CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB' rating to Xerox Corp.'s (Xerox) $400 million five-year senior notes offering. Fitch currently rates the long-term and short-term Issuer Default Ratings (IDRs) at 'BBB/F2' for Xerox. The Rating Outlook is Stable. A full list of current ratings follows at the end of this release.
Xerox issued $400 million of five-year senior unsecured notes and will use net proceeds from the senior notes issuance for general corporate purposes.
KEY RATING DRIVERS
Xerox's ratings and Stable Outlook reflect:
--Fitch's expectations the Services business will improve in 2016 and begin offsetting 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 (more than 85%).
--Solid liquidity supported by $1.6 billion of cash at June 30, 2015, an undrawn $2 billion revolving credit facility (RCF) due 2019, staggered debt maturities and consistent annual free cash flow (FCF). Annual FCF should (post-dividends) range from $1 billion to $1.5 billion.
--Fitch expectations for an increasingly diversified sales mix from faster growing Services businesses and declining exposure to the slower-growing print industry. Services accounts for 57% of Xerox's total revenue in the latest 12 months (LTM) ended June 30, 2015 and should continue edging toward 60% in the near term.
--Xerox's conservative financial policies. Fitch believes management remains committed to managing core debt levels to maintain strong core credit metrics for the rating as the company works to resume healthy organic revenue growth. Xerox has a track record of reducing debt to offset declining financing assets, resulting in flat core leverage.
Fitch expects core leverage (total non-financing related debt to core EBITDA, which excludes debt and profit related to financing activities) to remain below 1.5 times (x) over the intermediate term and was 1.6x for the latest 12 months (LTM) ended June 30, 2015, pro forma for the financing business related $400 million senior notes offering.
Fitch's credit concerns center on:
--Ongoing revenue pressures in DT, which Fitch forecasts will decline by mid-single digits through the intermediate term. Revenues for the first half of 2015 (1Q15) are down 7% on a constant currency basis, mainly due to double digit declines across all entry level product categories. Despite expectations for lower sales, profit margins for DT should continue expanding from higher mix of higher end equipment and the benefits from restructuring. Operating profit margin should remain in the 11%-13% range through the intermediate term, versus 10.8% in 2013 and 13.7% in 2014.
--The aggregate $2.6 billion underfunding of worldwide defined benefit (DB) pension plans as of year-end 2014, up from $1.9 billion in the prior year. The lower funded status primarily reflects higher benefit obligations due to a 90- and 110-basis point decrease in the U.S. and non-U.S. discount rate, respectively. Total contributions are expected to be $340 million in 2015 up from $284 million in 2014.
--Continued operating margin pressure in Services, although stronger following the ITO business sale. Higher than expected costs associated with government healthcare contracts, which caused Xerox to take an impairment in the second quarter and narrow focus on incremental contract opportunities, and increased investments should constrain meaningful operating profit margin expansion. Fitch expects operating margin to exceed 9% range in the near term, up from 7.5% for the first half of 2015.
--Low single digit constant currency revenue declines for 2015, driven by ongoing weakness in DT partially offset by stabilization and positive momentum in the second half in Services;
--Services growth beyond 2015 will offset expectations for further declines in DT, on a constant currency basis;
--Operating EBIT margin of more than 10%, driven by strengthening profitability in DT from restructuring, offset by cost overruns and increased investments that will constrain meaningful profit margin expansion in services;
--Cash pension contributions will range from $250 million to $500 million through the intermediate term;
--Core debt will remain roughly flat, resulting in core leverage returning below 1.5x in the near term; and
--Shareholder returns and acquisitions will approximate FCF, although Fitch believes shareholder returns will meaningfully exceed acquisitions over the intermediate term.
--Fitch's expectations for Services operating profit margin sustained below 9%;
--Sustained declines in DT more than offsetting growth in Services, resulting in a material decline in financial performance and credit metrics.
Positive rating actions are unlikely in the absence of:
--A significant reduction in the funding shortfall for Xerox's worldwide defined benefit pension plan;
--DT revenues levels stabilize with expectations for sustained operating profit margin near current levels;
--Revenue growth and margin expansion in Services results in expectations for FCF margin approaching 10%.
Xerox's liquidity is solid, supported by $1.6 billion of cash and an undrawn $2 billion RCF that matures in March 2019. Fitch's expectation for annual FCF of $1 billion to $1.5 billion also supports liquidity.
Pro forma for the senior notes issuance, total debt, including 50% equity credit applied to the $349 million of convertible preferred stock, was $8.2 billion as of June 30, 2015. As of June 30, 2015, $4 billion, or 52%, 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 $4.5 billion compared with $4.8 billion as of Dec. 31, 2014.
Xerox's nearest debt maturities include $700 million of senior notes due March 15, 2016 and $250 million of senior notes due April 1, 2016.
FULL LIST OF RATING ACTIONS
Fitch currently rates Xerox and ACS as follows:
--Long-term Issuer Default Rating (IDR) at 'BBB';
--Short-term IDR at 'F2';
--Revolving credit facility (RCF) at 'BBB';
--Senior unsecured debt at 'BBB';
--Commercial paper (CP) at 'F2'.
Affiliated Computer Services (ACS)
--IDR at 'BBB';
--Senior notes at 'BBB'.
The Rating Outlook is Stable.
Date of Relevant Committee: Dec. 1, 2014.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)