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Xerox Corporation (XRX - Analyst Report) reported adjusted (excluding special items) earnings of 26 cents per share in the second quarter of 2012, in line with the Zacks Consensus Estimate and its own guidance. However, profit, as reported, declined 3% to $309 million in the quarter from $319 million a year ago, but remained flat on a per-share basis at 22 cents.

Revenues in the quarter declined 1% (up 1% in constant currency) year over year to $5.54 billion, missing the Zacks Consensus Estimate of $5.58 billion by a whisker.

Ramp up of new services contracts along with higher mix of Services revenues led to a year over year drop in gross margins by 1.4 percentage points to 32% in the quarter.

Operating margin fell 0.7 percentage point year over year to 9.7% in the quarter. The decrease resulted from a lower gross margin, but was partially offset by expense reductions.

Segment Performance

Revenues in the Services segment, which include Document Outsourcing (DO), Business Process Outsourcing (BPO) and Information Technology Outsourcing (ITO), rose 5% to $2.8 billion (including a negative impact of 2 percentage points from currency), driven by higher revenues from all three subdivisions.

Growth in government healthcare, financial services and retail, travel and insurance businesses helped BPO revenues move up, but lower transaction volumes from existing contracts anchored the growth to some extent. Also, DO revenues jumped 3% (including a negative impact of 3 percentage points from currency) due to new partner print services offerings and new signings.

Revenues in the Technology segment dipped 7% to $2.4 billion, including a negative impact of 3 percentage points from currency. The decline was attributable to a 10% fall in equipment sales and a 6% decline in annuity revenues. The negative performance of this segment stems from the fact that Xerox’s customers are migrating to its partner print services offering within DO.

Revenues in the Other segment slid 6% to $365 million, including a negative impact of 2 percentage points from currency. The decline in revenues was attributable to lower paper sales.

Financial Position

Xerox had cash and cash equivalents of $814 million as of June 30, 2012, compared with $902 million as of December 31, 2011. Total debt stood at $9.2 billion as of June 30, 2012, compared with $8.6 billion as of December 31, 2011.

In the quarter, cash generated from operations stood at $228 million, down from $347 million last year. The company expects to generate cash flow of $2 billion to $2.3 billion from operations in 2012 and buyback shares worth $900 million to $1.1 billion.

Guidance

For 2012, the company now expects adjusted earnings between $1.07 and $1.12 per share, down from its earlier view of $1.12 to $1.18. The revision is based on weakness in its technology franchise. Xerox anticipates adjusted earnings of 24 cents to 26 cents in the third quarter of 2012.

Our Take

Xerox Corporation, headquartered in Norwalk, Connecticut, is a leader in the development, manufacture, marketing, servicing and financing of document equipment across the world. We appreciate the company’s clarity in every aspect of its financial results.

However, we believe economic weakness in Europe and intense competition from its peers – including Canon, Inc. (CAJ - Snapshot Report) and Hewlett-Packard Company (HPQ - Analyst Report) – might affect the company’s operations. We are also concerned about its rising debt level.

Xerox retains a Zacks #3 Rank, which translates to a short-term (1–3 months) Hold rating.

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