Xerox Earnings Call Insights: Services Business and Yen Outlook

Xerox Corporation (NYSE:XRX) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Services Business

Shannon Cross – Cross Research: I just have a question for Ursula and Lynn. I’m not sure who wants to take it. But looking at the Services business, you had anticipated some improvement and it was obviously flat year-over-year. You are accelerating restructuring throughout the business, I believe. So, how do we sort of think about what’s going on underlying in the Services business, and how do we think about the growth that you have in terms of signings if that might impact your ability to see substantial improve – or some improvement in margin as we go through the year? Just if you guys can sort of take that and better frame what you are seeing in Services right now.

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Ursula M. Burns – Chairman and CEO: I’ll take it, and maybe turn it over to Lynn in a little while if I don’t get to all of the points. First of all, we’re very pleased with the performance of Services in the first quarter. Our signings – our revenue growth at 4% was, as expected, without a big contribution from inorganic, from acquisitions. Our margins were essentially in line with what we expected. We expected a little bit of improvement, maybe 10 basis points or so, but we came in strong, and our signings, renewal rate, new business rate were all very, very, very strong. The predictions that we have for second quarter, the outlook that we have for second quarter, is continued expansion in margin on a sequential basis. We have a tough compare in quarter two, so it will be down a little year-over-year in quarter two sequential expansions, and then throughout the year continued expansion. We expect to end the year in the 10% to 12% range, up a little bit on a year-over-year basis. So I think if you look at our – the underlying of our business, the cost actions that we are taking, the management focus that we have on good mix of business and new business, and the look for continued acquisitions, you should be fairly confident in how we’ll – how the Services business will play out in 2013.

Lynn Blodgett – Corporate EVP and President, Xerox Services: The other thing, Shannon, I think is that in our cost restructuring that we talked about last quarter, we saw the flow-through of that. It was north of $30 million. We did have the run-off of our – we’ve started to see the run-off of our student loan business, which is very high margin. It’s a very mature contract, and so that had an impact. But our cost restructuring of the fourth quarter offset the discounts we have expected and the run-off. The other thing that we’re doing to – that gives us confidence about the ongoing margins and our ability to grow them is that we have our restructuring and our basic shift of our cost model is we’re just kind of getting underway with that. We saw – we did some things in the fourth quarter. We have a program now called Project Compete. That is our effort to move work, more work to low-cost domestic locations and to low-cost offshore locations. That’s underway, and it’s going to run through – right now clear through ’14, and probably beyond that. So we still have an awful lot of high-cost labor in our model and we are working to reduce that, and I think that’s our probably the main thing that gives me the confidence that we can increase margins…

Shannon Cross – Cross Research: Then my second question is just, Ursula can you talk a bit about what you are seeing from an economic standpoint, both perhaps in the enterprise as well as SMB and geographically we’ve had from obviously several companies so far and it’s clearly not a robust market environment out there, but I am curious as to what you are seeing in your verticals and just whatever you can provide to us. Thank you.

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Ursula M. Burns – Chairman and CEO: Macro and fiscal uncertainty definitely continued in Q1 and we saw that in our Document Technology business primarily. From a geographic perspective Europe remains weak and in the first quarter it had some shocks that we can deliver even further and we did see a slow down a bit of a slowdown in some developing market economies. We are hoping that doesn’t stay for a long time. But our business model is fairly resilient in developing markets which is good. We have a very flexible cost base there, so we can actually adjust our infrastructure cost to whatever revenue comes in. U.S. remains stable but weak, I mean we have not seen a pickup in the U.S. sequestration didn’t hurt us a whole lot didn’t help us in decision making. It continued to keep decision making slow. So what I would say is overall we have a status quo weak environment around the globe, with whenever there is a little bit of shock we see a little bit of shock in people’s outlooks but nothing too significantly worse than we saw in the fourth quarter.

 

Yen Outlook

Ben Reitzes – Barclays Capital: Wanted to ask about Technology. One of the – I wanted to hash out the yen. You probably get a profit benefit that’s either coming or you saw a little bit, but then it also – the last time this happened, I don’t know, 12, 13 years ago where the yen weakened quite a bit. Cannon cut price quite a bit and took a lot of share. I was wondering if that has started and what you think the pricing environment will be throughout the year, given the weak yen…

Ursula M. Burns – Chairman and CEO: Let me start with the yen and the impact on our business, and I’ll go into pricing a little bit. So the yen weakening overall is a positive for us. But as you know, we actually have two hedges there; one, we have currency sharing with Fuji Xerox, and the second is that we hedge the yen on a forward-basis. We were fairly aggressive in hedging in the fourth quarter – in the second half of 2012, as we saw the yen continuing to weak. So we don’t benefit as much from the yen weakening immediately as other – as the yen would – as you would expect from the yen, because we do have these two mechanisms to help offset those major moves. The benefit in the first half was less than – was kind of nominal. It will be more in the second half. It will be probably total around $50 million in the year backend loaded for us, if the yen stays where it was at the end of the year. As it weakens further, obviously, more benefit, we’ll continue to hedge in and the currency share. As far as pricing goes, we have seen a little bit of a move up in pricing aggressiveness. So we generally are and have been over time in this 5% to 10% range. This is primarily in Document Technology, obviously, and primarily on equipment, because the wholesale contracts are locked in for longer periods of time. We are seeing activity at the higher end of this 5% to 10% range. We are being aggressive. I mean, especially as we launch ConnectKey, which gives us a set of offers that allows us to be aggressive in the marketplace, a new set of offerings, we’re matching price as we have to win back share that we lost when we didn’t have the products in the second half of 2012. So pricing at the higher end of the 5% to 10% range and we’re being aggressive to make sure that we stay competitive.

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Ben Reitzes – Barclays Capital: Then could you just elaborate a little more on the government in particular? In the last question you mentioned some of it, but what is the latest in terms of government as a percent of sales and what – and the difference that you’re seeing in Services in particular between state and local and federal, and how it impacts your business? In particular, if you could touch on whether you expect things to get better this quarter in that vertical maybe somehow?

Ursula M. Burns – Chairman and CEO: We are not heavily exposed to the federal government. We have a small portion of our revenue, 5% or so, in federal government. More heavily concentrated in state government, 15%, 20% in state government. What we’ve seen – and so I’m speaking about state government and not too much about federal government, because it’s kind of de minimis for us, as I said. State government, we are seeing some good news, particularly in healthcare. We have strong position, as you know, in MMIS around the United States, and California is our big contract; New Hampshire just went live. We’re doing well there, decision making. So healthcare is a big segment for us. We do well there, and our profitability is improving in that segment actually very, very well. So I’m bullish about healthcare services. What we are seeing though is that any new decisions, any decision in government takes a little bit longer. A lot more discussions a lot more engagement, lot more senior level engagement with state officials and by us. So myself, Lynn our CFO are engaged in these kinds of discussions with state officials. The good news is that they do eventually come and we win our fair share. So slow reaction time, slow decision making progress, but our concentration is good and we are, our major concentration is in healthcare, we also have a transportation business that’s clearly government based as well and we do well there. So I don’t know if Lynn wants to say anything else.

Lynn Blodgett – Corporate EVP and President, Xerox Services: Just that I was right to add the comment about transportation that we saw good signings and we manage it separately, but that is part of the most of them are government entities. So we saw good singings there and just agree with whatever Ursula said.

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