Xerox Corp (NYSE: XRX) is likely to surprise investors this year, in a good way. In February, the iconic US maker of printers/copiers increased its dividend 35 percent (to 23 cents per share annually), indicating that its shift to higher-margin businesses is already panning out.

Granted, Xerox still has a lot to prove. Recently priced at $8.75 per share, Xerox stock has lost half its value since 2007, due to cutbacks in business spending, ever-increasing competition, and the company’s own failures to adjust. However, Xerox is undergoing a transformation.

Expansion into services. Xerox plans to be mostly a services provider by 2017, with about two-thirds of revenue coming from services. At present, about 52 percent of revenue is derived from this segment.

While Xerox’s total revenue and earnings have been declining in recent years, its transition into a servicesoriented company is already having a dramatically positive effect on cash flow. In 2012, operating cash flow hit $2.6 billion, up from $2 billion in the prior year. And free cash flow jumped to $2.1 billion, from $1.5 billion in 2011.

The renewal rate on Xerox’s service contracts is also rising, from 80 percent in 2011 to 85 percent last year. On top of that, profit margins have posted modest improvement as the company has transitioned away from its more capital-intensive equipment business.

Most of Xerox’s current service revenue comes from servicing installed Xerox equipment. But the company has been aggressively expanding into IT and business-process outsourcing in market segments where it can compete effectively, such as healthcare, energy and transportation, logistics, and state and local government services.

For example, 17 percent of Xerox’s service business is now healthcare, and this is likely to expand due to growth in Medicaid under the Affordable Care Act. Xerox is bidding on a variety of state-run Medicaid contracts across the US, to provide information-management systems for things such as eligibility screening and payment processing, areas where its technology and variety of price points allow it to be competitive.

While Xerox does generate about 25 percent of its services revenue from various levels of government (4 percent from federal), most of this is tied to non-discretionary spending, such as Medicaid, or state toll-road systems.

Upgraded equipment offerings. Xerox’s equipment sales have been shrinking (down 13 percent in fourth-quarter 2012). But this is likely to stabilize as Xerox starts to focus on growth areas.

In regular printers, Xerox is enhancing its offerings with “ConnectKey” technology that allows for secure, mobile printing from anywhere. And it’s shifting focus from commodity black-and-white printers to highermargin color printing, which is growing in use as the price per page continues to drop.

Xerox is also going after large-scale printing. Its recently launched “iGen4” digital-production press can generate high-quality prints at faster speeds than traditional off-set presses. While iGen4 is fairly expensive (several thousand dollars), Xerox is working to reduce the cost to tap more of the smaller print-shop market.

Despite its past challenges, Xerox’s finances are sound. Equity recently amounted to $11 billion vs. $8.5 billion in total debt. There is $1.2 billion in cash on the balance sheet, which can easily cover the $275 million in debt coming due the next two years.