(XRX) Xerox Exceeds Estimates in Second Quarter Earnings Report

Xerox Corporation (XRX) reported a net income of $319 million or 22 cents per share in the second quarter of 2011 compared with $227 million or 16 cents per share in the year-ago quarter.

Reported earnings in the quarter included charges of $54 million or 4 cents per share related to the amortization of intangible assets and a loss of $20 million or 1 cent per share associated with early extinguishment of liability.

Excluding these charges, adjusted income of Xerox stood at $393 million or 27 cents per share in the quarter, improving from last year’s adjusted income of $342 million or 24 cents per share. Adjusted earnings also exceeded the Zacks Consensus Estimate of 24 cents per share.

Revenues increased marginally by 2% year over year to $5.61 billion, but failed to beat the Zacks Consensus Estimate of $5.62 billion. Lower sales (down 4% year over year) negatively impacted revenues, despite a 5% growth in revenues from service, outsourcing and rentals.

Gross margin in the quarter declined slightly to 33.4% from 34.8% in the prior-year quarter, whereas operating margin rose to 10.4% from the year-ago level of 10.1%.

Segment Performance

Revenues in the Technology segment remained almost flat at $2.55 billion, driven by a 3% year-over-year decline in equipment sales, arising from the challenging supply chain scenario in Japan. The segment’s profit increased $27 million to $300 million from last year.

The increase in profit was attributed to lower costs and expenses, resulting from restructuring savings and lower bad debt expenses. Gross profit for the segment was affected by increased freight and logistic costs and a lower supplies mix.

Revenues in the Services segment increased approximately 6% to $2.67 billion from $2.53 billion reported in the year-ago quarter. This was attributed to remarkable improvements in each of its business process outsourcing (BPO), information technology outsourcing (ITO) and document outsourcing (DO) services.

Revenues from BPO increased 9% while the same for both ITO and DO businesses improved 10%.The segment’s profit was $322 million compared with the prior-year profit of $319 million.

Revenues in the Other segment declined 8% to $390 million from $424 million a year ago. However, the segment’s loss narrowed down to $73 million from the year-ago loss of $93 million.

Financial Position

Xerox had cash and cash equivalents of $1.10 billion, as of June 30, 2011, compared with $1.21 billion, as of December 31, 2010. Total debt amounted to $9.31 billion at the end of the second quarter of 2011 versus $8.61 billion at the end of the fourth quarter of 2010.

In the first six months of the year, net cash generated from operating activities dropped drastically to $317 million from $1.05 billion a year ago. The deterioration in cash flows was due to lower accounts payable and accrued compensation, higher net tax payments and higher contributions to pension benefit plans.

Guidance

Xerox anticipates GAAP and adjusted EPS of 20 cents–22 cents per share and 24 cents–26 cents per share, respectively, for the third quarter of 2011. For full year 2011, the company expects GAAP earnings between 91 cents and 96 cents per share and adjusted EPS in the range of $1.07 per share to $1.12 per share. However, the company reduced its full year operating cash flow guidance to $2 billion–$2.3 billion.

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 for expanding its business.

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 its 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 emerge as potential headwinds for the company going forward. The company’s key competitors include Canon Inc. (CAJ) and Pitney Bowes Inc. (PBI).

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

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