Fitch Rates Xerox's Senior Unsecured Note Offering 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BBB' rating to Xerox Corp.'s (Xerox) proposed offering of senior unsecured notes. Net proceeds from the offering will be used for general corporate purposes, including the potential repayment of a portion of Xerox's outstanding debt. The Rating Outlook is Stable.

KEY RATING DRIVERS

Xerox's ratings and Stable Outlook reflect:

--Revenue growth in Services is expected to mostly offset revenue declines in Document Technology (DT), primarily black-and-white (B&W) high-end production printing.

--Substantial recurring revenue from long-term services contracts, rentals and financing, and supplies (86% of total revenue).

--Solid liquidity supported by $1.6 billion of cash at March 31, 2013, an undrawn $2 billion revolving credit facility (RCF) due March 2019, staggered debt maturities and consistent annual free cash flow (FCF). Fitch believes FCF (post-dividends) will continue to exceed $1.4 billion annually through 2016.

--A highly diverse revenue mix and declining exposure to the slow-growth print industry due to stronger growth in the Services business. Services accounts for 57% of Xerox's total revenue.

--Conservative financial policies. Management remains committed to remaining at investment grade and has established a track record of reducing debt to offset declining financing assets, thereby maintaining flat core leverage, which excludes debt associated with the financing business.

Fitch's credit concerns center on:

--Revenue pressures in DT, inclusive of equipment and supplies bundled with Document Outsourcing (DO) contracts. DT revenue, including DO contracts, declined 2% in the first quarter of 2014 due to continued declines in B&W revenue. However, operating profit for DT on a stand-alone basis increased nearly 34%, reflecting tight expense control, lower pension expense and a decline in the Japanese yen relative to the U.S. dollar.

--The aggregate $1.1 billion shortfall in funded worldwide defined benefit (DB) pension plans on a projected benefit obligation basis as of year-end 2013, down from $1.8 billion in the prior year. The improvement in funded status primarily reflects lower benefit obligations due to a 110- and 20-basis point increase in the U.S. and non-U.S. discount rate, respectively. Total contributions are expected to be $250 million in 2014 compared with $230 million in 2013.

--Operating margin (OM) pressures in the Services business. The operating margin for Xerox's Services segment declined 61 basis points in the latest 12 months (LTM) ended March 31, 2014 to 9.6%, below the company's long-term target of 10%-12% and 130 basis points below the corresponding period in 2012.

The lower margin reflects: i) greater implementation expenses for a healthcare insurance exchange (HIX) platform deployed in Nevada and the rollout of a new Medicaid Management Information System (MMIS) platform; and to a lesser extent ii) continued run-off of the higher margin student loan processing business; and iii) typical price erosion following contract renewals.

--The print industry is intensely competitive, resulting in consistent equipment pricing pressure, particularly office products.

RATING SENSITIVITIES

Positive:

--Revenue growth and margin expansion in Services strengthens Xerox's FCF and credit protection metrics;

--Significant reduction in the funding shortfall for Xerox's worldwide defined benefit pension plan.

Negative:

--An accelerated decline in DT more than offsets growth in Services, resulting in a material decline in financial performance and credit metrics;

--A material increase in core debt to finance acquisitions and/or shareholder-friendly activities.

Xerox's liquidity is solid, supported by nearly $1.6 billion of cash at March 31, 2014 and an undrawn $2 billion RCF that matures in March 2019 and requires compliance with two financial covenants, consisting of a minimum total interest coverage of 3x and maximum total leverage of 3.75x. In the LTM ended March 31, 2014, Xerox generated $2 billion of reported FCF (post-dividends).

Total debt with equity credit was $8.2 billion on March 31, 2014, primarily consisting of approximately $8 billion of senior unsecured debt and $349 million of convertible preferred stock, which Fitch assigns 50% equity credit. As of March 31, 2014, $4.4 billion, or 54%, of total debt, supported Xerox's financing business based on a debt-to-equity ratio of 7:1 for the financing assets. Xerox's net financing assets, consisting of receivables and equipment on operating leases, totaled $5 billion compared with $5.6 billion in the prior year.

Xerox's annual FCF is expected to exceed annual debt maturities through at least 2017 due to a highly staggered debt maturity schedule. Debt maturities in 2014-2018 are $1 billion, $1.3 billion, $979 million, $1 billion and $1 billion, respectively.

Fitch estimates total leverage (total debt/operating EBITDA) and core (non-financing) leverage were 2.7x and 1.4x at March 31, 2014, respectively, compared with 2.8x and 1.4x in the year ago period. Total interest coverage (total operating EBITDA/interest expense) and core (non-financing) interest coverage was 7.6x and 11.3x at March 31, 2014, respectively, compared with 7.4x and 11.7x in the year ago period.

Fitch currently rates Xerox and its wholly owned subsidiary, ACS as follows:

Xerox

--Long-term Issuer Default Rating (IDR) 'BBB';

--Short-term IDR 'F2';

--Revolving credit facility (RCF) 'BBB';

--Senior unsecured debt 'BBB';

--Commercial paper (CP) 'F2'.

Affiliated Computer Services

--IDR 'BBB';

--Senior notes 'BBB'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 5, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

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Contacts

Fitch Ratings
Primary Analyst
John M. Witt, CFA
Senior Director
+1 212-908-0673
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jason Pompeii
Senior Director
+1 312-368-3210
or
Committee Chairperson
David Peterson
Senior Director
+1 312-368-3177
or
Media Relations
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
John M. Witt, CFA
Senior Director
+1 212-908-0673
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jason Pompeii
Senior Director
+1 312-368-3210
or
Committee Chairperson
David Peterson
Senior Director
+1 312-368-3177
or
Media Relations
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com