February 02, 2015 Xerox Corporation Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 10/18/2012 Current Price (01/30/15) $13.17 Target Price $14.00 52-Week High $14.32 52-Week Low $10.30 One-Year Return (%) 23.28 Beta 1.69 Average Daily Volume (sh) 6,616,049 Shares Outstanding (mil) 1,142 Market Capitalization ($mil) $15,034 Short Interest Ratio (days) 1.85 Institutional Ownership (%) 83 Insider Ownership (%) 1 Annual Cash Dividend $0.25 Dividend Yield (%) 1.90 5-Yr. Historical Growth Rates Sales (%) 2.1 Earnings Per Share (%) 6.3 Dividend (%) 10.9 using TTM EPS 11.8 using 2015 Estimate 12.4 using 2016 Estimate 11.2 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page (XRX-NYSE) SUMMARY Xerox reported modest fourth quarter 2014 results as adjusted earnings beat the Zacks Consensus Estimate by $0.03. Xerox remains committed to its 5-plank strategy that is centered on portfolio management, operational excellence, global growth, cost transformation, and analytics. In addition, it is integrating its Managed Print Services with business process and IT outsourcing capabilities to increase revenues from the Services segment to 66% of total revenue by 2017 from 54% at present. However, the presence of a large number of substitutes and strong competition are likely to peg back its profitability to some extent. Nevertheless, we maintain our long-term Neutral recommendation for the stock Risk Level * Below Avg., Type of Stock Large-Value Industry Office Auto&Eqp Zacks Industry Rank * 243 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 5,356 A 5,402 A 5,262 A 5,569 A 21,589 A 2014 5,121 A 5,292 A 5,120 A 5,033 A 20,566 A 2015 4,630 E 4,852 E 4,745 E 5,022 E 19,249 E 2016 19,244 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.27 A $0.27 A $0.26 A $0.29 A $1.09 A 2014 $0.27 A $0.27 A $0.27 A $0.31 A $1.12 A 2015 $0.21 E $0.27 E $0.28 E $0.30 E $1.06 E 2016 $1.18 E 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Founded in 1906, Xerox Corporation is a leader in the development, manufacture, marketing, servicing and financing of document equipment across the world. Headquartered in Norwalk, Connecticut, Xerox has its presence in more than 160 countries. The company offers business process outsourcing and IT outsourcing services, including data processing, healthcare solutions, HR benefits management, finance support, transportation solutions, and customer relationship management services for commercial and government organizations worldwide. The company also provides extensive leading-edge document technology, services, software and genuine Xerox supplies for graphic communication and office printing environments of any size. The company s financial performance is reported under three segments: Document Technology, Services and Others. The Document Technology segment (43% of fourth quarter 2014 revenues) incorporates the former Production and Office segments, excluding the document outsourcing business. The Production segment provides high-end digital monochrome and color systems designed for customers in the graphic communications industry and large enterprises. The Office segment develops and manufactures a range of color and black-and-white multifunction, printer, copier and fax products. The Services segment (54%) is comprised of two services viz. DO and BPO. The document outsourcing (DO) business is among Xerox s historical business process services and includes Managed Print Services. The company s acquired company, Affiliated Computer Services ( ACS ), is a provider of business process outsourcing (BPO). The Other segment (3%) covers revenues from Xerox Supplies Business Group (predominantly paper scales), wide-format systems, value-added services and Global Imaging Systems network integration solutions, electronic presentation systems, and non-allocated corporate items REASONS TO BUY Xerox continues to grow globally through successful acquisitions and disposal of non-core assets. Recently, Xerox announced its decision to divest the Information Technology Outsourcing (ITO) business to Atos - a leader in digital services provider - for $1.05 billion. The transaction also includes an additional consideration of $50 million on closing, which is expected in the first half of 2015. The initial proceeds of the divestiture will be used to boost share buybacks and acquisition spending. Also with this divestiture, Xerox intends to refocus on its Document Outsourcing businesses and other high-margin business services to offset the decline of the document printing business. The company remains focused on enhancing its Services offerings and expanding itself globally as it aims to invest up to $900 million in acquisitions in 2015. Xerox is also set to acquire Seattle-based firm Intrepid Learning Solutions to expand its learning portfolio. Post acquisition, Intrepid s cloud-based learning technology business will be excluded from Xerox and marketed under the Intrepid brand. Together, both companies will sign a partnership alliance to benefit their clients with Intrepid s technological expertise and Xerox s e-learning, consulting, administration and classroom training programs. Xerox is looking forward to expand its offerings through inorganic measures and such acquisitions will help the company to add more clients to its portfolio. Xerox also remains committed to its 5-plank strategy that is centered on portfolio management, global growth, cost transformation, operational excellence and analytics. With sustained investments to expand geographical footprint and build its services capabilities in areas that provide significant customer value, Xerox expects to reap benefits in the long run. In order to better adapt to the changing market trends, Xerox is continually shifting its business model by expanding indirect distribution channel and streamlining its supply chain and product portfolio. Going forward, the company expects to maintain its strong market share in Document Equity Research XRX Page 2
Technology business with innovative products to meet the demands of customized communications in digital printing. These include waterless and inkjet-based solutions that enable print providers to deliver tailor-made services. Xerox is also integrating its market-leading Managed Print Services (MPS) with its business process and IT outsourcing capabilities. MPS enables clients to gain visibility and control of printing to save money, improve productivity, boost environmental sustainability and document security. The integration will automate workflow with technology and consulting services to help clients meet the requirements of mobile workforce. At the same time, Xerox generates significant cash flow and deploys it to maximize shareholders value. All these augur well for its long-term growth. Xerox s Services business, which includes Document Outsourcing (DO) and Business Process Outsourcing (BPO) has been improving. The company expects to increase revenues from the Services segment to 66% of total revenue by 2017 from 54% at present. To achieve this objective, Xerox is focusing more on vertical markets like healthcare. The new Juvo platform is expected to boost Xerox's portfolio of business process management and give it a leading role in the changing healthcare model. Also, Xerox invested in HealthSpot, a pioneer in patient and provider-driven healthcare technology. As its exclusive BPO partner, Xerox will support HealthSpot to provide groundbreaking telehealth patients at convenient neighborhood locations. All these factors bode well for the long term growth of the company. REASONS TO SELL Advancements in IT have replaced the traditional means of sending and storing information by digital media. As a result, Xerox and other document industry firms are grappling with decreased demand for paper-related systems and products. This in turn is hurting its overall profitability. Another major threat involves the availability of a large number of substitutes because of strong peer presence, although there are lesser chances of new entry. Companies like Canon, Hewlett-Packard Lexmark and Toshiba are strong enough to provide tough competition to Xerox. Moreover, they are also broadening their product line and strengthening their global presence in almost the same way as Xerox. This has largely affected the profit margins of the company. A significant portion of the company s revenues are generated from operations outside the United States. Additionally, the company maintains significant operations and acquires or manufactures many of its products outside the United States. Fluctuations in foreign currency exchange rates affect the company s net investment in foreign subsidiaries and may cause instability in cash flows related to foreign denominated transactions. These undermine its long-term growth to some extent. Equity Research XRX Page 3
RECENT NEWS Xerox Beats on Q4 Earnings, Revenues Dip Y/Y December 31, 2014 Xerox reported net income (from continuing operations) of $305 million or $0.26 per share in fourth quarter of 2014 compared with $297 million or $0.23 a share in the year-ago quarter. The year-over-year increase in earnings per share was due to lower operating expenses. For full year 2014, the company reported net income (from continuing operations) of $1,084 million or $0.90 per share compared with $1,139 million or $0.89 a share in 2013. Excluding non-recurring items, adjusted earnings (from continuing operations) for the reported quarter were $357 million or $0.31 per share versus $344 million or $0.27 per share in the year-earlier quarter. Adjusted earnings for the reported quarter exceeded the Zacks Consensus Estimate of $0.28. Excluding non-recurring items, adjusted earnings (from continuing operations) for full year 2014 were $1,280 million or $1.07 per share versus $1,328 million or $1.04 per share in 2013. Adjusted earnings for the full year missed the Zacks Consensus Estimate by $0.01 Total revenues in the reported quarter decreased 3% year over year to $5,033 million. Quarterly revenues beat the Zacks Consensus Estimate of $5,015 million. The decrease in revenues was driven by lower sales in the Document Technology segment. Operating margin for the reported quarter was up 1.0 % year over year to 10.4%, while gross margin was 32.1%. Total revenues for full year 2014 decreased 2% year over year to $19,540 million. Segment Performance Revenues from the Services segment, which include Document Outsourcing (DO) and Business Process Outsourcing (BPO) increased 1% year over year to $2,725 million in the reported quarter (54% of total revenue). BPO revenues increased due to growth from acquisitions along with organic growth in several lines of business. Revenues from DO decreased year over year as growth in the partner print services offerings was offset by decline in Europe and other markets Segment margin increased 0.1% year over year to 9.8%. Total Services sales pipeline declined 5% year over year. The pipeline has been adjusted to remove the ITO business and reflect the realignment of its services go-to-market resources into industry focused business groups. Total contract value of service signings aggregated $3.2 billion with BPO and DO accounting for $2.2 billion and $1.0 billion, respectively. Total contract signings increased 20% in the reported quarter driven by renewals. Revenues in the Document Technology segment dipped 8% year over year to $2,159 million (43% of total revenue) due to a fall in equipment sales and annuity revenues. Segment margin increased 2.8% year over year in the reported quarter to 14.4% owing to benefits from cost initiatives, lower pension expense and positive effects from restructuring. The revenue mix for the segment comprised 56% mid-range, 25% high-end and 19% for entry-level products. Revenues in the Other segment decreased 12% to $149 million (3% of total revenue) due to lower licensing and patent sale revenues. Segment loss of $65 million increased $31 million from the year-ago quarter, primarily driven by lower licensing and patent sale revenues and lower gains on sales of businesses and asset. Equity Research XRX Page 4
Financial Position Xerox had cash and cash equivalents of $1,411 million as of Dec 31, 2014, compared with $1,764 million as of Dec 31, 2013. Long-term debt at the end of the reported quarter stood at $6,314 million versus $6,904 million as of Dec 31, 2013. Net cash provided by operating activities for the year ended Dec 31, 2014 stood at $2,063 million versus $2,375 million in the year-ago period. The company repurchased $1.07 billion worth of shares for full year 2014. Xerox increased the quarterly cash dividend by 12% to 7 cents per share, with the dividend payable on Apr 30, 2015. Other Recently, Xerox entered into an agreement to sell its Information Technology Outsourcing (ITO) business to Atos S.E. for $1.05 billion to focus on building up faster-growing units, business process outsourcing (BPO) and document outsourcing. The transaction is expected to close in the first half of 2015. Outlook For first quarter 2015, Xerox expects GAAP earnings between $0.16 to $0.18 per share, while adjusted earnings are expected to be within $0.20 to $0.22. For full-year 2015, Xerox expects adjusted earnings to be in the range of $1.00 to $1.06 per share. GAAP earnings from continuing operations are expected in the range of $0.83 to $0.89 per share. Xerox expects cash flow from operations to be in the range of $1.7 to $1.9 billion and free cash flow in the range of $1.3 to $1.5 billion, reflecting a negative $200 million impact to cash flow from operations and a negative $100 million impact to free cash flow. Xerox expects to offset the impact from the ITO sale on free cash flow by 2016. Equity Research XRX Page 5
VALUATION Xerox s current trailing 12-month earnings multiple is 11.8x, compared with the 11.4x average for the peer group and 18.6x for the S&P 500. Over the last five years, shares of Xerox have traded in a range of 6.0x to 15.1x trailing 12-months earnings. The stock is also trading at a discount to the peer group, based on forward earnings estimates. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the broader market. Our $14.00 target price, 13.2x our 2015 EPS estimate, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Xerox Corporation (XRX) 12.4 11.2 7.0 6.1 11.8 15.1 6.0 Industry Average 12.4 10.9 4.6 6.0 11.4 18.4 6.8 S&P 500 16.1 15.1 10.7 16.1 18.6 19.4 12.0 Ricoh Company Ltd ADR (RICOY) 9.9 9.7 3.4 4.4 9.4 25.7 9.8 Canon Inc ADR (CAJ) 15.4-1.0 7.5 16.1 36.4 12.6 Seiko Epson Corp (SEKEY) 6.7 5.6 8.5 1.5 Konica Minolta, Inc (KNCAY) 13.8 12.3 7.5 5.8 14.1 16.5 8.8 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Xerox Corporation (XRX) 1.3 1.3 0.7 10.9 0.5 1.9 7.8 Industry Average 4.6 4.6 4.6 43.4 1.8 2.5 6.3 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research XRX Page 6
Earnings Surprise and Estimate Revision History Equity Research XRX Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of XRX. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1117 companies covered: Outperform - 15.8%, Neutral - 77.2%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Analyst: Meenu Goyal Lead Analyst: Supriyo Bose Content Editor: Supriyo Bose QCA: Supriyo Bose Reasons for Update: 4Q14 & FY14 Earnings Update Equity Research XRX Page 8