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. |
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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.
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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.
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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 | ) | |
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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.
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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 | ||||||||||