Xerox Delivers Mixed 3Q

Xerox Corporation (XRX - Analyst Report) reported net income of $320 million or 22 cents per share in the third quarter of 2011 compared with $250 million or 17 cents per share in the year-ago quarter.

Reported earnings included charges of $54 million or 4 cents per share related to the amortization of intangible assets versus similar charges of $53 million or 4 cents per share and restructuring charges of $8 million or 1 cent per share in the year-ago quarter.

Excluding these charges, adjusted income of Xerox stood at $374 million or 26 cents per share in the quarter, significantly up from $314 million or 22 cents per share in the year-ago period. Adjusted earnings also exceeded the Zacks Consensus Estimate of 25 cents per share.

Revenues increased marginally by 3% year over year to $5.58 billion, nearly meeting the Zacks Consensus Estimate of $5.59 billion. Revenues from sales increased 2%, while the same from service, outsourcing and rentals increased 3%. However, finance income dropped 3% during the reported quarter.

Gross margin in the quarter declined slightly to 32.7% from 33.6% in the prior-year quarter, whereas operating margin rose to 9.6% from the year-ago level of 9.2%.

Segment Performance

Revenues from the Technology segment remained almost flat at $2.50 billion, as equipment sales inched up 1% year over year due to a decline in entry installs that more than offset the positive performance in mid-range and high-end color installs. The segment’s profit increased $11 million to $258 million in the quarter.

The improvement in profit was attributed to decrease in costs and expenses, resulting from restructuring savings and lower bad debt expenses combined with an increase in equity in net income from unconsolidated affiliates.

Services segment revenue increased 6.4% to $2.72 billion from $2.55 billion reported in the year-ago quarter. The increase was driven by improvement in business process outsourcing (BPO) and document outsourcing (DO) services, partially offset by flat information technology outsourcing (ITO) performance.

Revenues from DO increased 12% while the same from the BPO business improved 6%. The segment’s profit went up to $323 million from $286 million in the prior year due to increased productivity.

Revenues from the Other segment declined 10.3% to $366 million from $408 million a year ago. At the same time, the segment’s loss widened to $86 million from the year-ago loss of $79 million.

Financial Position

Xerox had cash and cash equivalents of $785 billion as of September 30, 2011, compared with $1.21 billion as of December 31, 2010. Total debt amounted to $9.20 billion at the end of the third quarter of 2011 versus $8.61 billion at the end of the fourth quarter of 2010. The company repurchased approximately $309 million of shares in the quarter, thereby resuming its share buyback plans.

In the first nine months of the year, net cash generated from operating activities dropped drastically to $683 million from $1.42 billion a year ago. The deterioration in cash flow was due to lower benefit from account receivable sales, higher net tax payments, high inventory levels and increased contributions to pension benefit plans. 

Guidance

Xerox anticipates GAAP and adjusted EPS of 28 cents–31 cents per share and 32 cents–35 cents per share, respectively, for the fourth quarter of 2011. For full-year 2011, the company expects GAAP earnings between 92 cents and 95 cents per share and adjusted EPS in the range of $1.08 per share to $1.11 per share. In addition, Xerox expects to repurchase shares worth $400 million in the upcoming quarter.

Our Take

Xerox is a highly recognized brand globally with an estimated brand value of $6.43 billion. The company is highly focused on expanding its business globally based on its well-knitted distribution network. The company has also identified huge opportunities in the domestic markets as well as in the emerging markets.

In order to seize the opportunities in the emerging markets, Xerox partnered with Trigon last year to offer its authorized products for the first time in the UAE. The company also appointed Seven Seas, a UAE-based systems integrator and reseller, as its channel partner with an objective to expand its indirect channel business and boost market share.

The company has also taken similar initiatives in the domestic market as well. The recent acquisitions by GIS testify the fact. Apart from Premier Office Equipment, GIS also acquired Illinois-based United Business Solutions and Pensacola-based Florida Imaging & Network Systems with the same objective.

With all these agreements, contracts and acquisitions, Xerox aims to capitalize on the growing market to strengthen its financial performance in the upcoming quarters.

However, growing competition, advancement in IT, reduced demand for papers and other document equipments may act as potential headwinds for the company going forward. The company’s key competitors include Canon Inc. (CAJ - Analyst Report) and Pitney Bowes Inc. (PBI - Analyst Report).

Thus, the shares of Xerox Corp. are maintaining a Zacks #3 Rank, which translates to a Hold rating over the short term (1 to 3 months) and we reiterate our recommendation of Neutral over the long term (more than 6 months).

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