Source: Seeking Alpha
Xerox Corporation (NYSE:XRX)
Q2 2014 Results Earnings Conference Call
July 25, 2014 10:00 AM ET
Ursula Burns – Chairman and CEO
Kathy Mikells – Executive Vice President and CFO
Jim Lesko – Vice President, Investor Relations
Bob Zapfel – EVP, President, Xerox Services
Jeff Jacobson – President, Document Technology
Brian Essex – Morgan Stanley
Ben Reitzes – Barclays
Shannon Cross – Cross Research
Jim Suva – Citigroup
George Tong – Piper Jaffray
Keith Bachman – BMO Capital Markets
Tien-tsin Huang – JPMorgan
Ananda Baruah – Brean Capital
Bill Shope – Goldman Sachs
James Friedman – Susquehanna
Good morning. And welcome to the Xerox Corporation Second Quarter 2014 Earnings Release Conference Call hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Kathy Mikells, Executive Vice President and Chief Financial Officer.
During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor. At the request of Xerox Corporation, today’s conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the express permission of Xerox. After the presentation, there will be a question-and-answer session. (Operator Instructions)
During this conference call, Xerox executives will make comments that contain forward-looking statements, which by their nature address matters that are in the future and are uncertain. Actual future financial results may be materially different than those expressed herein.
At this time, I would like to turn the meeting over to Ms. Burns. Ms. Burns, you may begin.
Ursula Burns – Chairman and CEO
Good morning and thanks for joining our call. Today we are reporting second quarter 2014 earnings that continued to reflect the benefits of our diversified portfolio and strong cash flow. We remain focused on our priorities and we are making progress.
This quarter we saw a return to growth in Services and the business is well-positioned for sustained improvement. Services is now 57% of revenue and we are on track to reach our target of two-third by 2017. This important shift will drive overall revenue growth.
Our Document Technology business drove strong profits again this quarter and continues to be an important for us, generating cash and profits above expectation. We continue our initiatives to improve Services profitability. We are seeing good profitability improvement especially within areas like document outsourcing, our commercial BPO business and ITO businesses, including healthcare and international services.
We know that more need to be done especially in government healthcare, where we continue to stand-up a new Medicaid platform and deal with a couple of challenging contracts. So this remains a top priority.
And of course, both segments, Services and Technology we remained focused on our important stakeholder with the keen attention on supporting our customers, delivering value for our investors and making Xerox a great place to work for our people.
In the quarter we invested $227 million in acquisitions. Welcoming into Xerox the employees and customers of Smart Data Consulting and ISG Holdings. ISG is a leading provider of workers compensation software in the U.S.
This acquisition will expand our significant present in the healthcare payor and insurance BPO markets, and we continue to invest organically in areas where we see good market opportunity, such as in private health exchanges, we have a differentiated offering for large employers through Buck Consultants at Xerox.
We have a business that delivers strong cash flow. This gives us flexibility to not only invest for growth, but also build short and long-term shareholder value through a balanced approach to capital allocation that includes share repurchases and dividends.
To execute on our direction, we have a strong team. Jeff Jacobson was recently named the President of our Document Technology business, taking over from Armando Zagalo de Lima, who is retiring after 31 years at Xerox.
I want to thank Armando for everything that he has done for Xerox. He has put our document technology business on a solid foundation by transforming the organization to be more customer-focused, profitable and well-positioned to adapt to changes in the market.
Here to look our results and my perspective. As I mentioned earlier, there are bright spots and positive trends, but we still have work — more work to do. We reported adjusted EPS of $0.27, which is at the high-end of the range that we said.
In the quarter we saw improvement in Services revenue growth. Services revenue was up 2%, that’s up from flat growth last quarter and the business is trending well.
Document Technology revenue had higher declines in the quarter as expected given timing of last year’s product launches. It is in the range of expectations for the first half and we are very excited about upcoming product launches.
Our operating margin is up year-over-year, driven by strong margins in Document Technology, the result of continue good operational discipline and focused on productivity.
As anticipated, though, we did see margin decline in Services, due to the pressures that we are experiencing in government healthcare. We took a non-cash charge in the quarter and are making progress transitioning out of some challenging contracts. Kathy will provide you with more details in a few minutes.
We are continuing our activities to create shareholder value, using our strong cash flow, which is up over $150 million for the first half to repurchase shares at a steady pace, supporting a growing dividend and acquiring companies that enhance our Services capability.
We have a talented and dedicated team and we are keeping our stakeholders at the center of all that we do. Our goal is to provide excellent product and services, and deliver the operational results that are expected of us.
With that, I will turn it over to Kathy. Then I will wrap up and we will open the call to your questions. Kathy?
Kathy Mikells – Executive Vice President and CFO
Thanks, Ursula, and good morning, everyone. Overall, we feel about our sequential program with the number of the themes from quarter one carrying through to quarter two. We continue to show operating profit growth, driven by strong margin expansion in Document Technology and we had good operational performance in the majority of our Services businesses.
As expected, the government healthcare business continues to pressure Services margin, as we invest in rolling out our Medicaid platform. Additionally, we took incremental non-cash impairment charges, driven by the transition out of the Nevada Health Insurance Exchange. I will cover all of these dynamics in much greater detail when I review segment performance.
First, I’d like to begin by walking through our earnings. Revenue in the quarter was down 2% at actual currency and down 2.5% in constant currency. Segment revenue trends were as expected, with Services revenue growth improving and Document Technology weaker as we face a challenging year-over-year compare due to last year’s product launch timing.
Gross margin of 30.8% was down 70 basis points year-over-year, driven by the Services margin decline, as well as the greater mix of Services. We again saw a significant improvement in both SAG and RD&E as we benefit from productivity initiative, as well as lower pension expense.
These improvements more than offset below our gross margin and resulted in operating margin expansion of 30 basis points year-over-year and 110 basis points sequentially, and enabled higher operating profit year-over-year.
Moving down to income statement, adjusted other net was $14 million higher year-over-year. The increase was split between OID, which was $9 million higher year-over-year, reflecting a real estate gain in the prior year and restructuring which is $38 million was $5 million higher year-over-year and in line with our guidance.
Adjusted tax rate of 27.7% was 360 basis points higher year-over-year and just above our guidance range of 25% to 27%. So, overall, there was a modest year-over-year headwind below operating profit. Adjusted EPS of $0.27 was flat year-over-year and at the high end of our guidance range of $0.25 to $0.27.
Looking at the first half, adjusted EPS of $0.54 was also flat year-over-year, operating profit grew 6% in the first half, despite the pressure we are seeing in our government healthcare business and when combined with lower share count more than offset higher restructuring costs, OID and a higher tax rate. So, all in all, I believe we are making progress, obviously, with more work yet to do.
With that, I will move to the Services segment slide to review those results in a little bit more detail. Services revenue growth once again improved sequentially and was up year-over-year 2% or 1% in constant currency, driven by a pick up in BPO which went from down 2% in Q1, so up 1% in Q2.