, and sales channels are as follows:
Three Months Ended March 31, | ||||||||
2018 | 2017 | |||||||
Primary geographical markets(1): | ||||||||
United States | $ | 1,414 | $ | 1,469 | ||||
Europe | 676 | 640 | ||||||
Canada | 144 | 145 | ||||||
Other | 201 | 200 | ||||||
Total Revenues | $ | 2,435 | $ | 2,454 | ||||
Major product and services lines: | ||||||||
Equipment(2) | $ | 499 | $ | 502 | ||||
Supplies, paper and other sales | 434 | 434 | ||||||
Maintenance agreements(3) | 631 | 640 | ||||||
Service arrangements(4) | 623 | 622 | ||||||
Rental and other | 177 | 180 | ||||||
Financing | 71 | 76 | ||||||
Total Revenues | $ | 2,435 | $ | 2,454 | ||||
Sales channels: | ||||||||
Direct equipment lease(5) | $ | 160 | $ | 160 | ||||
Distributors & resellers(6) | 331 | 321 | ||||||
Customer direct | 442 | 455 | ||||||
Total Sales | $ | 933 | $ | 936 | ||||
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(1) | Geographic area data is based upon the location of the subsidiary reporting the revenue. |
(2) | 2017 Equipment sale revenues exclude $11 of equipment-related training revenue, which was classified as Services under previous revenue guidance - see "Adoption Summary" above. |
(3) | Includes revenues from maintenance agreements on sold equipment as well as revenues associated with service agreements sold in our small and mid-sized business (SMB) focused channels and through our channel partners as Xerox Partner Print Services (XPPS). |
(4) | Primarily includes revenues from our Managed Document Services (MDS) offerings. Also includes revenues from embedded operating leases, which were not significant. |
(5) | Primarily reflects direct sales through bundled lease arrangements. |
(6) | Primarily reflects sales through our two-tier distribution channels. |
Other Revenue Recognition Policies
Contract assets and liabilities: We normally do not have contract assets, which are primarily unbilled accounts receivable that are conditional on something other than the passage of time. Our contract liabilities, which represent billings in excess of revenue recognized, are primarily related to advanced billings for maintenance and other services to be performed and were approximately $87 and $91 at March 31, 2018 and January, 1, 2018, respectively. The majority of the balance at March 31, 2018 will be amortized to revenue over approximately the next 30 months.
Contract Costs: Incremental direct costs of obtaining a contract primarily include sales commissions paid to sales people and agents in connection with the placement of equipment with associated post sale services arrangements. These costs are deferred and amortized on the straight-line basis over the estimated contract term, which is currently estimated to be approximately four years. We pay commensurate sales commissions upon customer renewals, therefore our amortization period is aligned to our initial contract term.
In the first quarter 2018, incremental direct costs of obtaining a contract of $17 were deferred and amortization was $24. The balance of deferred incremental direct costs net of accumulated amortization at March 31, 2018 was $179. This amount is expected to be amortized over its estimated period of benefit, which we currently estimate to be approximately four years.
We may also incur costs associated with our services arrangements to generate or enhance resources and assets that will be used to satisfy our future performance obligations included in these arrangements. These costs are considered contract fulfillment costs. These costs are amortized over the contractual service period of the arrangement to cost of services. In addition, we also provide inducements to certain customers in various forms, including contractual credits, which are capitalized and amortized as a reduction of revenue over the term of the contract. Amounts deferred associated with contract fulfillment costs and inducements were $10 at March 31, 2018.
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Equipment and software used in the fulfillment of service arrangements and where the company retains control are capitalized and depreciated over the shorter of their useful life or the term of the contract if an asset is contract specific.
Revenue-based Taxes: Revenue-based taxes assessed by governmental authorities that are both imposed on and concurrent with specific revenue-producing transactions, and that are collected by the company from a customer, are excluded from revenue. The primary revenue-based taxes are sales tax and value-added tax (VAT).
Shipping and Handling: Shipping and handling costs are accounted for as a fulfillment cost and are included in Cost of sales in the Condensed Consolidated Statements of Income.
Note 4 – Recent Accounting Pronouncements
Leases
In February 2016, the FASB issued ASU 2016-02, Leases. This update requires the recognition of leased assets and lease obligations by lessees for those leases currently classified as operating leases under existing lease guidance. Short term leases with a term of 12 months or less are not required to be recognized. The update also requires disclosure of key information about leasing arrangements to increase transparency and comparability among organizations. The accounting for lessors does not fundamentally change except for changes to conform and align guidance to the lessee guidance as well as to the new revenue recognition guidance in ASU 2014-09. This update is effective for our fiscal year beginning January 1, 2019. We are currently evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements. The aggregate undiscounted value of our operating lease commitments at December 31, 2017 was approximately $450 and was primarily related to leases of facilities.
Financial Instruments - Credit Losses
In June 2016, the FASB issued ASU 2016-13, Financial Instruments Credit Losses - Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for financial assets. The update impacts financial assets and net investment in leases that are not accounted for at fair value through net income. This update is effective for our fiscal year beginning January 1, 2020, with early adoption permitted as of January 1, 2019. We are currently evaluating the impact of the adoption of ASU 2016-13 on our consolidated financial statements.
Cash Flows
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments. This update provides specific guidance on eight cash flow classification issues where current guidance is either unclear or does not include specific requirements. We adopted ASU 2016-15 effective for our fiscal year beginning January 1, 2018. This update includes specific guidance which requires cash collected on beneficial interests received in a sale of receivables be classified as inflows from investing activities. Currently, those collections are reported in operating cash flows. We reported $54 of collections on beneficial interests as operating cash inflows on the Statement of Cash Flows for the three months ended March 31, 2017. Accordingly, since the update must be applied retrospectively, our reported 2017 operating and investing cash flows were revised in 2018 to report this amount as investing cash flows. There is no expected impact to our 2018 cash flows from this reporting change due to the termination of all accounts receivable sales arrangements in North America and most arrangements in Europe and the final repurchase of previously sold finance receivables during the fourth quarter of 2017. The other seven issues noted in this update are not expected to have a material impact on our financial condition, results of operations or cash flows.
Additionally, in November 2016 the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash. The update requires that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We adopted ASU 2016-18 effective for our fiscal year beginning January 1, 2018 and applied it retrospectively through a revision of previously reported amounts. We held $76 and $75 of restricted cash, currently reported in other current or long-term assets at March 31, 2018 and December 31, 2017, respectively. The changes in our restricted cash balances were primarily related to our accounts receivable sales programs, which were terminated during the fourth quarter of 2017. Accordingly, this update is not expected to have a material impact on our financial condition, results of operations or cash flows. Refer to Note 6 - Cash, Cash Equivalents and Restricted Cash for additional information.
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Retirement Benefits
In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This update changes how employers that sponsor defined benefit pension plans and other postretirement plans present net periodic benefit costs in the income statement. An employer is required to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the affected employees during the period. Other components of net retirement benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. We elected to report these costs as a separate item within Other expenses, net. The update also allows only the service cost component to be eligible for capitalization, when applicable. We adopted ASU 2017-07 effective for us beginning January 1, 2018. The presentation requirements of this update were required to be applied retrospectively through a revision of previously reported amounts. The requirement to limit capitalization to the service cost component was required to be applied prospectively. The adoption of this update is not expected to have a material impact on our financial condition, results of operations or cash flows. Refer to Note 15 - Employee Benefit Plans for the service cost component and other components of net retirement benefit cost.
The following table reflects the adjustment of selected lines from our Condensed Consolidated Statements of Income to the recasted amounts as a result of the adoption of this update:
Three Months Ended March 31, 2017 | ||||||||||||
(in millions) | As Reported | Adjustment | As Recasted | |||||||||
Cost of sales | $ | 567 | $ | (2 | ) | $ | 565 | |||||
Costs of services, maintenance and rentals | 900 | (19 | ) | 881 | ||||||||
Research, development and engineering expenses | 118 | (7 | ) | 111 | ||||||||
Selling, administrative and general expenses | 664 | (30 | ) | 634 | ||||||||
Restructuring and related costs | 120 | (2 | ) | 118 | ||||||||
Other expenses, net | 54 | 60 | 114 | |||||||||
Business Combinations
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. We adopted ASU 2017-01 effective for our fiscal year beginning January 1, 2018 and the adoption did not have nor is it expected to have a material impact on our financial condition, results of operations or cash flows.
Income Taxes
In October 2016, the FASB issued ASU 2016-16, Income Taxes - Intra-Entity Transfers of Assets Other than Inventory. This update requires recognition of the income-tax consequences of an intra-entity transfer of assets other than inventory when the transfer occurs. Under current GAAP, recognition of the income tax consequences for asset transfers other than inventory could not be recognized until the asset was sold to a third party. We adopted ASU 2016-16 effective for our fiscal year beginning January 1, 2018 and the adoption did not have nor is it expected to have a material impact on our financial condition, results of operations or cash flows.
In February 2018, the FASB issued ASU No, 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The update allows the reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act ("Tax Act") enacted in December 2017. Consequently, the update eliminates the stranded tax effects resulting from the Tax Act and will improve the usefulness of information reported to financial statement users. However, because the update only relates to the reclassification of the income tax effects of the Tax Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The update also requires certain disclosures about stranded tax effects. The update is effective for our fiscal year beginning January 1, 2019. Early adoption of this update is permitted, including adoption in any interim period. The update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The company is currently evaluating the impact of adopting this new guidance.
In December 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 118 (as further clarified by the FASB's ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118) to provide guidance for companies that may not have completed their
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accounting for the income tax effects of the Tax Act. SAB No. 118 provides for a provisional one year measurement period for entities to finalize their accounting for certain income tax effects related to the Tax Act. SAB No. 118 provides guidance where: (i) the accounting for the income tax effect of the Tax Act is complete and reported in the Tax Act's enactment period, (ii) the accounting for the income tax effect of the Tax Act is incomplete and reported as provisional amounts based on reasonable estimates (to the extent determinable) subject to adjustments during a limited measurement period until complete, and (iii) accounting for the income tax effect of the Tax Act is not reasonably estimable (no related provisional amounts are reported in the enactment period) and entities would continue to apply accounting based on tax law provisions in effect prior to the Tax Act enactment until provisional amounts are reasonably estimable. SAB No. 118 requires disclosure of the reasons for incomplete accounting additional information or analysis needed, among other relevant information. During the fourth quarter 2017, we recorded an estimated non-cash provisional charge of $400 reflecting the impact associated with the provisions of the Tax Act based on currently available information. No further adjustment of that estimated provisional charge was made in the first quarter 2018, however we continue to evaluate impacts from the Tax Act and likely will do so through the expected filing of our 2017 U.S. Tax Return in the third quarter 2018. Any adjustments to these provisional amounts will be reported as a component of Income tax expense in the reporting period in which any such adjustments are determined.
Derivatives
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in this update expand and refine hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments with the same income statement line item that the hedged item is reported and includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. This update is effective for our fiscal year beginning January 1, 2019, with early adoption permitted at any interim period. We are currently evaluating the impact of the adoption of ASU 2017-12 on our consolidated financial statements.
Other Updates
In 2018, 2017 and 2016, the FASB also issued the following Accounting Standards Updates which did not have or are not expected to have a material impact on our financial condition, results of operations or cash flows upon adoption. Those updates are as follows:
• | Investments - Debt Securities and Regulated Operations: ASU 2018-04, (Topics 320 and 980) Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update). |
• | Leases: ASU 2018-01, (Topic 842) Land Easement Practical Expedient for Transition to Topic 842. This update is effective for our fiscal year beginning January 1, 2019. |
• | Service Concession Arrangements: ASU 2017-10, (Topic 853) Determining the Customer of the Operation Services (a consensus of the FASB Emerging Issues Task Force). This update is effective for our fiscal year beginning January 1, 2018. |
• | Compensation - Stock Compensation: ASU 2017-09, (Topic 718) Scope of Modification Accounting. This update is effective for our fiscal year beginning January 1, 2018. |
• | Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets: ASU 2017-05, (Subtopic 610-20) Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. This update is effective for our fiscal year beginning January 1, 2018. |
• | Financial Instruments - Classification and Measurement: ASU 2016-01, Financial Instruments - Recognition and Measurement of Financial Instruments and Financial Liabilities. This update is effective for our fiscal year beginning January 1, 2018. |
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Note 5 – Divestitures
Business Process Outsourcing (BPO)
On December 31, 2016, Xerox completed the Separation of its BPO business through the Distribution of all of the issued and outstanding stock of Conduent to Xerox Corporation stockholders. As a result of the Separation and Distribution, the financial position and results of operations of the BPO business are presented as discontinued operations and, as such, have been excluded from continuing operations for all periods presented. The loss from operations in the first quarter 2017 primarily reflected changes in estimates of separation-related costs.
Summarized financial information for our Discontinued Operations is as follows:
Three Months Ended March 31, | ||||||||
2018 | 2017 | |||||||
Loss from operations | $ | — | $ | 8 | ||||
Loss on disposal | — | — | ||||||
Net loss before income taxes | — | (8 | ) | |||||
Income tax benefit | — | 2 | ||||||
Loss from discontinued operations, net of tax | $ | — | $ | (6 | ) | |||
Note 6 – Cash, Cash Equivalents and Restricted Cash
Cash, cash equivalents and restricted cash amounts were as follows:
March 31, 2018 | December 31, 2017 | |||||||
Cash and cash equivalents | $ | 1,398 | $ | 1,293 | ||||
Restricted cash | ||||||||
Tax and labor litigation deposits in Brazil | 72 | 72 | ||||||
Other restricted cash | 4 | 3 | ||||||
Total Restricted cash | 76 | 75 | ||||||
Cash, cash equivalents and restricted cash | $ | 1,474 | $ | 1,368 | ||||
Restricted Cash
Restricted cash primarily relates to escrow cash deposits made in Brazil associated with tax and labor litigation. As more fully discussed in Note 19 - Contingencies and Litigation, various litigation matters in Brazil require us to make cash deposits to escrow as a condition of continuing the litigation. Restricted cash amounts are classified in our Condensed Consolidated Balance Sheets based on when the cash is expected to be contractually or judicially released.
Restricted cash was reported in the Condensed Consolidated Balance Sheet as follows:
March 31, 2018 | December 31, 2017 | |||||||
Other current assets | $ | 2 | $ | 1 | ||||
Other long-term assets | 74 | 74 | ||||||
Total Restricted cash | $ | 76 | $ | 75 | ||||
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Note 7 – Accounts Receivable, Net
Accounts receivable, net were as follows:
March 31, 2018 | December 31, 2017 | |||||||
Invoiced | $ | 1,033 | $ | 1,048 | ||||
Accrued | 352 | 368 | ||||||
Allowance for doubtful accounts | (59 | ) | (59 | ) | ||||
Accounts receivable, net | $ | 1,326 | $ | 1,357 | ||||
Amounts to be invoiced in the subsequent quarter for current services provided are included in amounts accrued.
We perform ongoing credit evaluations of our customers and adjust credit limits based upon customer payment history and current creditworthiness. The allowance for uncollectible accounts receivable is determined principally on the basis of past collection experience as well as consideration of current economic conditions and changes in our customer collection trends.
Accounts Receivable Sales Arrangements
Accounts receivable sales arrangements are utilized in the normal course of business as part of our cash and liquidity management. The accounts receivable sold are generally short-term trade receivables with payment due dates of less than 60 days. During the fourth quarter 2017 we terminated all accounts receivable sales arrangements in North America and all but one arrangement in Europe. The remaining facility in Europe enables us to sell accounts receivable associated with our distributor network on an ongoing basis without recourse. Under this arrangement, we sell our entire interest in the related accounts receivable for cash and no portion of the payment is held back or deferred by the purchaser.
Of the accounts receivable sold and derecognized from our balance sheet, $114 and $161 remained uncollected as of March 31, 2018 and December 31, 2017, respectively.
Accounts receivable sales were as follows:
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Accounts receivable sales(1) | $ | 103 | $ | 511 | |||
Deferred proceeds | — | 52 | |||||
Loss on sales of accounts receivable | 1 | 3 | |||||
Estimated decrease to operating cash flows(2) | (50 | ) | (65 | ) | |||
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(1) | Customers may also enter into structured-payable arrangements that require us to sell our receivables from that customer to a third-party financial institution, which then makes payments to us to settle the customer's receivable. In these instances we ensure the sale of the receivables are bankruptcy remote and the payment made to us is without recourse. The activity associated with these arrangements is not reflected in this disclosure as payments under these arrangements have not been material and these are customer directed arrangements. |
(2) | Represents the difference between current and prior period receivable sales adjusted for the effects of: (i) the deferred proceeds, (ii) collections prior to the end of the quarter and, (iii) currency. |
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Note 8 - Finance Receivables, Net
Finance Receivables – Allowance for Credit Losses and Credit Quality
Finance receivables include sales-type leases, direct financing leases and installment loans arising from the marketing of our equipment. Our finance receivable portfolios are primarily in the U.S., Canada and Europe. We generally establish customer credit limits and estimate the allowance for credit losses on a country or geographic basis. Our policy and methodology used to establish our allowance for doubtful accounts has been consistently applied over all periods presented.
The following table is a rollforward of the allowance for doubtful finance receivables as well as the related investment in finance receivables:
Allowance for Credit Losses: | United States | Canada | Europe | Other(1) | Total | |||||||||||||||
Balance at December 31, 2017 | $ | 56 | $ | 15 | $ | 35 | $ | 2 | $ | 108 | ||||||||||
Provision | 5 | — | 4 | — | 9 | |||||||||||||||
Charge-offs | (5 | ) | (1 | ) | (4 | ) | — | (10 | ) | |||||||||||
Recoveries and other(2) | — | — | 1 | — | 1 | |||||||||||||||
Balance at March 31, 2018 | $ | 56 | $ | 14 | $ | 36 | $ | 2 | $ | 108 | ||||||||||
Finance receivables as of March 31, 2018 collectively evaluated for impairment (3) | $ | 1,994 | $ | 373 | $ | 1,364 | $ | 62 | $ | 3,793 | ||||||||||
Balance at December 31, 2016 | $ | 55 | $ | 16 | $ | 37 | $ | 2 | $ | 110 | ||||||||||
Provision | 4 | — | 5 | — | 9 | |||||||||||||||
Charge-offs | (6 | ) | (2 | ) | (2 | ) | — | (10 | ) | |||||||||||
Recoveries and other(2) | — | 2 | — | — | 2 | |||||||||||||||
Balance at March 31, 2017 | $ | 53 | $ | 16 | $ | 40 | $ | 2 | $ | 111 | ||||||||||
Finance receivables as of March 31, 2017 collectively evaluated for impairment(3) | $ | 2,108 | $ | 382 | $ | 1,276 | $ | 51 | $ | 3,817 | ||||||||||
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(1) | Includes developing market countries and smaller units. |
(2) | Includes the impacts of foreign currency translation and adjustments to reserves necessary to reflect events of non-payment such as customer accommodations and contract terminations. |
(3) | Total Finance receivables exclude the allowance for credit losses of $108 and $111 at March 31, 2018 and 2017, respectively. |
We evaluate our customers based on the following credit quality indicators:
• | Investment grade: This rating includes accounts with excellent to good business credit, asset quality and capacity to meet financial obligations. These customers are less susceptible to adverse effects due to shifts in economic conditions or changes in circumstance. The rating generally equates to a Standard & Poor's (S&P) rating of BBB- or better. Loss rates in this category are normally less than 1%. |
• | Non-investment grade: This rating includes accounts with average credit risk that are more susceptible to loss in the event of adverse business or economic conditions. This rating generally equates to a BB S&P rating. Although we experience higher loss rates associated with this customer class, we believe the risk is somewhat mitigated by the fact that our leases are fairly well dispersed across a large and diverse customer base. In addition, the higher loss rates are largely offset by the higher rates of return we obtain with such leases. Loss rates in this category are generally in the range of 2% to 5%. |
• | Substandard: This rating includes accounts that have marginal credit risk such that the customer’s ability to make repayment is impaired or may likely become impaired. We use numerous strategies to mitigate risk including higher rates of interest, prepayments, personal guarantees, etc. Accounts in this category include customers who were downgraded during the term of the lease from investment and non-investment grade evaluation when the lease was originated. Accordingly, there is a distinct possibility for a loss of principal and interest or customer default. The loss rates in this category are generally in the range of 7% to 10%. |
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Credit quality indicators are updated at least annually and the credit quality of any given customer can change during the life of the portfolio. Details about our finance receivables portfolio based on industry and credit quality indicators are as follows:
March 31, 2018 | December 31, 2017 | ||||||||||||||||||||||||||||||
Investment Grade | Non-investment Grade | Substandard | Total Finance Receivables | Investment Grade | Non-investment Grade | Substandard | Total Finance Receivables | ||||||||||||||||||||||||
Finance and other services | $ | 193 | $ | 334 | $ | 82 | $ | 609 | $ | 199 | $ | 345 | $ | 75 | $ | 619 | |||||||||||||||
Government and education | 480 | 62 | 6 | 548 | 490 | 61 | 6 | 557 | |||||||||||||||||||||||
Graphic arts | 86 | 93 | 133 | 312 | 84 | 97 | 141 | 322 | |||||||||||||||||||||||
Industrial | 80 | 84 | 15 | 179 | 82 | 84 | 14 | 180 | |||||||||||||||||||||||
Healthcare | 90 | 46 | 8 | 144 | 88 | 48 | 9 | 145 | |||||||||||||||||||||||
Other | 66 | 95 | 41 | 202 | 68 | 98 | 40 | 206 | |||||||||||||||||||||||
Total United States | 995 | 714 | 285 | 1,994 | 1,011 | 733 | 285 | 2,029 | |||||||||||||||||||||||
Finance and other services | 52 | 39 | 26 | 117 | 54 | 42 | 27 | 123 | |||||||||||||||||||||||
Government and education | 44 | 5 | 4 | 53 | 48 | 5 | 5 | 58 | |||||||||||||||||||||||
Graphic arts | 30 | 33 | 27 | 90 | 34 | 35 | 27 | 96 | |||||||||||||||||||||||
Industrial | 19 | 11 | 11 | 41 | 20 | 12 | 11 | 43 | |||||||||||||||||||||||
Other | 34 | 23 | 15 | 72 | 36 | 25 | 16 | 77 | |||||||||||||||||||||||
Total Canada | 179 | 111 | 83 | 373 | 192 | 119 | 86 | 397 | |||||||||||||||||||||||
France | 244 | 213 | 23 | 480 | 234 | 226 | 22 | 482 | |||||||||||||||||||||||
U.K./Ireland | 109 | 145 | 11 | 265 | 106 | 150 | 10 | 266 | |||||||||||||||||||||||
Central(1) | 196 | 144 | 16 | 356 | 189 | 149 | 16 | 354 | |||||||||||||||||||||||
Southern(2) | 46 | 153 | 14 | 213 | 52 | 144 | 13 | 209 | |||||||||||||||||||||||
Nordics(3) | 29 | 20 | 1 | 50 | 29 | 21 | 1 | 51 | |||||||||||||||||||||||
Total Europe | 624 | 675 | 65 | 1,364 | 610 | 690 | 62 | 1,362 | |||||||||||||||||||||||
Other | 38 | 21 | 3 | 62 | 38 | 28 | 6 | 72 | |||||||||||||||||||||||
Total | $ | 1,836 | $ | 1,521 | $ | 436 | $ | 3,793 | $ | 1,851 | $ | 1,570 | $ | 439 | $ | 3,860 | |||||||||||||||
_____________________________
(1) | Switzerland, Germany, Austria, Belgium and Holland. |
(2) | Italy, Greece, Spain and Portugal. |
(3) | Sweden, Norway, Denmark and Finland. |
Xerox 2018 Form 10-Q
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The aging of our billed finance receivables is based upon the number of days an invoice is past due and is as follows:
March 31, 2018 | |||||||||||||||||||||||||||
Current | 31-90 Days Past Due | >90 Days Past Due | Total Billed | Unbilled | Total Finance Receivables | >90 Days and Accruing | |||||||||||||||||||||
Finance and other services | $ | 14 | $ | 3 | $ | 1 | $ | 18 | $ | 591 | $ | 609 | $ | 11 | |||||||||||||
Government and education | 16 | 4 | 3 | 23 | 525 | 548 | 26 | ||||||||||||||||||||
Graphic arts | 12 | 1 | — | 13 | 299 | 312 | 5 | ||||||||||||||||||||
Industrial | 5 | 1 | 1 | 7 | 172 | 179 | 4 | ||||||||||||||||||||
Healthcare | 4 | 1 | 1 | 6 | 138 | 144 | 4 | ||||||||||||||||||||
Other | 6 | 1 | 1 | 8 | 194 | 202 | 3 | ||||||||||||||||||||
Total United States | 57 | 11 | 7 | 75 | 1,919 | 1,994 | 53 | ||||||||||||||||||||
Canada | 8 | 2 | 1 | 11 | 362 | 373 | 19 | ||||||||||||||||||||
France | 7 | — | — | 7 | 473 | 480 | 16 | ||||||||||||||||||||
U.K./Ireland | 1 | 1 | — | 2 | 263 | 265 | — | ||||||||||||||||||||
Central(1) | 1 | 1 | 1 | 3 | 353 | 356 | 6 | ||||||||||||||||||||
Southern(2) | 4 | 1 | 1 | 6 | 207 | 213 | 8 | ||||||||||||||||||||
Nordics(3) | 1 | — | — | 1 | 49 | 50 | — | ||||||||||||||||||||
Total Europe | 14 | 3 | 2 | 19 | 1,345 | 1,364 | 30 | ||||||||||||||||||||
Other | 3 | — | — | 3 | 59 | 62 | — | ||||||||||||||||||||
Total | $ | 82 | $ | 16 | $ | 10 | $ | 108 | $ | 3,685 | $ | 3,793 | $ | 102 | |||||||||||||
December 31, 2017 | |||||||||||||||||||||||||||
Current | 31-90 Days Past Due | >90 Days Past Due | Total Billed | Unbilled | Total Finance Receivables | >90 Days and Accruing | |||||||||||||||||||||
Finance and other services | $ | 18 | $ | 3 | $ | 1 | $ | 22 | $ | 597 | $ | 619 | $ | 12 | |||||||||||||
Government and education | 18 | 3 | 3 | 24 | 533 | 557 | 21 | ||||||||||||||||||||
Graphic arts | 12 | 1 | — | 13 | 309 | 322 | 6 | ||||||||||||||||||||
Industrial | 6 | 1 | 1 | 8 | 172 | 180 | 4 | ||||||||||||||||||||
Healthcare | 5 | 1 | 1 | 7 | 138 | 145 | 5 | ||||||||||||||||||||
Other | 7 | 1 | 1 | 9 | 197 | 206 | 3 | ||||||||||||||||||||
Total United States | 66 | 10 | 7 | 83 | 1,946 | 2,029 | 51 | ||||||||||||||||||||
Canada | 8 | 2 | 1 | 11 | 386 | 397 | 17 | ||||||||||||||||||||
France | 6 | — | — | 6 | 476 | 482 | 22 | ||||||||||||||||||||
U.K./Ireland | 3 | — | — | 3 | 263 | 266 | — | ||||||||||||||||||||
Central(1) | 1 | 2 | — | 3 | 351 | 354 | 6 | ||||||||||||||||||||
Southern(2) | 4 | 1 | 1 | 6 | 203 | 209 | 6 | ||||||||||||||||||||
Nordics(3) | — | — | — | — | 51 | 51 | — | ||||||||||||||||||||
Total Europe | 14 | 3 | 1 | 18 | 1,344 | 1,362 | 34 | ||||||||||||||||||||
Other | 3 | — | — | 3 | 69 | 72 | — | ||||||||||||||||||||
Total | $ | 91 | $ | 15 | $ | 9 | $ | 115 | $ | 3,745 | $ | 3,860 | $ | 102 | |||||||||||||
_____________________________
(1)Switzerland, Germany, Austria, Belgium and Holland.
(2)Italy, Greece, Spain and Portugal.
(3)Sweden, Norway, Denmark and Finland.
Xerox 2018 Form 10-Q
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Note 9 – Inventories
The following is a summary of Inventories by major category:
March 31, 2018 | December 31, 2017 | ||||||
Finished goods | $ | 857 | $ | 777 | |||
Work-in-process | 49 | 49 | |||||
Raw materials | 95 | 89 | |||||
Total Inventories | $ | 1,001 | $ | 915 | |||
Note 10 – Investment in Affiliates, at Equity
Our Equity in net (loss) income of unconsolidated affiliates was as follows:
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Fuji Xerox | $ | (70 | ) | $ | 37 | ||
Other | 2 | 3 | |||||
Total Equity in net (loss) income of unconsolidated affiliates | $ | (68 | ) | $ | 40 | ||
Fuji Xerox
Equity in net (loss) income of Fuji Xerox is affected by certain adjustments required to reflect the deferral of profit associated with intercompany sales. These adjustments may result in recorded equity (loss) income that is different from that implied by our 25% ownership interest. In addition, the Equity in net loss of Fuji Xerox for the three months ended March 31, 2018 includes $79 of after-tax restructuring and other charges.
In 2018, in connection with the completion of the audits of Fuji Xerox’s fiscal year-end financial statements as of and for the years ended March 31, 2016 and 2017, as well the review of Fuji Xerox’s unaudited interim financial statements as of and for the nine months ended December 31, 2017 and 2016 additional adjustments and misstatements were identified. These additional adjustments and misstatements were to the previously reported net income of Fuji Xerox for the period from 2010 through 2017 and are incremental to the items identified by the IIC discussed in Note 2 - Correction of Fuji Xerox Misstatement in Prior Period Financial Statements. These incremental adjustments primarily relate to Fuji Xerox’s Asia Pacific subsidiaries and involve improper revenue recognition, including revenue associated with leasing transactions, additional provisions for bad debt allowances and other asset impairments. In certain instances, some of the adjustments related to inappropriate accounting and reporting practices in the Fuji Xerox Asia Pacific subsidiaries where previous misstatements were identified.
Fuji Xerox recorded a cumulative charge of JPY 12 billion (approximately $110 based on the Yen/U.S. Dollar average exchange rate for the quarter ended March 31, 2018 of 108.07) in their net loss for the quarter ended March 31, 2018 (our first quarter 2018) related to the correction of these additional adjustments and misstatements. Our recognition of 25% of Fuji Xerox’s net loss for Xerox’s first quarter 2018 included an approximately $28 charge related to these adjustments and misstatements. We determined that the impact of the out-of-period misstatements was not material to Xerox’s consolidated financial statements for any individual prior quarter or year and the adjustment to correct the misstatements is not expected to be material to our full year 2018 results.
Xerox 2018 Form 10-Q
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The summarized financial information below for Fuji Xerox has likewise been revised accordingly to reflect the impact of the revision discussed in Note 2 - Correction of Fuji Xerox Misstatement in Prior Period Financial Statements:
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Summary of Operations: | |||||||
Revenues | $ | 2,465 | $ | 2,559 | |||
Costs and expenses | 2,771 | 2,352 | |||||
(Loss) Income before Income Taxes | (306 | ) | 207 | ||||
Income tax (benefit) expense | (39 | ) | 44 | ||||
Net (Loss) Income | (267 | ) | 163 | ||||
Less: Net income attributable to noncontrolling interests | — | 1 | |||||
Net (Loss) Income – Fuji Xerox | $ | (267 | ) | $ | 162 | ||
Weighted Average Exchange Rate(1) | 108.07 | 113.72 | |||||
_____________________________
(1) | Represents Yen/U.S. Dollar exchange rate used to translate. |
Note 11 – Restructuring Programs
During the three months ended March 31, 2018, we recorded net restructuring and asset impairment charges of $28, which included $24 of severance costs related to headcount reductions of approximately 400 employees worldwide and $12 of lease cancellation costs. These costs were partially offset by $8 of net reversals, primarily resulting from changes in estimated reserves from prior period initiatives. Costs related to professional support services associated with the implementation of the Strategic Transformation program were minimal.
Information related to restructuring program activity is outlined below:
Severance and Related Costs | Lease Cancellation and Other Costs | Asset Impairments(2) | Total | ||||||||||||
Balance at December 31, 2017 | $ | 108 | $ | 1 | $ | — | $ | 109 | |||||||
Provision | 24 | 12 | — | 36 | |||||||||||
Reversals | (8 | ) | — | — | (8 | ) | |||||||||
Net current period charges(1) | 16 | 12 | — | 28 | |||||||||||
Charges against reserve and currency | (41 | ) | (11 | ) | — | (52 | ) | ||||||||
Balance at March 31, 2018 | $ | 83 | $ | 2 | $ | — | $ | 85 | |||||||
____________________________
(1) | Represents net amount recognized within the Condensed Consolidated Statements of Income for the period shown for restructuring and asset impairments charges. |
(2) | Charges associated with asset impairments represent the write-down of the related assets to their new cost basis and are recorded concurrently with the recognition of the provision. |
The following table summarizes the reconciliation to the Condensed Consolidated Statements of Cash Flows:
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Charges against reserve and currency | $ | (52 | ) | $ | (57 | ) | |
Effects of foreign currency and other non-cash items | (2 | ) | (1 | ) | |||
Restructuring cash payments | $ | (54 | ) | $ | (58 | ) | |
Xerox 2018 Form 10-Q
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Note 12 – Debt
Bridge Facility
Refer to Note 20 - Fuji Xerox Transaction and Recent Developments for additional information regarding the bridge loan facility entered into in connection with the Fuji Xerox Transaction.
Interest Expense and Income
Interest expense and income were as follows:
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Interest expense(1) | $ | 65 | $ | 69 | |||
Interest income(2) | 74 | 78 | |||||
____________
(1) | Includes Cost of financing as well as non-financing interest expense that is included in Other expenses, net in the Condensed Consolidated Statements of Income. |
(2) | Includes Finance income as well as other interest income that is included in Other expenses, net in the Condensed Consolidated Statements of Income. |
Note 13 – Financial Instruments
Interest Rate Risk Management
We use interest rate swap agreements to manage our interest rate exposure and to achieve a desired proportion of variable and fixed rate debt. These derivatives may be designated as fair value hedges or cash flow hedges depending on the nature of the risk being hedged.
Fair Value Hedges
As of March 31, 2018, pay variable/receive fixed interest rate swaps with notional amounts of $300 and net liability fair value of $4 were designated and accounted for as fair value hedges. The swaps were structured to hedge the fair value of related debt by converting them from fixed rate instruments to variable rate instruments. No ineffective portion was recorded to earnings for the three months ended March 31, 2018.
The following is a summary of our fair value hedges at March 31, 2018:
Debt Instrument | Year First Designated | Notional Amount | Net Fair Value | Weighted Average Interest Rate Paid | Interest Rate Received | Basis | Maturity | |||||||||||||
Senior Note 2021 | 2014 | $ | 300 | $ | (4 | ) | 2.85 | % | 4.5 | % | Libor | 2021 | ||||||||
Foreign Exchange Risk Management
We are a global company that is exposed to foreign currency exchange rate fluctuations in the normal course of our business. As a part of our foreign exchange risk management strategy, we use derivative instruments, primarily forward contracts and purchased option contracts, to hedge the following foreign currency exposures, thereby reducing volatility of earnings or protecting fair values of assets and liabilities:
•Foreign currency-denominated assets and liabilities
• | Forecasted purchases and sales in foreign currency |
At March 31, 2018 and December 31, 2017, we had outstanding forward exchange and purchased option contracts with gross notional values of $1,557 and $1,788 respectively, with terms of less than 12 months. Approximately 70% of the contracts at March 31, 2018 mature within three months, 20% mature in three to six months and 10% in six to twelve months. The associated currency exposures being hedged at March 31, 2018 were materially consistent with our year-end currency exposures. There has not been any material change in our hedging strategy.
Foreign Currency Cash Flow Hedges
We designate a portion of our foreign currency derivative contracts as cash flow hedges of our foreign currency-denominated inventory purchases, sales and expenses. The net asset (liability) fair value of these contracts were $4 and $(14) as of March 31, 2018 and December 31, 2017, respectively.
Xerox 2018 Form 10-Q
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Summary of Derivative Instruments Fair Value
The following table provides a summary of the fair value amounts of our derivative instruments:
Designation of Derivatives | Balance Sheet Location | March 31, 2018 | December 31, 2017 | |||||||
Derivatives Designated as Hedging Instruments | ||||||||||
Foreign exchange contracts - forwards | Other current assets | $ | 5 | $ | 1 | |||||
Other current liabilities | (4 | ) | (15 | ) | ||||||
Foreign currency options | Other current assets | 3 | — | |||||||
Interest rate swaps | Other long-term assets | — | 1 | |||||||
Other long-term liabilities | (4 | ) | — | |||||||
Net designated derivative liability | $ | — | $ | (13 | ) | |||||
Derivatives NOT Designated as Hedging Instruments | ||||||||||
Foreign exchange contracts – forwards | Other current assets | $ | 4 | $ | 1 | |||||
Other current liabilities | (2 | ) | (10 | ) | ||||||
Net undesignated derivative asset (liability) | $ | 2 | $ | (9 | ) | |||||
Summary of Derivatives | Total Derivative Assets | $ | 12 | $ | 3 | |||||
Total Derivative Liabilities | (10 | ) | (25 | ) | ||||||
Net Derivative asset (liability) | $ | 2 | $ | (22 | ) | |||||
Summary of Derivative Instruments Gains (Losses)
Derivative gains (losses) affect the income statement based on whether such derivatives are designated as hedges of underlying exposures. The following is a summary of derivative gains (losses).
Designated Derivative Instruments Gains (Losses)
The following table provides a summary of gains (losses) on derivative instruments:
Three Months Ended March 31, | ||||||||
Gain (Loss) on Derivative Instruments | 2018 | 2017 | ||||||
Fair Value Hedges - Interest Rate Contracts | ||||||||
Derivative loss recognized in interest expense | $ | (5 | ) | $ | (1 | ) | ||
Hedged item gain recognized in interest expense | 5 | 1 | ||||||
Cash Flow Hedges - Foreign Exchange Forward Contracts and Options | ||||||||
Derivative gain recognized in OCI (effective portion) | $ | 12 | $ | 9 | ||||
Derivative Loss reclassified from AOCL to income - Cost of sales (effective portion) | (12 | ) | (4 | ) | ||||
During the three months ended March 31, 2018 and 2017 no amount of ineffectiveness was recorded in the Condensed Consolidated Statements of Income for these designated cash flow hedges and all components of each derivative’s gain or (loss) were included in the assessment of hedge effectiveness. In addition, no amount was recorded for an underlying exposure that did not occur or was not expected to occur.
As of March 31, 2018, a net after-tax gain of $5 was recorded in Accumulated other comprehensive loss associated with our cash flow hedging activity. The entire balance is expected to be reclassified into net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.
Non-Designated Derivative Instruments Gains (Losses)
Non-designated derivative instruments are primarily instruments used to hedge foreign currency-denominated assets and liabilities. They are not designated as hedges since there is a natural offset for the re-measurement of the underlying foreign currency-denominated asset or liability.
Xerox 2018 Form 10-Q
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The following table provides a summary of gains on non-designated derivative instruments:
Derivatives NOT Designated as Hedging Instruments | Three Months Ended March 31, | |||||||||
Location of Derivative Gain | 2018 | 2017 | ||||||||
Foreign exchange contracts – forwards | Other expense – Currency gain, net | $ | — | $ | 4 | |||||
For the three months ended March 31, 2018 and 2017, currency gains (losses), net were $2 and $(3), respectively. Net currency gains and losses include the mark-to-market adjustments of the derivatives not designated as hedging instruments and the related cost of those derivatives as well as the re-measurement of foreign currency-denominated assets and liabilities and are included in Other expenses, net.
Note 14 – Fair Value of Financial Assets and Liabilities
The following table represents assets and liabilities measured at fair value on a recurring basis. The basis for the measurement at fair value in all cases is Level 2 – Significant Other Observable Inputs.
March 31, 2018 | December 31, 2017 | ||||||
Assets: | |||||||
Foreign exchange contracts - forwards | $ | 9 | $ | 2 | |||
Foreign currency options | 3 | — | |||||
Interest rate swaps | — | 1 | |||||
Deferred compensation investments in mutual funds | 18 | 18 | |||||
Total | $ | 30 | $ | 21 | |||
Liabilities: | |||||||
Foreign exchange contracts - forwards | $ | 6 | $ | 25 | |||
Interest rate swaps | 4 | — | |||||
Deferred compensation plan liabilities | 18 | 19 | |||||
Total | $ | 28 | $ | 44 | |||
We utilize the income approach to measure the fair value for our derivative assets and liabilities. The income approach uses pricing models that rely on market observable inputs such as yield curves, currency exchange rates and forward prices, and therefore are classified as Level 2.
Fair value for our deferred compensation plan investments in mutual funds is based on quoted market prices for those funds. Fair value for deferred compensation plan liabilities is based on the fair value of investments corresponding to employees’ investment selections.
Summary of Other Financial Assets and Liabilities
The estimated fair values of our other financial assets and liabilities were as follows:
March 31, 2018 | December 31, 2017 | ||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | ||||||||||||
Cash and cash equivalents | $ | 1,398 | $ | 1,398 | $ | 1,293 | $ | 1,293 | |||||||
Accounts receivable, net | 1,326 | 1,326 | 1,357 | 1,357 | |||||||||||
Short-term debt | 678 | 679 | 282 | 283 | |||||||||||
Long-term debt | 4,811 | 4,880 | 5,235 | 5,373 | |||||||||||
The fair value amounts for Cash and cash equivalents and Accounts receivable, net, approximate carrying amounts due to the short maturities of these instruments. The fair value of Short and Long-term debt was estimated based on the current rates offered to us for debt of similar maturities (Level 2). The difference between the fair value and the carrying value represents the theoretical net premium or discount we would pay or receive to retire all debt at such date.
Xerox 2018 Form 10-Q
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Note 15 – Employee Benefit Plans
The components of Net periodic benefit cost and other changes in plan assets and benefit obligations were as follows:
Three Months Ended March 31, | |||||||||||||||||||||||
Pension Benefits | |||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | Retiree Health | |||||||||||||||||||||
Components of Net Periodic Benefit Costs: | 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||
Service cost | $ | 1 | $ | 1 | $ | 6 | $ | 7 | $ | 1 | $ | 1 | |||||||||||
Interest cost | 33 | 34 | 39 | 39 | 6 | 7 | |||||||||||||||||
Expected return on plan assets | (34 | ) | (31 | ) | (63 | ) | (53 | ) | — | — | |||||||||||||
Recognized net actuarial loss | 6 | 5 | 15 | 19 | — | — | |||||||||||||||||
Amortization of prior service credit | — | — | (1 | ) | (1 | ) | (1 | ) | (1 | ) | |||||||||||||
Recognized settlement loss | 25 | 42 | — | — | — | — | |||||||||||||||||
Defined benefit plans | 31 | 51 | (4 | ) | 11 | 6 | 7 | ||||||||||||||||
Defined contribution plans | 6 | 6 | 7 | 7 | n/a | n/a | |||||||||||||||||
Net Periodic Benefit Cost | 37 | 57 | 3 | 18 | 6 | 7 | |||||||||||||||||
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income: | |||||||||||||||||||||||
Net actuarial (gain) loss(1) | (58 | ) | 8 | — | — | — | — | ||||||||||||||||
Amortization of net actuarial loss | (31 | ) | (47 | ) | (15 | ) | (19 | ) | — | — | |||||||||||||
Amortization of prior service credit | — | — | 1 | 1 | 1 | 1 | |||||||||||||||||
Total Recognized in Other Comprehensive Income(2) | (89 | ) | (39 | ) | (14 | ) | (18 | ) | 1 | 1 | |||||||||||||
Total Recognized in Net Periodic Benefit Cost and Other Comprehensive Income | $ | (52 | ) | $ | 18 | $ | (11 | ) | $ | — | $ | 7 | $ | 8 | |||||||||
(1) | The net actuarial (gain) loss for U.S. Plans primarily reflects the re-measurement of our primary U.S. pension plans as a result of the payment of periodic settlements. |
(2) | Amounts represent the pre-tax effect included within Other comprehensive Income. Refer to Note 17 - Other Comprehensive Income for related tax effects and the after-tax amounts. |
Contributions
The following table summarizes cash contributions to our defined benefit pension plans and retiree health benefit plans.
Three Months Ended March 31, | Year Ended December 31, | |||||||||||||||
2018 | 2017 | Estimated 2018 | 2017 | |||||||||||||
U.S. plans | $ | 8 | $ | 6 | $ | 76 | $ | 675 | ||||||||
Non-U.S. plans | 30 | 17 | 116 | 161 | ||||||||||||
Total Pension | $ | 38 | $ | 23 | $ | 192 | $ | 836 | ||||||||
Retiree Health | $ | 15 | $ | 14 | $ | 62 | $ | 64 | ||||||||
There are no contributions required in 2018 for our U.S. tax-qualified defined benefit plans to meet the minimum funding requirements, however, our estimated 2018 contributions include $50 of voluntary contributions to these plans.
Xerox 2018 Form 10-Q
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Note 16 – Shareholders’ Equity
Common Stock | Additional Paid-in Capital | Retained Earnings | AOCL(4) | Xerox Shareholders’ Equity | Non-controlling Interests | Total Equity | |||||||||||||||||||||
Balance at December 31, 2017 | $ | 255 | $ | 3,893 | $ | 4,856 | $ | (3,748 | ) | $ | 5,256 | $ | 37 | $ | 5,293 | ||||||||||||
Cumulative effect of change in accounting principle(1) | — | — | 117 | — | 117 | — | 117 | ||||||||||||||||||||
Comprehensive income, net | — | — | 23 | 211 | 234 | 3 | 237 | ||||||||||||||||||||
Cash dividends declared - common(2) | — | — | (65 | ) | — | (65 | ) | — | (65 | ) | |||||||||||||||||
Cash dividends declared - preferred(3) | — | — | (4 | ) | — | (4 | ) | — | (4 | ) | |||||||||||||||||
Stock option and incentive plans, net | — | 15 | — | — | 15 | — | 15 | ||||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | (11 | ) | (11 | ) | ||||||||||||||||||
Balance at March 31, 2018 | $ | 255 | $ | 3,908 | $ | 4,927 | $ | (3,537 | ) | $ | 5,553 | $ | 29 | $ | 5,582 | ||||||||||||
Common Stock | Additional Paid-in Capital | Retained Earnings | AOCL(4) | Xerox Shareholders’ Equity | Non- controlling Interests | Total Equity | |||||||||||||||||||||
Balance at December 31, 2016 | $ | 254 | $ | 3,858 | $ | 4,934 | $ | (4,337 | ) | $ | 4,709 | $ | 38 | $ | 4,747 | ||||||||||||
Comprehensive income, net | — | — | 40 | 166 | 206 | 3 | 209 | ||||||||||||||||||||
Cash dividends declared - common(2) | — | — | (64 | ) | — | (64 | ) | — | (64 | ) | |||||||||||||||||
Cash dividends declared - preferred(3) | — | — | (4 | ) | — | (4 | ) | — | (4 | ) | |||||||||||||||||
Stock option and incentive plans, net | — | 6 | — | — | 6 | — | 6 | ||||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | (1 | ) | (1 | ) | ||||||||||||||||||
Balance at March 31, 2017 | $ | 254 | $ | 3,864 | $ | 4,906 | $ | (4,171 | ) | $ | 4,853 | $ | 40 | $ | 4,893 | ||||||||||||
_____________________________
(1)Refer to Note 3 - Adoption of New Revenue Recognition Standard for additional information.
(2)Cash dividends declared on common stock of $0.25 per share in the first quarter of 2018 and 2017.
(3)Cash dividends declared on preferred stock of $20.00 per share in the first quarter of 2018 and 2017.
(4)Refer to Note 17 - Other Comprehensive Income for components of AOCL.
Treasury Stock
There were no repurchases of Xerox Common Stock pursuant to Board authorized share repurchase programs during the first quarter 2018.
Xerox 2018 Form 10-Q
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Note 17 - Other Comprehensive Income
Other Comprehensive Income is comprised of the following:
Three Months Ended March 31, | ||||||||||||||||
2018 | 2017 | |||||||||||||||
Pre-tax | Net of Tax | Pre-tax | Net of Tax | |||||||||||||
Translation Adjustments Gains | $ | 184 | $ | 176 | $ | 134 | $ | 133 | ||||||||
Unrealized Gains (Losses): | ||||||||||||||||
Changes in fair value of cash flow hedges - gains | 12 | 8 | 9 | 6 | ||||||||||||
Changes in cash flow hedges reclassed to earnings(1) | 12 | 10 | 4 | 2 | ||||||||||||
Other losses | (1 | ) | (1 | ) | — | — | ||||||||||
Net unrealized gains | 23 | 17 | 13 | 8 | ||||||||||||
Defined Benefit Plans Gains (Losses): | ||||||||||||||||
Net actuarial/prior service gains (losses) | 58 | 43 | (8 | ) | (5 | ) | ||||||||||
Prior service amortization(2) | (2 | ) | (1 | ) | (2 | ) | (1 | ) | ||||||||
Actuarial loss amortization/settlement(2) | 46 | 35 | 66 | 44 | ||||||||||||
Fuji Xerox changes in defined benefit plans, net(3) | (21 | ) | (21 | ) | 13 | 13 | ||||||||||
Other losses(4) | (38 | ) | (38 | ) | (25 | ) | (25 | ) | ||||||||
Changes in defined benefit plans gains | 43 | 18 | 44 | 26 | ||||||||||||
Other Comprehensive Income | 250 | 211 | 191 | 167 | ||||||||||||
Less: Other comprehensive income attributable to noncontrolling interests | — | — | 1 | 1 | ||||||||||||
Other Comprehensive Income Attributable to Xerox | $ | 250 | $ | 211 | $ | 190 | $ | 166 | ||||||||
_____________________________
(1) | Reclassified to Cost of sales - refer to Note 13 - Financial Instruments for additional information regarding our cash flow hedges. |
(2) | Reclassified to Total Net Periodic Benefit Cost - refer to Note 15 - Employee Benefit Plans for additional information. |
(3) | Represents our share of Fuji Xerox's benefit plan changes. |
(4) | Primarily represents currency impact on cumulative amount of benefit plan net actuarial losses and prior service credits in AOCL. |
Accumulated Other Comprehensive Loss (AOCL)
AOCL is comprised of the following:
March 31, 2018 | December 31, 2017 | |||||||
Cumulative translation adjustments | $ | (1,605 | ) | $ | (1,781 | ) | ||
Other unrealized gains (losses), net | 5 | (12 | ) | |||||
Benefit plans net actuarial losses and prior service credits(1) | (1,937 | ) | (1,955 | ) | ||||
Total Accumulated other comprehensive loss attributable to Xerox | $ | (3,537 | ) | $ | (3,748 | ) | ||
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(1) | Includes our share of Fuji Xerox. |
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Note 18 – Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share of common stock (shares in thousands):
Three Months Ended March 31, | ||||||||
2018 | 2017 | |||||||
Basic Earnings (Loss) per Share: | ||||||||
Net Income from Continuing Operations Attributable to Xerox | $ | 23 | $ | 46 | ||||
Accrued dividends on preferred stock | (4 | ) | (4 | ) | ||||
Adjusted Net income from continuing operations available to common shareholders | 19 | 42 | ||||||
Net loss from discontinued operations attributable to Xerox | — | (6 | ) | |||||
Adjusted Net income available to common shareholders | $ | 19 | $ | 36 | ||||
Weighted average common shares outstanding | 254,660 | 254,038 | ||||||
Basic Earnings (Loss) per Share: | ||||||||
Continuing operations | $ | 0.08 | $ | 0.17 | ||||
Discontinued operations | — | (0.03 | ) | |||||
Basic Earnings per Share | $ | 0.08 | $ | 0.14 | ||||
Diluted Earnings (Loss) per Share: | ||||||||
Net Income from Continuing Operations Attributable to Xerox | $ | 23 | $ | 46 | ||||
Accrued dividends on preferred stock | (4 | ) | (4 | ) | ||||
Adjusted Net income from continuing operations available to common shareholders | 19 | 42 | ||||||
Net loss from discontinued operations attributable to Xerox | — | (6 | ) | |||||
Adjusted Net income available to common shareholders | $ | 19 | $ | 36 | ||||
Weighted average common shares outstanding | 254,660 | 254,038 | ||||||
Common shares issuable with respect to: | ||||||||
Restricted stock and performance shares | 2,810 | 2,104 | ||||||
Adjusted Weighted average common shares outstanding | 257,470 | 256,142 | ||||||
Diluted Earnings (Loss) per Share: | ||||||||
Continuing operations | $ | 0.08 | $ | 0.16 | ||||
Discontinued operations | — | (0.02 | ) | |||||
Diluted Earnings per Share | $ | 0.08 | $ | 0.14 | ||||
The following securities were not included in the computation of diluted earnings per share as they were either contingently issuable shares or shares that if included would have been anti-dilutive: | ||||||||
Stock options | — | — | ||||||
Restricted stock and performance shares | 2,977 | 3,937 | ||||||
Convertible preferred stock | 6,742 | 6,742 | ||||||
Total Anti-Dilutive Securities | 9,719 | 10,679 | ||||||
Dividends per Common Share | $ | 0.25 | $ | 0.25 | ||||
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Note 19 – Contingencies and Litigation
Legal Matters
We are involved in a variety of claims, lawsuits, investigations and proceedings concerning: securities law; governmental entity contracting; servicing and procurement law; intellectual property law; environmental law; employment law; the Employee Retirement Income Security Act (ERISA); and other laws and regulations. We determine whether an estimated loss from a contingency should be accrued by assessing whether a loss is deemed probable and can be reasonably estimated. We assess our potential liability by analyzing our litigation and regulatory matters using available information. We develop our views on estimated losses in consultation with outside counsel handling our defense in these matters, which involves an analysis of potential results, assuming a combination of litigation and settlement strategies. Should developments in any of these matters cause a change in our determination as to an unfavorable outcome and result in the need to recognize a material accrual, or should any of these matters result in a final adverse judgment or be settled for significant amounts, they could have a material adverse effect on our results of operations, cash flows and financial position in the period or periods in which such change in determination, judgment or settlement occurs.
Brazil Tax and Labor Contingencies
Our Brazilian operations are involved in various litigation matters and have received or been the subject of numerous governmental assessments related to indirect and other taxes, as well as disputes associated with former employees and contract labor. The tax matters, which comprise a significant portion of the total contingencies, principally relate to claims for taxes on the internal transfer of inventory, municipal service taxes on rentals and gross revenue taxes. We are disputing these tax matters and intend to vigorously defend our positions. Based on the opinion of legal counsel and current reserves for those matters deemed probable of loss, we do not believe that the ultimate resolution of these matters will materially impact our results of operations, financial position or cash flows.
The labor matters principally relate to claims made by former employees and contract labor for the equivalent payment of all social security and other related labor benefits, as well as consequential tax claims, as if they were regular employees. As of March 31, 2018, the total amounts related to the unreserved portion of the tax and labor contingencies, inclusive of any related interest, amounted to approximately $585, with the decrease from our December 31, 2017 balance of approximately $600, primarily related to closed cases, partially offset by interest. With respect to the unreserved balance of $585, the majority has been assessed by management as being remote as to the likelihood of ultimately resulting in a loss to the company. In connection with the above proceedings, customary local regulations may require us to make escrow cash deposits or post other security of up to half of the total amount in dispute. As of March 31, 2018, we had $72 of escrow cash deposits for matters we are disputing and additional letters of credit and surety bonds of approximately $131 and $107, respectively, which include associated indexation. There were no liens on any of our Brazilian assets as of March 31, 2018. Generally, any escrowed amounts would be refundable and any liens would be removed to the extent the matters are resolved in our favor. We routinely assess all these matters as to the probability of ultimately incurring a liability against our Brazilian operations and record our best estimate of the ultimate loss in situations where we assess the likelihood of an ultimate loss as probable.
Litigation Against the Company
Pending LItigation Relating to the Fuji Transaction: In February 2018, five complaints, including four putative class actions (which have been consolidated), were filed by Xerox shareholders in the Supreme Court of the State of New York, County ("Court") in connection with the proposed transaction to combine Xerox and Fuji Xerox (“Fuji Transaction”) (refer to Note 20 - Fuji Xerox Transaction and Recent Developments). All of the complaints name as defendants Xerox, its directors, and FUJIFILM Holdings Corporation (“Fujifilm”). The complaint in one of the actions also names as a defendant Ursula M. Burns, the former Chief Executive Officer of Xerox. The plaintiffs allege, among other things, that Xerox's directors breached their fiduciary duties in negotiating, approving, and purportedly making false and misleading disclosures about the Fuji Transaction, and that Fujifilm aided and abetted those breaches. The complaint in one of the actions further alleges that Xerox and the director defendants engaged in common law fraud by purportedly failing to disclose information about the joint venture agreements between Xerox and Fujifilm. The lawsuits seek injunctive relief preventing the proposed transactions, and/or additional disclosures by Xerox’s directors, unspecified damages from Xerox’s directors, costs and attorneys’ fees, as well as other relief.
Another complaint filed by Darwin Deason, a Xerox shareholder, against Xerox and its directors in the same Court on March 2, 2018 alleges that defendants breached their fiduciary duties by refusing Mr. Deason’s request for a waiver of the deadline for nomination of a new slate of Xerox directors, and seeks to enjoin Xerox and its directors from
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enforcing Xerox’s advance notice by-laws, thereby allowing Mr. Deason to proceed with the nominations, as well as costs, fees, and other relief.
On April 27, 2018, the Court issued decisions and orders granting plaintiffs’ preliminary injunction motions, which (i) enjoin Xerox from “taking any further action to consummate the change of control transaction between Xerox and Fuji that was announced on January 31, 2018 pending a final determination of the claims asserted in the underlying action;” (ii) enjoin Xerox from enforcing its advance notice bylaw provision requiring shareholders to nominate directors for election at the 2018 annual shareholder meeting by December 11, 2017; and (iii) require Xerox to waive such advance notice bylaw provision to permit the noticing of a slate of director nominees for election at the 2018 annual shareholder meeting, and denying defendants’ motions to dismiss.
On May 1, 2018, Xerox entered into a Director Appointment, Nomination and Settlement Agreement (the “Settlement Agreement”) with Carl Icahn and Darwin Deason, among others, that would have resolved the pending proxy contest in connection with Xerox’s 2018 Annual Meeting of Shareholders, as well as the ongoing litigation brought by Mr. Deason against Xerox and its directors related to the proposed Fuji Transaction. The agreement expired by its terms on May 3, 2018 without becoming effective.
On May 7, 2018, defendants filed with the Supreme Court of the State of New York, Appellate Division, First Judicial Department, notices of appeal of, and motions to stay pending appeal, the lower Court’s decision and order. Defendants also moved the appellate court for interim relief ordering that the appeal be heard on an expedited basis. At a hearing before the appellate court on May 7, 2018, the appellate court ruled that the appeals would be heard on an expedited basis and granted a partial interim stay allowing Xerox and Fujifilm to take steps to seek regulatory approvals related to the Fuji Transaction pending a ruling from the appellate court on defendants’ motions to stay pending appeal.
Xerox believes the lawsuits are meritless and will vigorously defend them. At this time, however, it is premature to make any conclusion regarding the probability of incurring material losses in these litigations. Should developments cause a change in our determination as to an unfavorable outcome, or result in a final adverse judgment or settlement, there could be a material adverse effect on our results of operations, cash flows and financial position in the period in which such change in determination, judgment, or settlement occurs, including an inability to close the proposed transactions.
State of Texas v. Xerox Corporation, Xerox State Healthcare, LLC, and ACS State Healthcare, LLC: On May 9, 2014, the State of Texas, via the Texas Office of Attorney General (the “State”), filed a lawsuit in the 53rd Judicial District Court of Travis County, Texas. The lawsuit alleges that Xerox Corporation, Xerox State Healthcare, LLC and ACS State Healthcare (collectively “the Defendants”) violated the Texas Medicaid Fraud Prevention Act in the administration of ACS’s contract with the Texas Department of Health and Human Services (“HHSC”). Xerox Corporation provided a guaranty of contractual performance with respect to the ACS contract. The State alleges that the Defendants made false representations of material facts regarding the processes, procedures, implementation and results regarding the prior authorization of orthodontic claims. The State seeks recovery of actual damages, two times the amount of any overpayments made as a result of unlawful acts, civil penalties, pre- and post-judgment interest and all costs and attorneys’ fees. The State references the amount in controversy as exceeding hundreds of millions of dollars. The Defendants filed their Answer in June 2014 denying all allegations. In August 2017, the State of Texas filed a Second Amended Petition, which makes substantially similar allegations and seeks similar remedies as the original lawsuit. On October 23, 2017, Xerox Corporation filed a Motion for Summary Judgment seeking judgment in Xerox's favor on all claims against it. The Defendants will continue to vigorously defend themselves in this matter. This matter is a “Conduent Liability”, as defined in the Separation and Distribution Agreement dated as of December 31, 2016 between Xerox Corporation and Conduent Incorporated, for which Conduent is required to indemnify Xerox. Conduent is entitled to direct the defense of this matter.
Oklahoma Firefighters Pension and Retirement System v. Xerox Corporation, Ursula M. Burns, Luca Maestri, Kathryn A. Mikells, Lynn R. Blodgett, Robert K. Zapfel, David H. Bywater and Mary Scanlon: On October 21, 2016, the Oklahoma Firefighters Pension and Retirement System (“plaintiff”) filed a purported securities class action complaint against Xerox Corporation, Ursula Burns, Luca Maestri, Kathryn Mikells, Lynn Blodgett and Robert Zapfel (collectively, “defendants”) in the U.S. District Court for the Southern District of New York on behalf of the plaintiff and certain purchasers or acquirers of Xerox common stock. The complaint alleged that defendants made false and misleading statements, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act and SEC Rule 10b-5, relating to the operations and prospects of Xerox’s Health Enterprise business. Plaintiff sought, among other things, unspecified monetary damages and attorneys’ fees. Other, similar lawsuits may follow. On December 28, 2016, the Court entered a stipulated order setting out a schedule for amendment of the complaint and for defendants’ response to that complaint following the Court’s appointment of lead plaintiff under the Private Securities Litigation Reform Act.
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On February 28, 2017, the Court issued an opinion and order appointing the Arkansas Public Employees Retirement System ("APERS") as lead plaintiff. On May 1, 2017, APERS filed an amended complaint, alleging substantially similar claims and seeking substantially similar relief, but adding David Bywater and Mary Scanlon as defendants. On June 30, 2017, defendants moved to dismiss the amended complaint, and the motions were fully briefed on October 13, 2017. On March 20, 2018, the Court entered an opinion and order granting the motions, and on March 23, 2018, the Court entered a judgment of dismissal and closed the case. On April 20, 2018, plaintiffs filed a notice of appeal in the U.S. Court of Appeals for the Second Circuit. Xerox will vigorously defend against this matter. At this time, it is premature to make any conclusion regarding the probability of incurring material losses in this litigation. Should developments cause a change in our determination as to an unfavorable outcome, or result in a final adverse judgment or settlement, there could be a material adverse effect on our results of operations, cash flows and financial position in the period in which such change in determination, judgment, or settlement occurs.
Other Contingencies
We have issued or provided approximately $366 of guarantees as of March 31, 2018 in the form of letters of credit or surety bonds issued to i) support certain insurance programs; ii) support our obligations related to the Brazil tax and labor contingencies; and iii) support certain contracts, primarily with public sector customers, which require us to provide a surety bond as a guarantee of our performance of contractual obligations.
In general, we would only be liable for the amount of these guarantees in the event we defaulted in performing our obligations under each contract; the probability of which we believe is remote. We believe that our capacity in the surety markets as well as under various credit arrangements (including our Credit Facility) is sufficient to allow us to respond to future requests for proposals that require such credit support.
Indemnifications
We have indemnified, subject to certain deductibles and limits, the purchasers of businesses or divested assets for the occurrence of specified events under certain of our divestiture agreements. Where appropriate, an obligation for such indemnifications is recorded as a liability. Since the obligated amounts of these types of indemnifications are often not explicitly stated and/or are contingent on the occurrence of future events, the overall maximum amount of the obligation under such indemnifications cannot be reasonably estimated. Other than obligations recorded as liabilities at the time of divestiture, we have not historically made significant payments for these indemnifications. Additionally, under certain of our acquisition agreements, we have provided for additional consideration to be paid to the sellers if established financial targets are achieved post-closing. We have recognized liabilities for these contingent obligations based on an estimate of the fair value of these contingencies at the time of acquisition. Contingent obligations related to indemnifications arising from our divestitures and contingent consideration provided for by our acquisitions are not expected to be material to our financial position, results of operations or cash flows.
Note 20 – Fuji Xerox Transaction and Recent Developments
Pending Litigation Relating to the Fuji Transaction
Refer to Note 19 - Contingencies and Litigation for discussion of the Pending Litigation Relating to the Fuji Transaction.
Fuji Xerox Transaction Overview
On January 31, 2018, Xerox entered into (i) a Redemption Agreement with FUJIFILM Holdings Corporation, a Japanese company (“Fujifilm”), and Fuji Xerox Co., Ltd., a Japanese company, in which Xerox indirectly holds a 25% equity interest while Fujifilm holds the remaining 75% equity interest (“Fuji Xerox”), and (ii) a Subscription Agreement with Fujifilm (collectively, the “Transaction Agreements”). The Transaction Agreements provide that, on the terms and subject to the conditions set forth in the Transaction Agreements, among other things:
• | Redemption and Issuance - Fuji Xerox will redeem most of the shares of Fuji Xerox owned by Fujifilm in exchange for cash. Immediately following the Redemption, Fujifilm will contribute to Xerox the cash it received in the Redemption and all shares of Fuji Xerox still held by Fujifilm after giving effect to the Redemption and, in exchange therefore, Xerox will issue to Fujifilm a number of shares of Xerox common stock such that Fujifilm will own 50.1% of the Xerox common stock, on a fully diluted basis, at the closing of the transactions (the “Closing”), a portion of which will be held in escrow in accordance with the terms of the Transaction Agreements. As a result of the transactions contemplated by the Transaction Agreements (referred to herein as the "combination"), Fuji Xerox will become a wholly owned subsidiary of Xerox and Xerox will become a direct, majority owned subsidiary of Fujifilm (with the remainder of Xerox continuing to be owned by Xerox’s existing shareholders). The escrowed shares will be released from escrow upon, among other things, (i) the conversion of any shares of Xerox Series B Convertible |
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Perpetual Preferred Stock into Xerox common stock or (ii) the issuance of any Xerox common stock in respect of any performance shares, options that were not in-the-money options or restricted stock units that remain unvested as of two business days prior to the Closing. If the events that could give rise to a release of the escrow shares to Fujifilm can no longer reasonably be expected to occur, then the escrow shares will be transferred back to the combined company (“new Fuji Xerox”) and thereafter cancelled. Prior to their release, Fujifilm, as the holder of the escrow shares, will be required to vote such shares in the same proportion as all of the outstanding shares of Xerox common stock that are not escrowed shares are voted (for or against, not voted, or abstained as the case may be) and to return to new Fuji Xerox any distributions of dividends received in respect thereof.
• | Special Dividend - In connection with the combination, subject to applicable law, Xerox will declare a special one-time cash dividend of $2.5 billion, in the aggregate, to the holders of record of Xerox common stock on the record date for the special dividend. The amount of the special dividend is currently estimated to be approximately $9.80 per share of Xerox common stock (based on the shares of Xerox common stock outstanding as of March 31, 2018). The special dividend will be paid immediately prior to the Closing and funded by a new borrowing. Fujifilm will not be a shareholder of Xerox as of the record date for the special dividend and therefore will not receive any payment in respect thereof. |
As previously announced, the Company and Fujifilm have been in discussions about improving the terms of their announced transaction. In connection with such discussions, the Company has had correspondence with Fujifilm as to whether Xerox has the right to terminate the Subscription Agreement.
Fuji Xerox has been determined to be the accounting acquirer and Xerox to be the accounting acquiree under the acquisition method of accounting based on various considerations. As noted above, immediately following the Closing, Fujifilm, the former parent of Fuji Xerox, is expected to own approximately 50.1% of the fully diluted capital stock of new Fuji Xerox and the other Xerox shareholders are expected to own approximately 49.9%. Further, pursuant to the Shareholders Agreement, to be entered into by Xerox and Fujifilm at Closing (the “Shareholders Agreement”), the board of directors of new Fuji Xerox will have twelve directors, which will initially be composed of seven individuals designated by Fujifilm (including the current CEO of Xerox) and five individuals from among the members of the board of directors of Xerox immediately prior to Closing designated by Xerox in consultation with and subject to reasonable approval by Fujifilm. Accordingly, the combination is expected to be accounted for as a reverse acquisition as per ASC Topic 805-40 "Business Combinations - Reverse Acquisitions".
Under certain circumstances, including the following, Xerox must pay to Fujifilm a $183 termination fee (the “Termination Fee”): in the event that the Subscription Agreement is terminated (i) by either party because the applicable shareholder approvals are not obtained if an alternative acquisition proposal is publicly announced prior to the Xerox shareholder meeting duly called for the purpose of obtaining the applicable shareholder approvals and Xerox enters into a definitive agreement with respect to, or otherwise consummates, an alternative acquisition proposal within 12 months after the termination of the Subscription Agreement; (ii) by Fujifilm (A) in connection with a material and intentional breach by Xerox of its non-solicitation obligations resulting in a third party making an alternate acquisition proposal that is reasonably likely to materially interfere with the Fujifilm Transactions or (B) following a change in the recommendation by the Board of Directors of Xerox; or (iii) by Xerox in order to enter into a definitive agreement with a third party with respect to a superior proposal, in each case as set forth in, and subject to the conditions of, the Fujifilm Transaction Agreements.
The completion of the Fujifilm Transactions will require Xerox shareholder approval as well as customary regulatory approvals, filings with the U.S. Securities and Exchange Commission, tax considerations, and securing any necessary financing. Until the combination is complete, each of Xerox, Fuji Xerox and Fujifilm will continue to be separate, independent organizations and will operate as usual.
Bridge Facility
On January 31, 2018, Xerox entered into a Commitment Letter with Citigroup Global Markets Inc. and Morgan Stanley Senior Funding, Inc., which provides a commitment, subject to the satisfaction of customary conditions, for a $2.5 billion unsecured bridge loan facility. This facility would be available for Xerox to pay the special one-time cash dividend of $2.5 billion to existing shareholders of Xerox as described herein. Xerox has not borrowed funds nor does it currently plan to borrow funds from this facility, rather, prior to closing, Xerox intends to secure alternative financing to meet its obligation to pay the special dividend. At March 31, 2018, we had approximately $11 of debt issuance costs deferred in connection with this facility, which are currently being amortized over the remainder of the year, and another $6 was paid in the second quarter 2018, which will also be deferred and amortized. Xerox may also secure financing to fund approximately $350 required to settle certain of Xerox's obligations in respect of unfunded supplemental pension plans and deferred compensation plans which will accelerate in connection with the combination (such accelerated payments, the "change-in-control payments").
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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Xerox Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes.
Throughout this document, references to “we,” “our,” the “company,” and “Xerox” refer to Xerox Corporation and its subsidiaries. References to “Xerox Corporation” refer to the stand-alone parent company and do not include its subsidiaries.
Currency Impact
To better understand the trends in our business, we believe that it is helpful to analyze the impact of changes in the translation of foreign currencies into U.S. Dollars on revenue and expenses. We refer to this analysis as "constant currency", “currency impact” or “the impact from currency.” This impact is calculated by translating current period activity in local currency using the comparable prior year period's currency translation rate. This impact is calculated for all countries where the functional currency is the local country currency. We do not hedge the translation effect of revenues or expenses denominated in currencies where the local currency is the functional currency. Management believes the constant currency measure provides investors an additional perspective on revenue trends. Currency impact can be determined as the difference between actual growth rates and constant currency growth rates. The constant currency impact for signings growth is calculated on the basis of plan currency rates.
Overview
Fuji Xerox Transaction and Recent Developments
Refer to Note 19 - Contingencies and Litigation and Note 20 - Fuji Xerox Transaction and Recent Developments in the Condensed Consolidated Financial Statements for additional information related to this transaction and related matters.
Fuji Xerox Adjustments
As previously disclosed, in April 2017 Fujifilm publicly announced it had formed an independent investigation committee ("IIC") to conduct a review of the appropriateness of the accounting practices at Fuji Xerox’s New Zealand subsidiary related to the recovery of receivables associated with certain bundled leasing transactions that occurred in, or prior to, Fuji Xerox’s fiscal year ending March 31, 2016. The IIC’s review, completed during the second quarter 2017, identified total aggregate adjustments to Fuji Xerox's financial statements of approximately JPY 40 billion (approximately $360 million based on the Yen/U.S. Dollar spot exchange rate at March 31, 2017 of 111.89). The adjustments identified by the IIC primarily related to misstatements at Fuji Xerox's New Zealand subsidiary as well as their Australian subsidiary and certain other adjustments. We determined that our cumulative share of the total aggregate adjustments identified as part of the investigation was approximately $90 million and affected our fiscal years 2009 through 2017. In the second quarter 2017, we determined that the misstatements to our Equity in net income of unconsolidated affiliates in prior years and the first quarter of 2017 identified through the IIC's review were immaterial to our previously issued financial statements. However, we concluded that the cumulative correction of these misstatements would have had a material effect on our full year 2017 consolidated financial statements. Accordingly, we revised our previously issued annual consolidated financial statements for 2015 and 2016. As a result of the IIC’s findings and recommendations, Fuji Xerox began the process of implementing improved management controls, an entity level monitoring system for financial statements of subsidiaries, and oversight and governance policies, practices and procedures.
In 2018, in connection with the completion of the audits of Fuji Xerox’s fiscal year-end financial statements as of and for the years ended March 31, 2016 and 2017, as well as the review of Fuji Xerox’s unaudited interim financial statements as of and for the nine months ended December 31, 2017 and 2016, additional adjustments and misstatements were identified. These additional adjustments and misstatements were to the previously reported net income of Fuji Xerox for the period from 2010 through 2017 and are incremental to the items identified by the IIC noted above. These incremental adjustments primarily relate to Fuji Xerox’s Asia Pacific subsidiaries and involve improper revenue recognition, including revenue associated with leasing transactions, additional provisions for bad debt allowances and other asset impairments. In certain instances, some of the adjustments related to inappropriate accounting and reporting practices in the Fuji Xerox Asia Pacific subsidiaries and are further evidence of inadequate management oversight and an insufficient entity level monitoring system for financial statements of subsidiaries beyond what was previously identified by the IIC. Fuji Xerox is committed to implementing additional measures to remediate these newly identified issues.
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Fuji Xerox recorded a cumulative charge of JPY 12 billion (approximately $110 million based on the Yen/U.S. Dollar average exchange rate for the quarter ended March 31, 2018 of 108.07) in their net loss for the quarter ended March 31, 2018 (our first quarter 2018) related to the correction of these additional adjustments and misstatements. Our recognition of 25% of Fuji Xerox’s net loss for Xerox’s first quarter 2018 included an approximately $28 million charge related to these adjustments and misstatements. We determined that the impact of the out-of-period misstatements was not material to Xerox’s consolidated financial statements for any individual prior quarter or year and the adjustment to correct the misstatements is not expected to be material to our full year 2018 results.
Refer to Note 10 - Investments in Affiliates, at Equity in the Condensed Consolidated Financial Statements for additional information.
First Quarter 2018 Review
Total revenue of $2.44 billion for first quarter 2018 declined 0.8% from first quarter 2017 including a 3.8-percentage point favorable impact from currency. Post-sale revenue, which primarily reflects contracted services, equipment maintenance, supplies and financing, were $1.94 billion and represented 80% of total revenues. Post-sale revenue, declined 0.3% including a 3.8-percentage point favorable impact from currency. The decline in post-sale revenue primarily reflected continuing lower page volume trends and a lower population of devices as well as the higher mix of installs of lower usage devices. These declines were partially offset by higher revenues from our Managed Document Services and Global Imaging business. Equipment revenues of $499 million declined by 2.7%, including a 3.7-percentage point favorable impact from currency. Excluding the impact from currency, equipment revenues declined across all product areas and reflected price declines of approximately 5% as well as the follow-on impact of higher entry and mid-range sales in fourth quarter 2017 related to the expansion of our U.S. indirect channels. The decline in equipment sales also reflected the overall market decline trends, unfavorable mix and lower revenues from our OEM business.
Net income from continuing operations attributable to Xerox for the three months ended March 31, 2018 was $23 million and included after-tax costs of $155 million related to the amortization of intangible assets, restructuring and related costs, transaction and related costs, non-service retirement-related costs and other discrete adjustments, resulting in adjusted1 net income from continuing operations attributable to Xerox of $178 million. Net income from continuing operations attributable to Xerox for the three months ended March 31, 2017 was $46 million and included after-tax costs of $130 million related to the amortization of intangible assets, restructuring and related costs, non-service retirement-related costs and other discrete adjustments, resulting in adjusted1 net income from continuing operations attributable to Xerox of $176 million. The decrease in net income from continuing operations attributable to Xerox for the three months ended March 31, 2018 as compared to the prior year period was primarily due to lower equity income from our unconsolidated affiliates, which included our share of a significant restructuring charge recorded by Fuji Xerox, transaction and related costs and higher income taxes. These impacts were partially offset by lower restructuring and related costs and non-service retirement-related costs. The increase in adjusted1 net income from continuing operations attributable to Xerox for the three months ended March 31, 2018 as compared to the prior year period was primarily related to increased operating profits reflecting the continued benefits of cost savings and productivity improvements, which offset the decline in revenues, as well as lower interest expense and a gain on the sale of non-core assets. These impacts were partially offset by lower equity income from unconsolidated affiliates and higher income taxes.
Operating cash flow from continuing operations for the three months ended March 31, 2018 was $216 million, as compared to $132 million for the prior year period. The increase is primarily due to improved operating profits, working capital2 and the prior year reclassification of $54 million of collections of deferred proceeds and beneficial interests from the sale of receivables to investing cash flows as a result of an accounting change (Refer to Note 4 - Recent Accounting Pronouncements in the Condensed Consolidated Financial Statements for additional information).
Cash used in investing activities for the three months ended March 31, 2018 was $2 million and included capital expenditures (including internal use software) of $18 million which were partially offset by proceeds of $16 million from the sale of non-core business assets. Cash used in financing activities of $117 million for the three months ended March 31, 2018 primarily reflects payments of $25 million related to the termination of a capital lease obligation and $13 million of bridge facility costs, as well as dividend payments of $67 million.
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(1) | See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. |
(2) | Working capital reflects Accounts receivable, net, Inventories and Accounts payable and Accrued compensation. |
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Financial Review
Revenues
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Three Months Ended March 31, | ||||||||||||||||||||
(in millions) | 2018 | 2017 | % Change | CC % Change | % of Total Revenue 2018 | % of Total Revenue 2017 | ||||||||||||||
Equipment sales | $ | 499 | $ | 513 | (2.7 | )% | (6.4 | )% | 20 | % | 21 | % | ||||||||
Post sale revenue | 1,936 | 1,941 | (0.3 | )% | (4.1 | )% | 80 | % | 79 | % | ||||||||||
Total Revenue | $ | 2,435 | $ | 2,454 | (0.8 | )% | (4.6 | )% | 100 | % | 100 | % | ||||||||
Reconciliation to Condensed Consolidated Statements of Income: | ||||||||||||||||||||
Sales | $ | 933 | $ | 936 | (0.3 | )% | (3.4 | )% | ||||||||||||
Less: Supplies, paper and other sales | (434 | ) | (434 | ) | — | % | (2.4 | )% | ||||||||||||
Add: Equipment-related training(1) | — | 11 | NM | NM | ||||||||||||||||
Equipment sales | $ | 499 | $ | 513 | (2.7 | )% | (6.4 | )% | ||||||||||||
Services, maintenance and rentals | $ | 1,431 | $ | 1,442 | (0.8 | )% | (5.1 | )% | ||||||||||||
Add: Supplies, paper and other sales | 434 | 434 | — | % | (2.4 | )% | ||||||||||||||
Add: Financing | 71 | 76 | (6.6 | )% | (10.6 | )% | ||||||||||||||
Less: Equipment-related training(1) | — | (11 | ) | NM | NM | |||||||||||||||
Post sale revenue | $ | 1,936 | $ | 1,941 | (0.3 | )% | (4.1 | )% | ||||||||||||
North America | $ | 1,438 | $ | 1,473 | (2.4 | )% | (2.8 | )% | 59 | % | 60 | % | ||||||||
International | 891 | 852 | 4.6 | % | (5.5 | )% | 37 | % | 35 | % | ||||||||||
Other | 106 | 129 | (17.8 | )% | (17.8 | )% | 4 | % | 5 | % | ||||||||||
Total Revenue(2) | $ | 2,435 | $ | 2,454 | (0.8 | )% | (4.6 | )% | 100 | % | 100 | % | ||||||||
Memo: | ||||||||||||||||||||
Managed Document Services(3) | $ | 862 | $ | 820 | 5.1 | % | 0.6 | % | 35 | % | 33 | % | ||||||||
CC - See "Currency Impact" section for a description of Constant Currency.
(1) | In 2018, upon adoption of ASU 2014-09 Revenue Recognition, revenue from training related to equipment installation is now included in Equipment sales. In prior periods, this revenue was reported within Services, maintenance and rentals. |
(2) | Refer to the "Geographic Sales Channels and Product and Offerings Definitions" section. |
(3) | Excluding equipment revenue, Managed Document Services (MDS) was $753 million in first quarter 2018 and $714 million in first quarter 2017, representing an increase of 5.5% including a 4.4-percentage point favorable impact from currency. |
First quarter 2018 total revenue decreased 0.8% as compared to first quarter 2017, with a 3.8-percentage point favorable impact from currency. First quarter 2018 total revenue reflected the following:
Post sale revenue primarily reflects contracted services, equipment maintenance, supplies and financing. These revenues are associated with the population of devices in the field, which is affected by installs and removals, as well as the page volumes generated by the usage of such devices and the revenue per printed page. Post sale revenue decreased 0.3% as compared to first quarter 2017, with a 3.8-percentage point favorable impact from currency.
• | Services, maintenance and rentals revenue includes rental and maintenance revenue (including bundled supplies) as well as the post sale component of the document services revenue from our Managed Document Services (MDS) offerings, and revenues from our Communication and Marketing Solutions (CMS). These revenues decreased 0.8%, with a 4.3-percentage point favorable impact from currency. The decline at constant currency1 reflected the continuing trends of lower page volumes and a lower population of devices, which are partially associated with lower signings and installs in prior periods, as well as the impact of a higher mix of installs of lower usage products. These impacts are partially offset by higher revenues from MDS driven by our SMB-focused channels, along with revenues from acquisitions within our Global Imaging business and higher revenues from developing markets. |
• | Supplies, paper and other sales includes unbundled supplies and other sales. These revenues were flat compared to the first quarter of 2017, with a 2.4-percentage point favorable impact from currency. The decline at constant currency1 was driven by continued declines in equipment manufacturer (OEM) supplies as well as lower supplies demand consistent with a lower population of devices in the field, partially offset by higher supplies sales within our Global Imaging business. |
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• | Financing revenue is generated from financed equipment sale transactions. The 6.6% decline in these revenues reflected a declining finance receivables balance due to lower equipment sales in prior periods and included a 4.0-percentage point favorable impact from currency. |
Three Months Ended March 31, | % of Equipment Sales | |||||||||||||||
(in millions) | 2018 | 2017 | % Change | CC % Change | 2018 | 2017 | ||||||||||
Entry(1) | $ | 53 | $ | 56 | (5.4)% | (10.9)% | 11% | 11% | ||||||||
Mid-range | 334 | 332 | 0.6% | (2.5)% | 67% | 65% | ||||||||||
High-end | 92 | 97 | (5.2)% | (9.4)% | 18% | 19% | ||||||||||
Other(1) | 20 | 28 | (28.6)% | (28.6)% | 4% | 5% | ||||||||||
Equipment sales(2) | $ | 499 | $ | 513 | (2.7)% | (6.4)% | 100% | 100% | ||||||||
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CC - See "Currency Impact" section for a description of Constant Currency.
(1) | In 2018 revenues from our OEM business are included in Other, which had historically been reported within Entry. This reclassification was made to provide better transparency to our business results. Prior year amounts have been adjusted to conform to this change. |
(2) | In 2018, upon adoption of ASU 2014-09 Revenue Recognition, revenue from training related to equipment installation is now included in Equipment Sales (previously included in Post Sale Revenue). Prior year amounts have been adjusted to conform to this change. |
Equipment sales revenue decreased 2.7% as compared to first quarter 2017, with a 3.7-percentage point favorable impact from currency and was impacted by price declines of approximately 5% (which were in-line with our historic declines). This decrease also reflected the follow-on impact of higher entry and mid-range sales in fourth quarter 2017 related to the expansion of our U.S. indirect channels. The decline at constant currency1 in entry sales reflected in part higher sales in the prior year related to the indirect channels transition to the new products as well as lower revenues within our indirect channel in the current year, and a higher mix of low-end personal devices mainly in our developing markets. Mid-range declined modestly at constant currency1 reflecting higher installs of new products offset by ongoing declines consistent with overall market trends. The decrease at constant currency1 in high-end sales primarily reflected lower revenues from iGen and continuous feed systems due in part to timing of installs in the prior year, as well as lower revenues from black-and-white systems consistent with market decline trends; these declines were partially mitigated by higher activity from the Versant entry production color systems that were launched in the second quarter of 2017.
Total Installs
Revenue associated with equipment installations, discussed below, may be reflected up-front in Equipment sales or over time either through rental income or as part of our Managed Document Services revenues (which are both reported within our post-sale revenues), depending on the terms and conditions of our agreements with customers.
Install activity includes Managed Document Services and Xerox-branded products shipped to Global Imaging Systems. Detail by product group (see Geographic Sales Channels and Product and Offerings Definitions) is shown below:
Entry(1)
• | 4% increase in color multifunction devices, reflecting demand for recently launched products. |
• | 18% increase in black-and-white multifunction devices, driven largely by higher activity for low-end devices in developing markets. |
Mid-Range(2)
• | 16% increase in mid-range color installs, reflecting higher demand for recently launched products. |
• | 11% increase in mid-range black-and-white, as demand for recently launched products more than offset market trends. |
High-End(2)
• | 6% increase in high-end color systems, as growth from Versant products offset lower installs of higher-end color systems. |
• | 9% decrease in high-end black-and-white systems reflecting market trends. |
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Signings
Signings are defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts. Our reported signings mostly represent those from our Enterprise deals, as we do not currently include signings from our growing partner print services offerings or those from our Global Imaging Systems channel. Total Contract Value (TCV) is the estimated total contractual revenue related to signed contracts; our signings expressed in TCV were as follows:
Three Months Ended March 31, | ||||||||||||
(in millions) | 2018 | 2017 | % Change | CC % Change | ||||||||
Signings | $ | 509 | $ | 512 | (0.6)% | (2.0)% | ||||||
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CC - See "Currency Impact" section for a description of Constant Currency.
First quarter 2018 signings decreased 0.6% from first quarter 2017, with a 1.4-percentage point favorable impact from currency, reflecting lower contribution from new business. On a trailing twelve month (TTM) basis, signings increased 1.1% from the comparable prior year period, with a 0.5-percentage point unfavorable impact from currency.
New business TCV decreased 5.2% from first quarter 2017, with a 1.4-percentage point favorable impact from currency, and decreased 12.2% at constant currency1 on a TTM basis, led by lower signings in Europe.
Renewal Rate
Renewal rate is defined as the annual recurring revenue (ARR) on contracts that are renewed during the period as a percentage of ARR on all contracts for which a renewal decision was made during the period. Contract renewal rate for the first quarter 2018 was 85%, compared to our full year 2017 renewal rate of 84%.
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CC - See "Currency Impact" section for a description of Constant Currency.
(1)See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure.
Geographic Sales Channels and Product and Offerings Definitions
Our business is aligned to a geographic focus and is primarily organized on the basis of go-to-market sales channels, which are structured to serve a range of customers for our products and services:
• | North America, which includes our sales channels in the U.S. and Canada. |
• | International, which includes our sales channels in Europe, Eurasia, Latin America, Middle East, Africa and India. |
• | Other primarily includes our OEM business, as well as sales to and royalties from Fuji Xerox, and our licensing revenue. |
Our products and offerings include:
• | “Entry”, which includes A4 devices and desktop printers. Prices in this product group can range from approximately $150 to $3,000. |
• | “Mid-Range”, which includes A3 Office and Light Production devices that generally serve workgroup environments in mid to large enterprises. Prices in this product group can range from approximately $2,000 to $75,000+. |
• | “High-End”, which includes production printing and publishing systems that generally serve the graphic communications marketplace and large enterprises. Prices for these systems can range from approximately $30,000 to $1,000,000+. |
• | Managed Document Services (MDS) revenue, which includes solutions and services that span from managing print to automating processes to managing content. Our primary offerings within MDS are Managed Print Services (including from Global Imaging Systems), as well as workflow automation services, and Centralized Print Services and Solutions (CPS). MDS excludes Communications and Marketing Solutions (CMS). |
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(1) | Entry installations exclude OEM sales; including OEM sales, Entry color multifunction devices increased 7%, while Entry black-and-white multifunction devices increased 16%. |
(2) | Mid-range and High-end color installations exclude Fuji Xerox digital front-end sales; including Fuji Xerox digital front-end sales, Mid-range color devices increased 16%, and High-end color systems increased 5%. |
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Costs, Expenses and Other Income
Summary of Key Financial Ratios
The following is a summary of key financial ratios used to assess our performance:
Three Months Ended March 31, | |||||||||||||
(in millions) | 2018 | 2017 | B/(W) | ||||||||||
Gross Profit | $ | 970 | $ | 975 | $ | (5 | ) | ||||||
RD&E | 100 | 111 | 11 | ||||||||||
SAG | 628 | 634 | 6 | ||||||||||
Equipment Gross Margin | 32.3 | % | 30.7 | % | 1.6 | pts. | |||||||
Post sale Gross Margin | 41.8 | % | 42.1 | % | (0.3 | ) | pts. | ||||||
Total Gross Margin | 39.8 | % | 39.7 | % | 0.1 | pts. | |||||||
RD&E as a % of Revenue | 4.1 | % | 4.5 | % | 0.4 | pts. | |||||||
SAG as a % of Revenue | 25.8 | % | 25.8 | % | — | pts. | |||||||
Pre-tax Income (Loss) | $ | 134 | $ | (16 | ) | $ | 150 | ||||||
Pre-tax Income (Loss) Margin | 5.5 | % | (0.7 | )% | 6.2 | pts. | |||||||
Adjusted(1) Operating Profit | $ | 253 | $ | 270 | $ | (17 | ) | ||||||
Adjusted (1) Operating Margin | 10.4 | % | 11.0 | % | (0.6 | ) | pts. | ||||||
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(1)See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure.
Pre-tax Income (Loss) Margin
First quarter 2018 pre-tax income margin of 5.5% increased 6.2-percentage points as compared to first quarter 2017. The increase was primarily driven by lower restructuring and related costs that reflected the phasing of our strategic transformation initiatives, as well as lower Other expense, net partially offset by Transaction related costs.
Adjusted1 Operating Margin
First quarter 2018 adjusted1 operating margin of 10.4% decreased 0.6-percentage points as compared to first quarter 2017, reflecting a 1.2-percentage point impact from lower Equity in income (associated with our share of Fuji Xerox net income), partially offset by improvement in other areas of our business as a result of cost savings, including savings from strategic transformation which more than offset the impact of revenue decline and investments in the business. Adjusted1 operating margin includes favorable transaction currency of 0.7-percentage points.
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(1)Refer to the Operating Income/Margin reconciliation table in the "Non-GAAP Financial Measures" section.
Gross Margin
First quarter 2018 gross margin of 39.8% increased by 0.1-percentage points compared to first quarter 2017. This performance reflected cost productivity savings, along with favorable transaction currency of 0.7-percentage points partially offset by the impact of lower revenues.
First quarter 2018 equipment gross margin of 32.3% increased 1.6-percentage points as compared to first quarter 2017, reflecting benefits from transaction currency and cost productivity savings.
First quarter 2018 post sale gross margin of 41.8% decreased 0.3-percentage points as compared to first quarter 2017 reflecting in part, the impact of lower revenues, partially offset by net productivity savings as well as favorable transaction currency.
Research, Development and Engineering Expenses (RD&E)
Three Months Ended March 31, | ||||||||||||
(in millions) | 2018 | 2017 | Change | |||||||||
R&D | $ | 81 | $ | 88 | $ | (7 | ) | |||||
Sustaining engineering | 19 | 23 | (4 | ) | ||||||||
Total RD&E Expenses | $ | 100 | $ | 111 | $ | (11 | ) | |||||
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First quarter 2018 RD&E as a percentage of revenue of 4.1% was 0.4-percentage points lower compared to first quarter 2017.
RD&E of $100 million decreased by $11 million compared to first quarter 2017 and reflected cost savings, including restructuring savings and lower expenses from the sales of businesses and associated transfers of resources to third parties during the prior year. We strategically coordinate our R&D investments with Fuji Xerox.
Selling, Administrative and General Expenses (SAG)
SAG as a percentage of revenue of 25.8% was flat compared to first quarter 2017.
SAG of $628 million was $6 million lower than first quarter 2017, including an approximate $19 million unfavorable impact from currency as well as $9 million of accelerated depreciation related to the early termination of a capital lease associated with a surplus facility. These adverse impacts were more than offset by cost savings, including restructuring savings, partially offset by higher compensation and benefit expense as well as expenses from Global Imaging acquisitions. Bad debt expense of $13 million was flat compared to first quarter 2017 and remained at less than one percent of receivables.
Restructuring and Related Costs
First quarter 2018 restructuring and related costs of $28 million included $24 million of severance costs related to headcount reductions of approximately 400 employees worldwide and $12 million of lease cancellation charges reflecting continued optimization of our operating locations. These costs were partially offset by $8 million of net reversals for changes in estimated reserves from prior period initiatives. First quarter 2018 actions impacted several functional areas, with approximately 55% focused on gross margin improvements and approximately 45% on SAG reductions. Costs related to professional support services associated with the implementation of the Strategic Transformation program were minimal.
First quarter 2017 restructuring and related costs of $118 million included net restructuring and asset impairment charges of $108 million as well as $10 million of additional costs primarily related to professional support services associated with the implementation of the Strategic Transformation program.
First quarter 2017 net restructuring and asset impairment charges of $108 million included $108 million of severance costs related to headcount reductions of approximately 1,000 employees worldwide and $2 million of lease cancellation charges. The first quarter 2017 actions impacted several functional areas, with approximately 30% of the actions focused on gross margin improvements, approximately 60% on SAG reductions and approximately 10% on RD&E optimization. These costs were partially offset by $2 million of net reversals for changes in estimated reserves from prior period initiatives.
The restructuring reserve balance as of March 31, 2018 for all programs was $85 million, of which $82 million is expected to be spent over the next twelve months.
Refer to Note 11 - Restructuring Programs in the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs.
Transaction and Related Costs
During first quarter 2018, we recorded costs of $36 million related to Xerox's planned combination transaction with Fuji Xerox, which is currently halted as a result of a court injunction. These costs were primarily for third-party investment banking, accounting, legal, consulting and other similar types of services as well as certain employee-related costs associated with the planned combination. These costs will also include additional expenses expected to be incurred in the second quarter 2018 for third-party legal and other related costs associated with the ongoing litigation with certain shareholders as well as other related matters.
Amortization of Intangible Assets
First quarter 2018 amortization of intangible assets of $12 million was $2 million lower than first quarter 2017.
Worldwide Employment
Worldwide employment was approximately 35,000 as of March 31, 2018 and decreased by approximately 300 from December 31, 2017. The reduction is primarily due to the impact of restructuring and productivity-related reductions.
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Other Expenses, Net
Three Months Ended March 31, | ||||||||
(in millions) | 2018 | 2017 | ||||||
Non-financing interest expense | $ | 31 | $ | 36 | ||||
Non-service retirement-related costs | 25 | 60 | ||||||
Interest income | (3 | ) | (2 | ) | ||||
Gains on sales of businesses and assets | (16 | ) | — | |||||
Currency (gains) losses, net | (2 | ) | 3 | |||||
Loss on sales of accounts receivable | 1 | 3 | ||||||
Loss on early extinguishment of debt | — | 13 | ||||||
Bridge facility costs | 2 | — | ||||||
All other expenses, net | (6 | ) | 1 | |||||
Other expenses, net | $ | 32 | $ | 114 | ||||
Non-Financing Interest Expense
First quarter 2018 non-financing interest expense of $31 million was $5 million lower than first quarter 2017. When combined with financing interest expense (Cost of financing), total interest expense declined by $4 million from first quarter 2017 due to a lower debt balance reflecting debt repayments of approximately $1.3 billion in the first quarter 2017 partially offset by $1.0 billion of new debt issued in the third quarter 2017 to fund, among other things, a $500 million voluntary contribution to our U.S. defined benefit pension plans; the decline also reflected lower average interest rates.
Non-Service Retirement-Related Costs
First quarter 2018 non-service retirement-related costs were $35 million lower than first quarter 2017, primarily driven by lower losses from pension settlements and the favorable impact of higher pension contributions and asset returns in the prior year.
Gains on Sales of Businesses and Assets
First quarter 2018 gains on sales of businesses and assets of $16 million reflected the sale of non-core business assets.
Loss on Early Extinguishment of Debt
During the first quarter of 2017, we recorded a $13 million loss associated with the repayment of $300 million in Senior Notes.
Income Taxes
First quarter 2018 effective tax rate was 29.9%. On an adjusted1 basis, first quarter 2018 effective tax rate was 28.3%. These rates were higher than the U.S. statutory tax rate of 21% primarily due to impacts associated with the 2017 Tax Act, as discussed below, as well as the geographical mix of profits. The adjusted1 effective tax rate excludes the tax benefits associated with the following charges: restructuring and related costs, amortization of intangible assets, transaction and related costs, non-service retirement-related costs and other discrete items.
First quarter 2017 tax benefit was at an effective tax rate of 150.0%, which was higher than the U.S. statutory tax rate of 35% primarily due to the favorable re-measurement of certain unrecognized tax positions. On an adjusted1 basis, first quarter 2017 tax expense was at an effective tax rate of 27.0% which was lower than the U.S. statutory tax rate primarily due to foreign tax credits and the geographic mix of profits. The adjusted1 effective tax rate excludes the majority of the benefit from the re-measurement of certain unrecognized tax positions as well as the tax benefits associated with the following charges: restructuring and related costs, amortization of intangible assets, non-service retirement-related costs and other discrete items.
Our effective tax rate is based on nonrecurring events as well as recurring factors, including the taxation of foreign income. In addition, our effective tax rate will change based on discrete or other nonrecurring events that may not be predictable.
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(1) | Refer to the Effective Tax Rate reconciliation table in the "Non-GAAP Financial Measures" section. |
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Tax Cuts and Jobs Act (the “Tax Act”)
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted. The Tax Act significantly revises the U.S. corporate income tax system by, among other things, lowering the U.S. statutory corporate income tax rate from 35% to 21% and implementing a territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries.
During the fourth quarter 2017, we recorded an estimated non-cash charge of $400 million reflecting the impact associated with the provisions of the Tax Act based on currently available information. Our estimated charge incorporates assumptions made based on our current interpretation of the Tax Act as well as currently available information and may change, possibly materially, as we complete our analysis and receive additional clarification and implementation guidance. Changes in interpretations and assumptions as well as actions we may take as a result of the Tax Act may also impact this estimated charge. The $400 million estimated provisional charge continues to be our best estimate of the impacts from the Tax Act and no further adjustment of that charge was made in the first quarter 2018. However, we continue to evaluate the impacts from the Tax Act and likely will do so through the expected filing of our 2017 U.S. Tax Return in the third quarter 2018. Any adjustments to these provisional amounts will be reported as a component of Income tax expense in the reporting period in which any such adjustments are determined.
Effective January 1, 2018, we became subject to several provisions of the Tax Act including computations related to Global Intangible Low Taxed Income ("GILTI"), Foreign Derived Intangible Income ("FDII"), Base Erosion and Anti-Abuse Tax ("BEAT"), and IRC Section 163(j) interest limitation (Interest Limitation). Our current estimate for the GILTI, FDII and Interest Limitation rules was determined to be immaterial, however we currently estimate that we are subject to BEAT. Accordingly, our first quarter 2018 effective tax rate includes the estimated impact for BEAT, which has also been incorporated into our estimated annual effective tax for 2018. Similar to the provisional charge recorded in the fourth quarter 2017 associated with the enactment of the Tax Act, the estimates for these additional provisions of the Tax Act were made based on our current interpretation of the Tax Act as well as currently available information and may change, as we complete our analysis and receive additional clarification and implementation guidance. Changes in interpretations and assumptions as well as actions we may take as a result of the Tax Act may also impact these estimates.
Equity in Net (Loss) Income of Unconsolidated Affiliates
Three Months Ended March 31, | ||||||||
(in millions) | 2018 | 2017 | ||||||
Total equity in net (loss) income of unconsolidated affiliates | $ | (68 | ) | $ | 40 | |||
Fuji Xerox after-tax restructuring and other charges included in equity (loss) income | 79 | — | ||||||
Equity in net (loss) income of unconsolidated affiliates primarily reflects our 25% share of Fuji Xerox net loss. First quarter 2018 equity loss of $68 million included an approximate $28 million charge related to the out-of-period adjustments described in Note 10 - Investments in Affiliates, at Equity in the Condensed Consolidated Financial Statements and in the "Fuji Xerox Adjustments" section above, and was $108 million worse compared to first quarter 2017, including $79 million of higher year-over-year charges related to our share of Fuji Xerox after-tax restructuring and other charges. Other charges included costs associated with the combination transaction.
We have revised Equity in net income of unconsolidated affiliates for the prior year period presented throughout this document. Refer to Note 2 - Correction of Fuji Xerox Misstatement in Prior Period Financial Statements in the Condensed Consolidated Financial Statements, for additional information on this revision.
Net Income from Continuing Operations
First quarter 2018 net income from continuing operations attributable to Xerox was $23 million, or $0.08 per diluted share. On an adjusted1 basis, net income from continuing operations attributable to Xerox was $178 million, or $0.68 per diluted share. First quarter 2018 adjustments to net income include restructuring and related costs, amortization of intangible assets, transaction and related costs and non-service retirement-related costs as well as other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section.
First quarter 2017 net income from continuing operations attributable to Xerox was $46 million, or $0.16 per diluted share. On an adjusted1 basis, net income from continuing operations attributable to Xerox was $176 million, or $0.67 per diluted share. First quarter 2017 adjustments to net income include restructuring and related costs, amortization of intangible assets, and non-service retirement-related costs as well as other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section.
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Refer to Note 18 - Earnings per Share in the Condensed Consolidated Financial Statements, for additional information regarding the calculation of basic and diluted earnings per share.
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(1) | Refer to the Net Income and EPS reconciliation table in the "Non-GAAP Financial Measures" section. |
Discontinued Operations
Discontinued operations relate to our Business Process Outsourcing (BPO) business, which was separated effective December 31, 2016. Refer to Note 5 - Divestitures in the Condensed Consolidated Financial Statements for additional information regarding discontinued operations.
Net Income
First quarter 2018 net income attributable to Xerox was $23 million, or $0.08 per diluted share. First quarter 2017 net income attributable to Xerox was $40 million, or $0.14 per diluted share.
Other Comprehensive Income
First quarter 2018 Other comprehensive income attributable to Xerox was $211 million as compared to $166 million in first quarter 2017. The $45 million increase is primarily due to a $43 million increase in net translation adjustment gains of $176 million for the first quarter 2018 as compared to $133 million for the first quarter 2017. The increase reflected a greater strengthening of our major foreign currencies against the U.S. Dollar in first quarter 2018 as compared to the prior year period. Additionally, 2018 Other comprehensive income included a $9 million year-over-year benefit from higher net unrealized gains on derivatives. Both the net translation adjustment gains and net unrealized gains were offset by lower net year-over-year changes in defined benefits of $8 million.
Refer to Note 13 - Financial Instruments in the Condensed Consolidated Financial Statements, for additional information regarding derivatives, and Note 15 - Employee Benefit Plans in the Condensed Consolidated Financial Statements, for additional information regarding net changes in our defined benefit plans.
Capital Resources and Liquidity
As of March 31, 2018 and December 31, 2017, total cash, cash equivalents and restricted cash were $1,474 million and $1,368 million, respectively. There were no borrowings under our Credit Facility or Commercial Paper Program at March 31, 2018 or December 31, 2017, respectively.
Cash Flow Analysis
The following summarizes our cash, cash equivalents and restricted cash:
Three Months Ended March 31, | Change | |||||||||||
(in millions) | 2018 | 2017 | ||||||||||
Net cash provided by operating activities of continuing operations | $ | 216 | $ | 132 | $ | 84 | ||||||
Net cash used in operating activities of discontinued operations | — | (80 | ) | 80 | ||||||||
Net cash provided by operating activities | 216 | 52 | 164 | |||||||||
Net cash used in investing activities | (2 | ) | (11 | ) | 9 | |||||||
Net cash used in financing activities | (117 | ) | (1,258 | ) | 1,141 | |||||||
Effect of exchange rate changes on cash, cash equivalents and restricted cash | 9 | 9 | — | |||||||||
Increase (decrease) in cash, cash equivalents and restricted cash | 106 | (1,208 | ) | 1,314 | ||||||||
Cash, cash equivalents and restricted cash at beginning of period | 1,368 | 2,402 | (1,034 | ) | ||||||||
Cash, Cash Equivalents and Restricted Cash at End of Period | $ | 1,474 | $ | 1,194 | $ | 280 | ||||||
Cash Flows from Operating Activities
Net cash provided by operating activities of continuing operations was $216 million in first quarter 2018. The $84 million increase in operating cash from first quarter 2017 was primarily due to the following:
• | $71 million increase in pre-tax income before transaction and related costs, depreciation and amortization, gain on sales of businesses and assets, restructuring charges and defined benefit pension costs. |
• | $123 million increase from accounts receivable primarily due to the timing of collections and lower revenue, as well as the prior year reclassification of $48 million of collections of deferred proceeds from the sales of accounts receivables to investing. |
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• | $20 million increase from finance receivables primarily related to a higher level of run-off due to lower originations. |
• | $73 million decrease primarily related to the prior year settlements of foreign currency derivative contracts. |
• | $29 million decrease from inventory primarily due to lower equipment sales. |
• | $15 million decrease from higher pension contributions primarily in the U.K. |
• | $15 million decrease due to payments for transaction and related costs. |
Cash Flows from Investing Activities
Net cash used in investing activities was $2 million in first quarter 2018. The $9 million change from first quarter 2017 was primarily due to the following:
• | $54 million decrease primarily as a result of the termination of certain accounts receivables sales arrangements in fourth quarter 2017. |
• | $15 million increase primarily from the sale of non-core business assets in 2018. |
• | $11 million increase due to no acquisitions in 2018. |
• | $8 million increase due to lower capital expenditures. |
Cash Flows from Financing Activities
Net cash used in financing activities was $117 million in first quarter 2018. The $1,141 million decrease in the use of cash from first quarter 2017 was primarily due to the following:
• | $1,287 million decrease from net debt activity. 2018 reflects payments of $25 million related to the termination of a capital lease obligation and $13 million of bridge facility costs. 2017 reflects payments of $1.0 billion on Senior Notes and net payments of $326 million on the tender and exchange of certain Senior Notes including transaction costs. |
• | $20 million decrease from common and preferred stock dividends. |
• | $161 million increase resulting from the prior year final cash adjustment with Conduent. |
• | $11 million increase due to higher distributions to noncontrolling interests as a result of the timing of payments. |
Cash, Cash Equivalents and Restricted Cash
Refer to Note 6 - Cash, Cash Equivalents and Restricted Cash in the Condensed Consolidated Financial Statements for additional information.
Debt and Customer Financing Activities
The following summarizes our debt:
(in millions) | March 31, 2018 | December 31, 2017 | ||||||
Principal debt balance(1) | $ | 5,552 | $ | 5,579 | ||||
Net unamortized discount | (33 | ) | (35 | ) | ||||
Debt issuance costs | (30 | ) | (32 | ) | ||||
Fair value adjustments(2) | ||||||||
- terminated swaps | (4 | ) | 4 | |||||
- current swaps | 4 | 1 | ||||||
Total Debt | $ | 5,489 | $ | 5,517 | ||||
____________________________
(1) | Includes Notes Payable of $4 million and $6 million as of March 31, 2018 and December 31, 2017, respectively. |
(2) | Fair value adjustments include the following - (i) fair value adjustments to debt associated with terminated interest rate swaps, which are being amortized to interest expense over the remaining term of the related notes; and (ii) changes in fair value of hedged debt obligations attributable to movements in benchmark interest rates. Hedge accounting requires hedged debt instruments to be reported inclusive of any fair value adjustment. |
Finance Assets and Related Debt
The following represents our total finance assets, net associated with our lease and finance operations:
(in millions) | March 31, 2018 | December 31, 2017 | ||||||
Total finance receivables, net(1) | $ | 3,685 | $ | 3,752 | ||||
Equipment on operating leases, net | 448 | 454 | ||||||
Total Finance Assets, net(2) | $ | 4,133 | $ | 4,206 | ||||
___________________________
(1) | Includes (i) Billed portion of finance receivables, net, (ii) Finance receivables, net and (iii) Finance receivables due after one year, net as included in our Condensed Consolidated Balance Sheets. |
(2) | The change from December 31, 2017 includes an increase of $36 million due to currency. |
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Our lease contracts permit customers to pay for equipment over time rather than at the date of installation; therefore, we maintain a certain level of debt (that we refer to as financing debt) to support our investment in these lease contracts, which are reflected in total finance assets, net. For this financing aspect of our business, we maintain an assumed 7:1 leverage ratio of debt to equity as compared to our finance assets.
Based on this leverage, the following represents the breakdown of total debt between financing debt and core debt:
(in millions) | March 31, 2018 | December 31, 2017 | ||||||
Finance receivables debt(1) | $ | 3,224 | $ | 3,283 | ||||
Equipment on operating leases debt | 392 | 397 | ||||||
Financing debt | 3,616 | 3,680 | ||||||
Core debt | 1,873 | 1,837 | ||||||
Total Debt | $ | 5,489 | $ | 5,517 | ||||
____________________________
(1) | Finance receivables debt is the basis for our calculation of "Cost of financing" expense in the Condensed Consolidated Statements of Income. |
Debt Activity
Bridge Facility
Refer to Note 20 - Fuji Xerox Transaction and Recent Developments in the Condensed Consolidated Financial Statements for additional information regarding the bridge facility entered into in connection with the Fuji Xerox Transaction.
Sales of Accounts Receivable
During the fourth quarter 2017 we terminated all accounts receivable sales arrangements in North America and all but one arrangement in Europe.
Refer to Note 7 - Accounts Receivable, Net in the Condensed Consolidated Financial Statements for additional information regarding our accounts receivable sales arrangements.
Liquidity and Financial Flexibility
We manage our worldwide liquidity using internal cash management practices, which are subject to (1) the statutes, regulations and practices of each of the local jurisdictions in which we operate, (2) the legal requirements of the agreements to which we are a party and (3) the policies and cooperation of the financial institutions we utilize to maintain and provide cash management services.
Our principal debt maturities are in line with historical and projected cash flows and are spread over the next five years as follows:
(in millions) | Amount | |||
2018 Q2 | $ | 270 | ||
2018 Q3 | 1 | |||
2018 Q4 | — | |||
2019 | 962 | |||
2020 | 1,052 | |||
2021 | 1,064 | |||
2022 | 301 | |||
2023 and thereafter | 1,902 | |||
Total | $ | 5,552 | ||
Treasury Stock
There were no share repurchases through the first quarter of 2018 or through the date of our filing on May 10, 2018.
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Financial Risk Management
We are exposed to market risk from changes in foreign currency exchange rates and interest rates, which could affect operating results, financial position and cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when appropriate, through the use of derivative financial instruments. These derivative financial instruments are utilized to hedge economic exposures, as well as to reduce earnings and cash flow volatility resulting from shifts in market rates. We enter into limited types of derivative contracts, including interest rate swap agreements, foreign currency spot, forward and swap contracts and net purchased foreign currency options to manage interest rate and foreign currency exposures. Our primary foreign currency market exposures include the Japanese Yen, Euro and U.K. Pound Sterling. The fair market values of all our derivative contracts change with fluctuations in interest rates and/or currency exchange rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial instruments are held solely as risk management tools and not for trading or speculative purposes. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities.
We are required to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. As permitted, certain of these derivative contracts have been designated for hedge accounting treatment. Certain of our derivatives that do not qualify for hedge accounting are effective as economic hedges. These derivative contracts are likewise required to be recognized each period at fair value and therefore do result in some level of volatility. The level of volatility will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the currency and interest rate markets during the period. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities.
By their nature, all derivative instruments involve, to varying degrees, elements of market and credit risk. The market risk associated with these instruments resulting from currency exchange and interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. We do not believe there is significant risk of loss in the event of non-performance by the counterparties associated with these instruments because these transactions are executed with a diversified group of major financial institutions. Further, our policy is to deal with counterparties having a minimum investment grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties.
The current market events have not required us to materially modify or change our financial risk management strategies with respect to our exposures to interest rate and foreign currency risk. Refer to Note 13 – Financial Instruments in the Condensed Consolidated Financial Statements for further discussion and information on our financial risk management strategies.
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Non-GAAP Financial Measures
We have reported our financial results in accordance with generally accepted accounting principles (GAAP). In addition, we have discussed our financial results using the non-GAAP measures described below. We believe these non-GAAP measures allow investors to better understand the trends in our business and to better understand and compare our results. Accordingly, we believe it is necessary to adjust several reported amounts, determined in accordance with GAAP, to exclude the effects of certain items as well as their related income tax effects.
A reconciliation of these non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are set forth below as well as in the first quarter 2018 presentation slides available at www.xerox.com/investor.
These non-GAAP financial measures should be viewed in addition to, and not as a substitute for, the company’s reported results prepared in accordance with GAAP.
Adjusted Earnings Measures
• | Net income and Earnings per share (EPS) |
• | Effective tax rate |
The above measures were adjusted for the following items:
Amortization of intangible assets: The amortization of intangible assets is driven by our acquisition activity which can vary in size, nature and timing as compared to other companies within our industry and from period to period. The use of intangible assets contributed to our revenues earned during the periods presented and will contribute to our future period revenues as well. Amortization of intangible assets will recur in future periods.
Restructuring and related costs: Restructuring and related costs include restructuring and asset impairment charges as well as costs associated with our Strategic Transformation program beyond those normally included in restructuring and asset impairment charges. Restructuring consists of costs primarily related to severance and benefits paid to employees pursuant to formal restructuring and workforce reduction plans. Asset impairment includes costs incurred for those assets sold, abandoned or made obsolete as a result of our restructuring actions, exiting from a business or other strategic business changes. Additional costs for our Strategic Transformation program are primarily related to the implementation of strategic actions and initiatives and include third-party professional service costs as well as one-time incremental costs. All of these costs can vary significantly in terms of amount and frequency based on the nature of the actions as well as the changing needs of the business. Accordingly, due to that significant variability, we will exclude these charges since we do not believe they provide meaningful insight into our current or past operating performance nor do we believe they are reflective of our expected future operating expenses as such charges are expected to yield future benefits and savings with respect to our operational performance.
Non-service retirement-related costs: Our defined benefit pension and retiree health costs include several elements impacted by changes in plan assets and obligations that are primarily driven by changes in the debt and equity markets as well as those that are predominantly legacy in nature and related to employees who are no longer providing current service to the company (e.g. retirees and ex-employees). These elements include (i) interest cost, (ii) expected return on plan assets, (iii) amortization of prior plan amendments, (iv) amortized actuarial gains/losses and (v) the impacts of any plan settlements/curtailments. Accordingly, we consider these elements of our periodic retirement plan costs to be outside the operational performance of the business or legacy costs and not necessarily indicative of current or future cash flow requirements. This approach is consistent with the classification of these costs as non-operating in Other expenses, net as a result of our adoption of ASU 2017-07 - Reporting of Retirement Related Benefit Costs in 2018. Adjusted earnings will continue to include the service cost elements of our retirement costs, which is related to current employee service as well as the cost of our defined contribution plans.
Transaction and related costs: Transaction and related costs are expenses incurred in connection with Xerox's planned combination transaction with Fuji Xerox, which is currently halted as a result of a court injunction. These costs are primarily for third-party investment banking, accounting, legal, consulting and other similar types of services as well as certain employee-related costs associated with the planned combination. These costs will also include additional expenses expected to be incurred in the second quarter 2018 for third-party legal and other related costs associated with the ongoing litigation with certain shareholders as well as other related matters. These costs are considered incremental to our normal operating charges and were incurred or are expected to be incurred solely as a result of the planned combination transaction and the related shareholder settlement agreement. Accordingly, we are excluding these expenses from our Adjusted Earnings Measures in order to evaluate our performance on a comparable basis.
Restructuring and other charges - Fuji Xerox: We also adjust our 25% share of Fuji Xerox’s net income for similar items noted above such as Restructuring and related costs and Transaction and related costs based on the same rationale discussed above.
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Other discrete, unusual or infrequent items: In addition, we also excluded the following items given their discrete, unusual or infrequent nature and their impact on our results for the period:
• | 2018 - Bridge facility costs relate to the previously disclosed $2.5 billion bridge loan facility, which was entered into in the first quarter 2018 to provide funding for the payment of the expected $2.5 billion dividend associated with the Fuji Xerox combination transaction in the event Xerox does not secure permanent financing. Since these costs are related to the Fuji Xerox combination transaction, the exclusion was considered consistent with Transaction and related costs discussed above. |
• | 2017 - Loss on early extinguishment of debt in the first quarter of 2017. |
• | 2017 - A benefit from the remeasurement of a tax matter in the first quarter of 2017 that related to a previously adjusted item. |
We believe the exclusion of these items allows investors to better understand and analyze the results for the period as compared to prior periods and expected future trends in our business.
Adjusted Operating Income and Margin
We also calculate and utilize adjusted operating income and margin measures by adjusting our reported pre-tax income (loss) and margin amounts. In addition to the costs and expenses noted as adjustments for our Adjusted Earnings measures, adjusted operating income and margin also exclude the remaining amounts included in Other expenses, net, which are primarily non-financing interest expense and certain other non-operating costs and expenses. We exclude these amounts in order to evaluate our current and past operating performance and to better understand the expected future trends in our business. Adjusted Operating income and margin also include Equity in net (loss) income of unconsolidated affiliates. Equity in net (loss) income of unconsolidated affiliates primarily reflects our 25% share of Fuji Xerox's net income. We include this amount in our measure of operating income and margin as Fuji Xerox is our primary product supplier and intermediary to the Asia/Pacific market for distribution of Xerox branded products and services.
Constant Currency (CC)
Refer to "Currency Impact" for a discussion of this measure and its use in our analysis of revenue growth.
Summary
Management believes that all of these non-GAAP financial measures provide an additional means of analyzing the current period’s results against the corresponding prior period’s results. However, these non-GAAP financial measures should be viewed in addition to, and not as a substitute for, the company’s reported results prepared in accordance with GAAP. Our non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP measures and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Our management regularly uses our supplemental non-GAAP financial measures internally to understand, manage and evaluate our business and make operating decisions. These non-GAAP measures are among the primary factors management uses in planning for and forecasting future periods. Compensation of our executives is based in part on the performance of our business based on these non-GAAP measures.
A reconciliation of these non-GAAP financial measures and the most directly comparable measures calculated and presented in accordance with GAAP are set forth on the following tables:
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Net Income and EPS reconciliation:
____________________________
Three Months Ended March 31, | ||||||||||||||||
2018 | 2017 | |||||||||||||||
(in millions, except per share amounts) | Net Income | EPS | Net Income | EPS | ||||||||||||
Reported(1) | $ | 23 | $ | 0.08 | $ | 46 | $ | 0.16 | ||||||||
Adjustments: | ||||||||||||||||
Restructuring and related costs | 28 | 118 | ||||||||||||||
Amortization of intangible assets | 12 | 14 | ||||||||||||||
Transaction and related costs | 36 | — | ||||||||||||||
Non-service retirement-related costs | 25 | 60 | ||||||||||||||
Loss on early extinguishment of debt | — | 13 | ||||||||||||||
Bridge facility costs | 2 | — | ||||||||||||||
Income tax on adjustments(2) | (27 | ) | (59 | ) | ||||||||||||
Remeasurement of unrecognized tax positions | — | (16 | ) | |||||||||||||
Restructuring and other charges - Fuji Xerox(3) | 79 | — | ||||||||||||||
Adjusted | $ | 178 | $ | 0.68 | $ | 176 | $ | 0.67 | ||||||||
Dividends on preferred stock used in adjusted EPS calculation(4) | $ | — | $ | — | ||||||||||||
Weighted average shares for adjusted EPS(4) | 264 | 263 | ||||||||||||||
Fully diluted shares at end of period(5) | 264 | |||||||||||||||
(1) | Net Income and EPS from continuing operations attributable to Xerox. |
(2) | Refer to Effective Tax Rate reconciliation. |
(3) | Other charges in 2018 represent costs associated with the combination transaction. |
(4) | For those periods that exclude the preferred stock dividend, the average shares for the calculations of diluted EPS include 7 million shares associated with our Series B convertible preferred stock, as applicable. |
(5) | Represents common shares outstanding at March 31, 2018 as well as shares associated with our Series B convertible preferred stock plus potential dilutive common shares as used for the calculation of diluted earnings per share for the first quarter 2018. |
Effective Tax Rate reconciliation:
Three Months Ended March 31, | |||||||||||||||||||||
2018 | 2017 | ||||||||||||||||||||
(in millions) | Pre-Tax Income | Income Tax Expense | Effective Tax Rate | Pre-Tax (Loss) Income | Income Tax (Benefit) Expense | Effective Tax Rate | |||||||||||||||
Reported(1) | $ | 134 | $ | 40 | 29.9 | % | $ | (16 | ) | $ | (24 | ) | 150.0 | % | |||||||
Non-GAAP Adjustments(2) | 103 | 27 | 205 | 59 | |||||||||||||||||
Remeasurement of unrecognized tax positions | — | — | — | 16 | |||||||||||||||||
Adjusted(3) | $ | 237 | $ | 67 | 28.3 | % | $ | 189 | $ | 51 | 27.0 | % | |||||||||
____________________________
(1) | Pre-Tax Income (Loss) and Income Tax Expense (Benefit) from continuing operations. |
(2) | Refer to Net Income and EPS reconciliation for details. |
(3) | The tax impact on Adjusted Pre-Tax Income from continuing operations is calculated under the same accounting principles applied to the As Reported Pre-Tax Income (Loss) under ASC 740, which employs an annual effective tax rate method to the results. |
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Operating Income / Margin reconciliation:
Three Months Ended March 31, | ||||||||||||||||||||||
2018 | 2017 | |||||||||||||||||||||
(in millions) | Profit | Revenue | Margin | (Loss) Profit | Revenue | Margin | ||||||||||||||||
Reported(1) | $ | 134 | $ | 2,435 | 5.5 | % | $ | (16 | ) | $ | 2,454 | (0.7 | )% | |||||||||
Adjustments: | ||||||||||||||||||||||
Restructuring and related costs | 28 | 118 | ||||||||||||||||||||
Amortization of intangible assets | 12 | 14 | ||||||||||||||||||||
Transaction and related costs | 36 | — | ||||||||||||||||||||
Non-service retirement-related costs | 25 | 60 | ||||||||||||||||||||
Equity in net (loss) income of unconsolidated affiliates | (68 | ) | 40 | |||||||||||||||||||
Restructuring and other charges - Fuji Xerox(2) | 79 | — | ||||||||||||||||||||
Other expenses, net | 7 | 54 | ||||||||||||||||||||
Adjusted | $ | 253 | $ | 2,435 | 10.4 | % | $ | 270 | $ | 2,454 | 11.0 | % | ||||||||||
____________________________
(1) | Pre-Tax Income (Loss) and revenue from continuing operations. |
(2) | Other charges in 2018 represent costs associated with the combination transaction. |
ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set forth under the “Financial Risk Management” section of this Quarterly Report on Form 10-Q is hereby incorporated by reference in answer to this Item.
ITEM 4 — CONTROLS AND PROCEDURES
(a)Evaluation of Disclosure Controls and Procedures
The company’s management evaluated, with the participation of our principal executive officer and principal financial officer, or persons performing similar functions, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms relating to Xerox Corporation, including our consolidated subsidiaries, and was accumulated and communicated to the company’s management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
(b)Changes in Internal Controls
In connection with the evaluation required by paragraph (d) of Rule 13a-15 under the Exchange Act, there was no change identified in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1 — LEGAL PROCEEDINGS
The information set forth under Note 19 – Contingencies and Litigation in the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q is incorporated by reference in answer to this Item.
ITEM 1A — RISK FACTORS
Reference is made to the Risk Factors set forth in Part I, Item 1A of our 2017 Annual Report. The Risk Factors remain applicable from our 2017 Annual Report.
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ITEM 2 — UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) | Sales of Unregistered Securities during the Quarter ended March 31, 2018 |
During the quarter ended March 31, 2018, Registrant issued the following securities in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”).
Semi-Annual Director Fees:
a. | Securities issued on January 14, 2018: Registrant issued 25,137 deferred stock units (DSUs), representing the right to receive shares of Common Stock, par value $1 per share, at a future date. |
b. | No underwriters participated. The shares were issued to each of the non-employee Directors of Registrant: Gregory Q. Brown, Joseph J. Echevarria, William Curt Hunter, Robert J. Keegan, Cheryl Gordon Krongard, Charles Prince, Ann N. Reese, Stephen H. Rusckowski and Sara Martinez Tucker. |
c. | The DSUs were issued at a deemed purchase price of $32.225 per DSU (aggregate price $810,040), based upon the market value on the date of issuance, in payment of the semi-annual Director's fees pursuant to Registrant's 2004 Equity Compensation Plan for Non-Employee 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. |
Dividend Equivalent:
a. | Securities issued on January 31, 2018: Registrant issued 2,832 DSUs, representing the right to receive shares of Common Stock, par value $1 per share, at a future date. |
b. | No underwriters participated. The shares were issued to each of the non-employee Directors of Registrant: Gregory Q. Brown, Jonathan Christodoro, Joseph J. Echevarria, Richard J. Harrington, William Curt Hunter, Robert J. Keegan, Cheryl Gordon Krongard, Charles Prince, Ann N. Reese, Stephen H. Rusckowski and Sara Martinez Tucker. |
c. | The DSUs were issued at a deemed purchase price of $29.295 per DSU (aggregate price $82,963), based upon the market value on the date of record, in payment of the dividend equivalents due to DSU holders pursuant to Registrant’s 2004 Equity Compensation Plan for Non-Employee 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. |
(b) | Issuer Purchases of Equity Securities during the Quarter ended March 31, 2018 |
Board Authorized Share Repurchases Programs:
There were no repurchases of Xerox Common Stock pursuant to Board authorized share repurchase programs during the first quarter 2018 or through the date of our filing on May 10, 2018.
Repurchases Related to Stock Compensation Programs(1):
Total Number of Shares Purchased | Average Price Paid per Share(2) | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum That May Be Purchased under the Plans or Programs | |||||||
January 1 through 31 | 42,318 | $ | 29.15 | n/a | n/a | |||||
February 1 through 28 | — | — | n/a | n/a | ||||||
March 1 through 31 | — | — | n/a | n/a | ||||||
Total | 42,318 | |||||||||
____________________________
(1) | These repurchases are made under a provision in our restricted stock compensation programs for the indirect repurchase of shares through a net-settlement feature upon the vesting of shares in order to satisfy minimum statutory tax-withholding requirements. |
(2) | Exclusive of fees and costs. |
ITEM 3 — DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 — MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5 — OTHER INFORMATION
None.
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ITEM 6 — EXHIBITS
101.CAL | XBRL Taxonomy Extension Calculation Linkbase. | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase. | |
101.INS | XBRL Instance Document. | |
101.LAB | XBRL Taxonomy Extension Label Linkbase. | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase. | |
101.SCH | XBRL Taxonomy Extension Schema Linkbase. | |
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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) | |
By: | /S/ JOSEPH H. MANCINI, JR. |
Joseph H. Mancini, Jr. Vice President and Chief Accounting Officer (Principal Accounting Officer) | |
Date: May 10, 2018
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EXHIBIT INDEX
101.CAL | XBRL Taxonomy Extension Calculation Linkbase. | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase. | |
101.INS | XBRL Instance Document. | |
101.LAB | XBRL Taxonomy Extension Label Linkbase. | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase. | |
101.SCH | XBRL Taxonomy Extension Schema Linkbase. | |
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