Xerox Corporation (XRX) announced today second-quarter 2007 earnings per share of 28 cents. When I previewed the report I said “can they make the numbers without asking investors to ignore a bunch of stuff? I don’t doubt they will earn $0.27 as expected but wonder how they’ll get there.”
Well, as it turns out they didn’t ask investors to ignore a bunch of stuff. Unfortunately, however, the report still didn’t strike me as being particularly strong. I’ll run down a few of my observations.
Total revenue of $4.2 billion grew 6 percent in the quarter. Post-sale and financing revenue - Xerox’s annuity streams that represent more than 70 percent of total revenue - increased 7 percent. Both total revenue and post-sale revenue included a currency benefit of 2 percentage points as well as the benefit from Xerox’s acquisition of Global Imaging Systems, which was completed in early May.
So… 4% growth excluding the currency benefit and $100-$200 million from Global Imaging, the sales looked about flat. With Global Imaging having clocked in $1 billion in sales last year, it should be expected to boost sales by 6.25% in its first full quarter as a Xerox subsidiary, or slightly more than half that in the partial quarter just completed. Xerox is spending billions of dollars on acquisitions not to grow but to stay in place.
A fundamental measure of Xerox’s business is increasing the number of Xerox systems installed in customers’ workplaces. This install activity generates sales of supplies and services that are expected to drive gains in post-sale revenue.
They keep saying that. I’m still waiting for them to prove it. For example, during the second quarter, install activity increased 54 percent for the company’s color multifunction devices that print, copy, fax and scan. But revenue from color grew 12 percent in the second quarter and now represents 38 percent of Xerox’s total revenue, up 4 points from the second quarter of 2006. Why isn’t the sales keeping up with the install rate? Shouldn’t all those installs be generating post-sale revenue by now?
Gross margins were 40.3 percent, a less than one point decline from second quarter of 2006.
I don’t need to add anything there.
Xerox expects third-quarter 2007 earnings in the range of 24-26 cents per share. The company increased its range of earnings expectations for full-year 2007 to $1.16 - $1.18.
After beating in the current quarter, the high end of the guidance range for the rest of the year only matches consensus. That is the equivalent of cutting guidance in the coming quarters.
With sales up just 7% (including all the aforementioned benefits) accounts receivable and inventories are up 11% year to date. Some of that increase, however, may be seasonal.
Cash flow from operations were up for the quarter and year-to-date, but only because the company contributed less to its underfunded pension plan than it did last year. Excluding pension contributions (which are discretionary) the cash flow would have been down.
Long story short, there is nothing to shout about with Xerox’s earnings.
Xerox must work on retaining customers not trying to outrun losses through sales. It won't happen. Sales gets rewarded for sales activity with over 90% of that activity coming from existing customers, not new customers. So the rewards to sales come even though they may be losing more than they are bringing in because there is no penalty for the loss.