XRX: Xerox Managing Expectations Better Than Operations

From William Trent, CFA of Stock Market Beat

Xerox Reports First-Quarter Earnings of 24 Cents Per Share:

Xerox Corporation (XRX) announced today first-quarter 2007 earnings per share of 24 cents.The company’s earnings include a 2-cent charge to reflect its share of a restructuring charge recorded by Fuji Xerox Co., Ltd. This previously announced restructuring was initially expected to be a 3-cent charge to Xerox’s first-quarter earnings.

Total revenue of $3.8 billion grew 4 percent in the first quarter. Post-sale and financing revenue – Xerox’s annuity streams that represent more than 70 percent of total revenue – increased 6 percent. This growth was largely driven by a 7 percent increase in post-sale revenue from digital systems. Both total revenue and post-sale revenue included a currency benefit of 3 percentage points.

When we issued our earnings preview, we said: Xerox (XRX) – Consensus expects $0.20 on $3.82 billion this quarter and $0.27 on $4.09 next. The estimates have come down but are at the high end of revised guidance.

The new official guidance, which included the charge, was $0.18-$0.20. Since the charge was $0.02 instead of $0.03 it should have been $0.19-$0.21. Estimates properly came down after the guidance revision, so the earnings including the charge are the ones that matter. And on these, Xerox beat by $0.03. Guidance for next quarter was in line:

Xerox expects second-quarter 2007 earnings in the range of 26-28 cents per share.

What is amazing to us is how much glowing coverage the company received for mediocre 4% growth that was itself primarily due to currency effects rather than operational success. For example, “InPlay: Xerox beats by $0.05, ex items; guides in-line for Q2;” or even more laughably “[$$] Xerox’s Net Income Rises 17%, Boosted By Strong Sales.” Boosted by Strong Euro, they should say.

Still, the stock looks to rally on the news, which tells us management is good at managing expectations, anyway. Moving to the nitty gritty:

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. As Xerox accelerated activity in key markets during the first quarter, the continued impact of pricing declines put pressure on equipment sales, which were down 2 percent including a 2 point benefit from currency.

They are trying to say they are willing to lose money selling the razor in order to sell more blades. However, until they can produce overall growth in excess of nominal GDP we remain thoroughly unconvinced of the strategy.

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