Welcome to the Xerox Holdings Corporation Third Quarter 2023 Earnings Release Conference Call. After the presentation, there will be a question-and-answer session. [Operator Instructions] At this time, I would like to turn the meeting over to Mr. David Beckel, Vice President of Investor Relations. Please go ahead, sir..

Good morning, everyone. I am David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation third quarter 2023 earnings release conference call hosted by Steve Bandrowczak, Chief Executive Officer. He is joined by Xavier Heiss, Executive Vice President and Chief Financial Officer.

At the request of Xerox Holdings Corporation, today’s conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the expressed permission of Xerox.

During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor and will make comments that contain forward-looking statements, which, by their nature, address matters that are in the future and uncertain. Actual future financial results may be materially different than those expressed herein.

At this time, I’d like to turn the meeting over to Mr. Bandrowczak..

operating efficiencies across IT, business support functions and the supply chain. While the Reinvention is expected to result in a more profitable and streamlined organization, it is not simply a cost-cutting program.

Equally important, if not more so, is Xerox’s ability to transition over time to become a services-led, software-enabled provider of advanced workplace solutions. A transition of this magnitude requires select investment in organic and inorganic growth opportunities.

These investments are expected to be self-funded and will target opportunities to grow our share of wallet in print and print services as well as high-growth adjacent markets where we have a clear path to win, such as managed IT services for small and midsized clients and digital services.

In total, Reinvention is expected to generate substantial improvement in operating income and income margin over the next few years. By 2026, we expect to deliver an improvement to 2023 adjusted operating income of at least $300 million, resulting in return to double-digit adjusted operating income margins.

Importantly, this improvement is inclusive of investments in growth, which are expected to drive a more diversified revenue mix with greater exposure to markets with high rates of growth. We will provide more specifics and the phasing of operating income improvements as specific actions are taken in future quarters.

To recap, we are confident in our ability to successfully execute this Reinvention. Project Own It has instilled in this company a culture of continuous operating improvement.

Our management team is more than capable of delivering a transformation of this magnitude, and our brand, client relationships and history of innovation give us the right to play and win in digital and managed IT services. Reinvention will not only improve Xerox profitability but reposition the company for long-term sustainable growth.

And with strong free cash flow supporting our dividend, investors will be rewarded as the strategy progresses. I will now hand over to Xavier..

Thank you, Steve and good morning everyone. As Steve mentioned, we delivered another quarter of growth in adjusted operating income and income margin despite a decline in revenue, evidencing our ability to manage profitability amid fluctuation in revenue.

The year-over-year decline in revenue this quarter was driven mainly by a decline in transactional non-contractual post-sales revenue components. Equipment revenue declined modestly relative to the prior year due, in large part, to a reduction in equipment backlog in the prior year quarter. Turning to profitability.

We delivered our first consecutive quarter of year-over-year improvement in growth on operating profit margin. Gross margin improved 60 basis points over the prior year quarter, mainly due to the benefit associated with pricing increases on cost efficiency actions, partially offset by a 50 basis point headwind from the termination of Fuji royalties.

Increases in product costs were more than offset by improvement in supply chain related expense and pricing actions.

Adjusted operating margin of 4.1% increased 40 basis points year-over-year as the effect of lower revenue and gross profit, along with higher compensation and bad debt expenses, were offset by close to 400 basis points of improvement from ongoing operating efficiencies and pricing actions.

Adjusted other expenses net were $29 million lower year-over-year due to higher gains from the sales of non-core business assets and lower non-financing interest expense.

Adjusted tax rate was 7.3% compared to 42.1% in the same quarter last year, largely due to the tax benefit associated with the release of uncertain tax positions and the remeasurement of deferred tax assets in the current year period as well as a non-recurring unfavorable effect of changes in certain tax elections in the prior year period.

Adjusted EPS of $0.46 in the third quarter was $0.27 higher than the prior year, driven by an increase in the sale of non-core business assets on a lower tax rate. GAAP EPS of $0.28 was $2.76 higher than the prior year, mainly due to an after-tax non-cash COVID impairment charge of $395 million or $2.54 per share in the prior year.

There were no EPS impact this quarter associated with the recent repurchase of shares from Carl Icahn and affiliates. Let me now review revenue and cash flow in more details. Turning to revenue. Equipment sales of $386 million in Q3 declined 1% year-over-year in actual currency or 2% in constant currency.

The decline in equipment revenue reflects stable demand conditions, offset by the effect of EMEA backlog reductions in the prior year. Consistent with recent quarters, revenue trend outpaced equipment in solution activity due to favorable product and geographic mix as well as higher prices.

This was particularly true with our A3 product, which experienced unfavorable geographic mix effect in the prior year due to backlog reduction in EMEA. Entry A4 installations were lower again this quarter due to the ongoing normalization of work-from-home trends.

Post sales revenue of $1.3 billion declined 9% in constant currency year-over-year and 7% in actual currency. As noted, post sale decline were mainly driven by a reduction in cyclical transactional items, most notably a significant decline in low-margin paper sales on lower IT and device placements.

Wholesale revenue was further impacted by the termination of Fuji royalties and the effect of specific strategic actions, which resulted in lower financing on PARC revenue.

Revenues from contractual print and digital services declined slightly as digital and managed IT services revenue growth was offset by a decline in print services for production clients, which have generally been more affected by macroeconomic pressure than office clients. Geographically, both regions declined in actual and constant currency.

The decline in EMEA was more pronounced given the substantial reduction in EMEA backlog in the prior year quarter on a weakening macroeconomic outlook. In the Americas, an increase in equipment revenue was more than offset by a decline in post sales revenue due in part to lower sales of the aforementioned cyclical transactional items.

Let’s now review cash flow. Free cash flow was $112 million in Q3, higher by $130 million year-over-year. Operating cash flow was $124 million in Q3 compared to a use of $8 million in Q3 2022. Improvements were mainly driven by a net source of cash associated with financing assets and an improvement in working capital.

Finance asset activity was a use of cash this quarter of $51 million compared to a use of cash of $54 million in the prior year, reflecting the benefit of our forward work program with HPS, partially offset by higher origination Working capital was a source of cash of $27 million, resulting in a $41 million year-over-year increase in cash driven mainly by a reduction in inventory.

Investing activity were a source of cash of $25 million compared to a use of cash of $33 million in the prior year due to higher proceeds from sale of non-core business assets in the current quarter and the prior year acquisition of Go Inspire.

Financing activity consumed $94 million of cash this quarter, which includes a payment of around $60 million of secured debt on dividend totaling $43 million. In addition, we secured a $555 million bridge loan facility, the proceeds of which were used to repurchase share from Carl Icahn and affiliates.

This facility is expected to be replaced in the near-term with an alternative debt instrument. Turning to segments. FITTLE origination volume grew 9% year-over-year.

Captive product origination were up 24% while non-captive channel origination, which includes third-party dealers on non-Xerox vendor, fell 8%, a reflection of the recent change in FITTLE strategy to return its focus towards captive-only financing solutions.

As expected, FITTLE finance receivables were down roughly 4% sequentially in actual currency, reflecting the runoff of existing finance receivable on HPS funding of more than 50% of FITTLE Q3 originations. As a result of the change in FITTLE strategy, we expect its finance receivable balance to decline and normalize closer to $1 billion by 2027.

FITTLE revenue was flat year-over-year in Q3 as higher commission from the sales of finance receivable asset were offset by lower finance income and other fees associated with the decline in FITTLE finance receivable asset base.

Segment profit for FITTLE was $4 million, up $2 million year-over-year primarily due to lower bad debt expense and lower intercompany commissions. As previously indicated, we expect further improvement to bad debt expense going forward as our finance receivable book decline.

Print and Other revenue fell 6% year-over-year in Q3, primarily to lower post sales revenue. Print and Other segment profit improved by around 2% versus the prior year quarter resulting in a 30 basis point expansion in segment profit margin year-over-year, driven by the benefit of price and cost actions, partially offset by lower revenue.

Turning to capital structure. We ended Q3 with approximately $620 million of cash, cash equivalents and restricted cash. Roughly $2.5 billion of the remaining $3.6 billion of our outstanding debt support our finance asset, with the remaining debt of around $1.1 billion attributable to the non-leasing business.

Total debt consists of senior unsecured bonds, finance asset securitization, the bridge loan associated with the Q3 share repurchase and borrowing under our asset-backed credit facility. We maintain a balanced bond maturity ladder over the next few years. Finally, I will address guidance.

Our outlook for full year revenue remained unchanged at flat to down low single digits at constant currency. We continue to see momentum in demand for our product and services particularly in the Americas and for our faster-growing digital services.

However, in the past 3 months, we have seen a mild softening of demand for print services and equipment in our European market, reflecting a weakening macroeconomic condition. As a result, we now expect full year revenue to come in at the lower end of our guided range.

As a reminder, we face a difficult equipment revenue compare in Q4 due to a significant reduction in backlog in the prior year. Further, we expect some of the headwinds affecting post-sale revenue in Q3 to persist in Q4.

Despite a slight reduction to our revenue outlook, we maintain our guidance for full year adjusted operating margin of 5.5% to 6% due to the successful implementation of ongoing cost efficiency program and the other events of low or unprofitable revenue opportunities.

Q4 operating margin is expected to improve sequentially but will be lower year-over-year as margins in the prior year benefited from an unusual high mix of highly profitable A3 equipment install. As noted by Steve, we expect significant improvement in operating income margin in future years as we progress along our Reinvention.

Finally, we maintained our free cash flow guidance of at least $600 million. In summary, we remain on track to deliver our full year guidance as we balance a dynamic macroeconomic backdrop with a rigorous approach to managing operating costs.

So one work is being laid for a multiyear improvement in profit and revenue mix, including a return to double-digit operating profit margin, the details of which we will share in the coming year. We will now open the line for Q&A..

[Operator Instructions] And our first question comes from the line of Ananda Baruah from Loop Capital. Your question please. .

Hey, good morning, guys. And thanks for taking the question. So I guess there is a bunch of near-term and bigger picture stuff to sort of get into. I guess I’ll start with bigger picture, just with regards to Reinvention.

Can you talk to any degree to which you’re getting a bit of, I guess, I’ll call it like a running start into the revenue component and the Reinvention? Steve, I think you kind of referred to it as software and services enabled or software and services led.

Sort of what’s going on there already that we may not be super aware of that might sort of lend itself to Reinvention? And then I know you talked about making comments in the future about what rev potential looks like.

But can you give us any sense of maybe with like the rev growth rate of the areas of the services market and software market, the TAM, I guess, looks like today. So at least we get a sense of what you guys are shooting against from a TAM perspective. I guess I’ll start with that..

Yes. Great question. So let me make a couple of comments. So first of all, from a Reinvention standpoint, really looking at a comprehensive and structural simplification of our business, right, which strategically reposition us going forward.

What does that mean? We’re looking at focus areas around geographic optimization where we can think about how we sell direct versus indirect, use a partner-led distribution models in subscale areas, focusing on simplification of both our product offering and pricing which will generate more revenue and generate more demand in those areas as we accelerate that.

And then operating efficiencies, really looking at our business end-to-end from order to cash to hire-to-retire all across our entire business and really thinking about both simplification as well as enabling technology in each one of those processes. You’ve heard me talk about where we’ve embedded AI and augmented reality.

And we’re seeing significant, not only in terms of productivity but differentiation in our service model and our service offerings as we go forward. So I said that as the foundation, right, and from a high level, right, delivering double-digit operating income margins, getting back to that.

We thought it was really important that we have to go drive and we get back to double-digit operating income margins. And obviously, we talk about $300 million of operating income by 2026.

What have we already started? And what do you see in terms of the run rate and some of the acceleration going into 2024? We’ve obviously been working on – and I’ve talked about this for a while now, how do we expand our wallet share inside of our existing clients with new products and services, IT services, digital services? And we talked about client success, really focusing on how do we drive the outcomes for our clients in many areas that we see in terms of verticals that need productivity help significantly, specifically in areas like we see in healthcare, we see in education, we see inside of law firms and driving very specific solutions.

We are seeing direct results of that strategy in our renewals. And we talked about it, we’re seeing our renewal rate – revenue renewal rate over 100% now.

What does that mean? That means that as we are seeing some of the secular decline in some of our clients in terms of renewals, we’re now topping it up with new products and services that are very specifically led and driven by client success either in IT services and end points, I am talking about services like RPA and security as well as digital services which help them with productivity.

So that’s given us both a run rate improvement in terms of our revenue and growing inside those existing accounts. and it’s also given us a running start in productivity in areas like supply chain, areas like service delivery, areas like our ordering process and order to cash process.

Xavier, any other comments?.

Yes. Just on – Ananda, just to comment on the revenue side or the revenue shift we are expecting here. So, we know the trend on print. The print business is still a strong business for us, generate a lot of margin on profit and cash here. At the same time, you know that we have started the foundation on developing IT services and digital services there.

The market growth of the company is large. It is large tons in this market. IT service is above $600 billion, digital services in the range of $70 billion. And when we look at the data from this market, we are between 5% to 10% growth.

So, at the end of the day, what we are planning to do with Reinvention is to drive the revenue shift from a print-only or print-centric company into a company where print will still be present, but also targeting higher ongoing market that will give the revenue – improve the revenue trajectory of the company, not relying only on print..

That’s all really helpful context. I appreciate all of that. That’s super helpful. And then I guess, as a quick follow-up, the sort of the revenue environment from the September quarter that you guys talked about, sounds like Europe may have been a little softer than you thought it was going into the quarter.

You are not the first ones that we have heard that from. So, that seems to be kind of foundational. Anything other than Europe that was softer than anticipated that you saw during the quarter? And I guess, sort of any meaningful leverage impact you got from the softer revenue? You guys grew margins 40 basis points year-over-year.

But I guess would it have been stronger, the year-over-year growth, margin growth expansion, if not for the softer revenue? Thanks. So, that’s it..

No, no, Ananda, your comments are fair here. So, Europe has been a little bit worse than what we were thinking here. However, at the same time, and you know that since we have implemented Own It, Own It DNA is still within the company.

We have created what we call a flexible cost base and within as well being able to adjust some of the costs but also being selective in the type of revenue we are targeting there. I will give you an example, we saw certain erosion on margin on, I call that, non-cyclical, not contractual type of business. Simple example is paper.

Another one is endpoint solution in IT services. We are not interested in going after like revenue only with no profitability. As you know it, this team is driven by a very balanced execution mindset model there. And we have discipline on driving our investment, on our revenue call based on strict return IRR or ROIC [ph] project.

So, paper, I can quote it here because the paper market is very different to what it was before, and we are not willing, as an example, to go after a paper deal with no margin here..

That’s great. Great context. Thanks a lot guys. Appreciate it..

Thank you, Ananda..

Thank you. [Operator Instructions] And our next question comes from the line of Erik Woodring from Morgan Stanley. Your question please..

Hi guys. This is Maya on for Erik. Thanks for having me in. Maybe a first question for Steve. Can you talk a little bit about the change in strategy with FITTLE? Earlier this year, we were talking about expanding the portfolio to more third-parties, but now it’s reverting back to kind of a captive financing solution.

So, my first question is how that impacts your receivables factoring program? And second, there was once a thought that you could sell the FITTLE business. But given it’s now becoming a captive financing business, that seems less likely, is that correct, that FITTLE would likely no longer be for sale? Thank you and I have a follow-up..

Yes. So, let me – and I stated it I think in previous calls. With the changing interest rate environment, it was no longer palatable for us to leverage our balance sheet in the leasing business.

And we changed the strategy mid to late last year, and we were no longer going to use Xerox balance sheet for this business and we were going to look for other sources of capital to help us with that business.

However, it was extremely important that it is a big component of driving our value in the field that we have the ability to be able to do leasing and bundle pricing in the field with leasing. And so we turn to HPS and PEAC, and we are being – and using them strategically so that we don’t leverage our balance sheet.

You are absolutely right, 2 years ago, we were trying to target growing that business, and potentially, it would have been an operation that potentially would have been up for sale. We have reversed that. It is now going back to an internal captive business and we are not expanding beyond just supporting our business.

Xavier?.

Yes. No. You said it, Steve, there on the – Maya, the other focus that we have there is to make it an offer that support our business rather than looking at it as a pure separated business here. As Steve mentioned it as well, our balance sheet, the current interest rate environment make us – more than 2 years ago, making this decision here.

And at the end of the day, if I look at the current free cash flow being generated and maybe you spotted when we – I commented what will be the benefit of this transaction. Until 2027, we are expecting the finance receivables balance to decrease up to $1 billion. And if you look at the current situation, 2.6 going down there.

This will be, over time, free cash flow being generated supporting and driving the case for also the Reinvention that we are building at this time. So, at the end of the day, the good decision was made 2 years ago.

This decision is helping us currently from a balance sheet point of view, and we have kept this ability to be captive and develop our business without hurting it..

Got it. Thank you. So, maybe just if we take a step back, printing is a secularly declining market. And while I realize that you are leaning into IT and digital service to try and offset some of those pressures, this business is still overwhelmingly print-focused.

But there is a huge TAM in Asia that’s untapped for Xerox with no licensing reductions in place now.

So, why not go after the Asia market? And what are kind of the barriers to entry there?.

And I think there is a couple of different things. First of all, I have stated a couple of times, I think we can grow in our existing accounts with our existing TAM today both in the EMEA region and here in the Americas region. And so we have got a tremendous amount of opportunity to grow and just execute on what we already have today.

If you take a look at our share, there is a significant share growth opportunity even inside of print. And I believe our services differentiation and our product differentiation, if we execute, we can actually grow TAM.

To go expand into Asia, into other markets, you have to go build the supply chain, you have got to go build the go-to-market, and you have got to go build a logistics infrastructure in and around spare parts. It’s a significant capital outlay to go expand in those margins.

Even if you go with partner-led strategy, you still have significant cash and capital outlay. We believe that the focus that we have on the capital that we already have, we could expand and grow operating margin, as we have shared with you, significantly faster if we do it in the Americas and EMEA and not expand into that region..

Got it. Thank you..

Thank you. [Operator Instructions] And our next question comes from the line of Samik Chatterjee from JPMorgan. You question please..

Hi. Good morning and thanks for taking my questions. I guess if I can start on Project Reinvention.

Can you just help us understand, when you are thinking about the $300 million of improvement there, how should we think about impact on profitability of a sale or essentially benefit to cost of goods sold or gross profit relative to how much of this is an improvement on OpEx? And any thoughts around how long these changes on the go-to-market take for you and how sort of the timing of this $300 million should we be expecting in terms of the linearity of the improvement through the next couple or 3 years? Thank you and I have a follow-up..

Yes. Thanks Samik and thanks for asking a question on Reinvention because this is really a strategic movement for the company, and we are pleased to unveil more on this strategy here. So, from a profit point of view, as we mentioned it, we are expecting roughly to double the operating margin that we have on profitability until 2026.

So, it will be like 3 years journey that will continue beyond 2026. But we wanted to plant a seed and give you numbers so you can, I would say, model and look at the trajectory of the profitability here. We are expecting the vast majority of the benefit to be in OpEx.

Some of it will be in cost of goods sold, but it will be mainly in OpEx because this is where we will rewire entirely the company and look at not only like the key function or some of the function like go-to-market. You have heard about geo simplification.

At the end of the day, what does geo simplification is, again, back to this concept of balanced execution on very disciplined way of looking at 0.5 year [ph] is where should we be present. It does not mean leaving geographies there, but what is the best go-to-market model we should have in all the countries that we are representing here.

So, OpEx will be a key driver there. And obviously, we are expecting, combined with the benefit of FITTLE, free cash flow to go up significantly. As we mentioned it as well, we are expecting this initiative to be self-funded. So, we are not expecting to leverage furthermore the company here.

As you know it, we have just completed the transaction with Carl Icahn. We are always opportunistic when we are looking at accretive and value-accretive acquisition. But at the same time, we have a journey on the trajectory, which is modeled now that will create this profit improvement on the $300 million operating profit that we mentioned here..

Got it. And for my follow-up, you did mention the weakness you are seeing in the transaction business, and I think particularly in EMEA is what you are calling out. I just wanted to understand the nature of what you are hearing from your customers.

Is it really budget consideration and pushing some of those sales out to next year, or are they rethinking sort of their installed base or something else on a more structural basis on the devices or printer front, any insights there, please. Thank you..

Yes, let me start. And so if you think about the headwinds that we are seeing, macro headwinds around inflation, around interest rates, around labor, and so what we hear from our clients and aligns really well with our strategy, and that is we have got to drive their success through our solutions and products and services.

And that’s why I talk about we could expand in existing clients today, and that’s why we are seeing our renewal rate higher. So, things like Robotics-as-a-Service, things like digital workflow in terms of driving productivity inside a very specific verticals.

So, where we are aligning what we are hearing from our clients, number one, is they are looking for help to be able to offset some of these macro trends and drive more productivity, helping them with the challenges around labor, helping them with the challenges around higher cost of capital, things like as a service and subscription model.

All of those are actually playing very well into new products and services that we can bring into our clients to help them offset some of the challenges.

Xavier?.

Yes, back also to your point, Samik, here. From a macro point of view, so Europe, we are not the only one quoting it there, but a little bit of softening. This is not a full decline or a more – really more than what we are expecting, but we are seeing a softening there. What we have seen as well, I mentioned the paper business.

The paper business, just also to clarify, this is not a significant business for Xerox. This is like a very low-single digit number in revenue. But compared to last year, where this paper business with certainly some scarcity of paper, we have been able to benefit from later.

This year is not as good, And we see more flow of Asian paper currently on the market, putting pressure on prices there. The other element we are monitoring currently is on the high-end production business.

This business obviously is highly connected to, I would say, GDP evolution and the trend on the market share, but also on the access to capital for our high-end production customer.

And what we have seen recently is a little bit – due to interest rate increasing, a little bit more scarcity on the ability or the capacities that this customer have to invest in this equipment. Not highly concerned at this stage, but this is something that we are monitoring, and we will provide updates during the quarter.

All of this, everything that I am describing here is included in our revenue guidance. And we also expect that we will be able to deliver the profitability and free cash flow guidance that we have maintained compared to prior quarter..

Got it. Thank you..

Thank you, Samik..

Thank you. This does conclude the question-and-answer session of today’s program. I would like to hand the program back to Steve for any further remarks..

Thank you for listening to our earnings conference call this morning. Balanced execution of our strategic priorities has resulted in a simplified, more profitable Xerox. And Reinvention is the next step along our journey towards sustainable improvement in profits and revenue.

We look forward to sharing our progress along that journey in future quarters. Have a wonderful day..

Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day..