Xerox Holdings Corporation (XRX) on Q1 2021 Results - Earnings Call Transcript
Operator: Good morning, and welcome to the Xerox Holdings Corporation First Quarter 2021 Earnings Release Conference Call hosted by John Visentin, Vice Chairman and Chief Executive Officer. He is joined by Xavier Heiss, Chief Financial Officer. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor. 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. After the presentation, there will be a question-and-answer session.
John Visentin: Good morning and thank you for joining our Q1 2021 earnings call. I hope everyone is safe and healthy. Our first quarter results were in line with our expectations. Revenue totaled $1.71 billion down 8.1% year-over-year or 10.4% in constant currency. Free cash flow was $100 million, down $50 million from last year. Adjusted earnings per share totaled $0.22, up $0.01 year-over-year and adjusted operating margin was 5.2%, up 50 basis points year-over-year. In the first quarter and in an environment where many offices remain closed, we grew equipment sales and IT services revenue year-over-year. I am proud of how our employees have continued to deliver for us customers during the pandemic. With small and medium sized businesses and enterprise clients planning to return more employees to the office, our differentiated offerings are well positioned to serve their growing needs. The strength of our performance, portfolio, and strategy gives us confidence we will return Xerox to growth in 2021. The team remains laser focused on our four strategic initiatives; optimize operations, drive revenue, reenergize the innovation engine, and focus on cash flow and increasing capital returns. We made progress across each of these initiatives during the quarter. Continuing to optimize operations for simplicity, improve our cost structure, and expand margins must be balanced against investing in growth. Project Own It helps us strike the right balance as does our focus on cash. Project Own It is on track to deliver $375 million of gross cost savings this year. Part of these savings are funding investments in growth areas, and transformational initiatives, such as our effort to re-imagine the service experience from supply chain logistics to customer care. Our investments in artificial intelligence, augmented reality, predictive analytics, robotics, and workflow automation are reducing our costs and making it easier to work with Xerox. We have now integrated these technologies to create software solutions that can transform how service teams support customers. We deployed these software solutions within our technical service organization. Our differentiated capabilities paired with our experience have allowed us to commercialize both the software solutions and a technical services offering, creating new revenue streams for Xerox. In fact, we recently signed our first competitive OEM customer for technical service.
Xavier Heiss: Thank you, John, and good morning, everyone. As John mentioned, we are pleased with quarter 1 performance. For revenue we delivered a strong improvement compared to the trend over the last three quarters. Most equipment on post sales revenue improved in March, consistent with the progress of vaccinations on the gradual reopening of workplaces. Equipment revenue growth was stronger than higher margin post sales revenue driving the 260 basis point gross margin erosion year-over-year. I will provide more details on revenue in the next slide. Adjusted operating margin of 5.2% in the first quarter, increased 50 basis points year-over-year. The 50 basis point improvement in margins reflect the favorable impact from lower bad debt expense, savings from Project Own It on discretionary spend action, partially offset by the impact of lower post sales gross profit. SAG expense of $448 million decreased $93 million year-over-year, reflecting a continuous focus on cost. The improvement includes the impact of an incremental $60 million bad debt reserve taken in the first quarter of 2020, lower selling expense, cost savings associated with Project Own It on temporary cost reduction measure. RD&E investment we have maintained to protect innovation in future revenue streams. Investment focus on existing and new product and solution in the Print business as well as adjacencies on innovation tower. Quarter 1 RD&E as a percent of revenue was 4.3% lesser, 20 basis point lower year-over-year, reflecting continuous optimization of the print portfolio. Other expenses, net of $4 million were $19 million lower year-over-year, primarily driven by a reduction in non-service retirement related costs, partially offset by higher net interest expense. First quarter, adjusted tax rate was 27.7%, compared to 29.4% last year. The 170 basis point year-over-year decrease results primarily from the change in the geographical mix of earnings. Adjusted EPS of $0.22 compared to $0.21 in the same quarter last year, reflecting a slightly lower adjusted net income impacted by $10 million higher net non-financing interest expense, which was more than offset by our reduced share count. GAAP EPS of $0.18 was $0.21 higher year-over-year due to lower year-over-year restructuring and related costs, non-service retirement related costs on transaction on related costs.
John Visentin: Thank you, Xavier. Now, let’s open the line for questions.
Operator: Thank you. Our first question comes from Ananda Baruah with Loop Capital. Your line is open.
Ananda Baruah: Hi, good morning guys and congrats on the solid progress. Hey, a few if I could. You guys mentioned that small medium business is opening up faster than large enterprise makes sense. I noticed small medium business expansion in general is an important part of the structural strategy and so I was wondering if there's anything that you're doing there to accelerate the small medium business expansion given if that’s the part of the economy that you see opening up more quickly? And then I have two follow-ups thanks quickly.
John Visentin: Yes, Ananda with small and medium business, we're seeing progress in different areas. Our IT services business, so we're helping them not only open up again, but we're helping them focus on their cost reductions and managing their businesses. So our IT services offerings, we've seen some good progression in SMB. We just announced six bot offerings, that inside of the first quarter, we already had clients that are taking it over. So, it's a full solution for SMB and that's how we've been approaching it.
Ananda Baruah: And John, do you have -- I guess, like sort of if you dial it back, kind of five, six quarters ago, do you believe the revenue opportunity there over time, because of the solution, some of the new solutions that have risen as a result of the last 12 months or so do you think that levels up the revenue opportunity there?
John Visentin: Yes, I think what gives us confidence is, if you look back, we announced the IT services. We continue to announce offerings in SMB. We've also expanded IT services in the UK, and what gives us confidence is seeing not only our growth in these services, but also our growth in the ESR and in the hardware that we saw in the first quarter.
Ananda Baruah: That's awesome. And just real quick on large enterprise, or just enterprise in general is it free from SMB, do you have any context you can share from your conversations with enterprise customers? Sort of the timing of after they open up when they may begin, like how long before they begin to print projects on?
John Visentin: What we've noticed is, as clients open and think of as clients open our clicks, as we call them, continue to increase. But I think, as we're looking at the correlation between the vaccination rates, the page volumes in our geographies, we're seeing our post sales growth as well. And more and more CEOs are talking up if they're going to reopen, but when and at what speed.
Ananda Baruah: Okay, that's helpful and then one quick one for Xavier. Xavier, any reason that long-term free cash flow should not return to the same percentage of net income as historically it's been?
Xavier Heiss: So, as John mentioned it, there as you know our business is based on two revenue streams, the equipment stream and the post sales stream. The post sales stream is gradually recovering and this is a stream that has the higher margin here. So, when overall time this mix will improve and we see that we have seen some positive signs on sales volume coming back, and also activities that we are doing for our customer, which are not directly related to print, but related to transactional volume. These volumes are increasing. We see increasing the opportunity for income growing and then free cash flow growing as well.
Ananda Baruah: Okay, that's helpful, guys. Thanks a lot. I appreciate it.
Xavier Heiss: Thank you, Ananda.
Operator: Thank you. Our next question comes from Matt Cabral with Credit Suisse. Your line is open.
Matthew Cabral: Yes, thank you. Good bounce back on the equipment side this quarter. I guess as we dig underneath there, I'm curious how much you characterize is some sort of backlog or pent up demand as employees are returning to the office versus more just the underlying demand picture that you're seeing and just going forward, how we should think about the cadence of equivalent revenue for the balance of the year?
Xavier Heiss: So Matt, what we see that the sales of our equipment probably grew in every segment. So have you seen it on the pay for entry segments, it was a significant growth, but also a suite on production growth during the quarter. So, we see confidence from customer bringing back in line with vaccination employees in the office and the acquiring or renewing, some equipment, so which will drive at the end is page volume on the annuity stream. That is, one of the main stream of our review here. So it's not only, like a backlog we have, we ended the quarter with a productive strong backlog. But it's not only like a backlog of work are very literally related to confidence that the business has currently in order to bring back employees in the office.
Matthew Cabral: Thanks for that, and then on XFS on the stand up I'm wondering if you could expand a little more on the opportunity you see that securitizes a cheaper way to get access to financing versus, historically you used the wider Xerox balance sheet as you've tried to get capital. And I guess as that securitization picks up going forward, I'm curious what that means in terms of incremental balance sheet capacity for more of the core business, and assuming that does free up some capacity, just what you'd like to do with it going forward?
Xavier Heiss: Yes, so the first one, securitization, as you mentioned, it gives us two benefits, the first benefit is it moderate or decrease the cost of funds that we have to support this business and this is part of the strategy that we initiated by signing up XFS. So as you know, XFS is a significant part of the enablement that we bring in this business and I'm sure you saw it as well, we are now expanding the XFS portfolio and offering not only to develop products, but to also sell to the OEM on other lender here. So, securitization apart from a firm point of view, securitization helps us also own -- our ability to expand this activity and to manage properly our free cash flow on this one. We will certainly be more, I will say industrial or more stricter in the way we approach the securitization, quarter-by-quarter and we have started last year having two main tranches of a securitization and we carry on this year on securitization as well.
Matthew Cabral: Thank you.
Operator: Thank you. Our next question comes from Katy Huberty with Morgan Stanley. Your line is open.
Katy Huberty: Thank you. Good morning. I'm a little surprised to see the Americas revenue so weak just given the success of the vaccine rollout here and also, given all the surveys are showing that U.S. tech spending is rebounding much faster than Europe. I know you made a few comments about SMB exposure in Europe, but can you talk a little bit more about why that is? Are European customers less likely to be on contracts or that's just a more transactional business? And then, just as a second part to that, what do you think the contribution to equipment sales was in the quarter from inventory rebuild at some of those channel partners?
Xavier Heiss: Okay, so Katy, I will take care of North America first. The America revenue is in line with our expectations. As you mentioned it vaccination progress here, we are a large enterprise, are starting, slowly to bring people on SMB, we saw growth specifically on our SMB businesses here, as a growth we saw improvement in the page volume coming back here. Europe, as you know, it has been hit last year for all the year as well. So when you look at the year-over-year, compare, you had more weeks of COVID impact in Europe compared to this year. You have seen as well that in both geography EMEA and in Europe, after the quarter 4 where we see, we saw some activity coming back on page volume. December, we have seen some lockdowns and then January, February, in certain geography in EMEA, Canada as an example, certain states in the U.S. and certain geographies were slower. The good sign or indicator that we are seeing currently is in March, in both geographies, both territories we saw page volume improving and transaction improving here, which give us confidence as well, and it to the fact that year sales revenue was strong give us confidence in the revenue trajectory. Commenting now on the equipment sales on the building inventory there is no direct correlation. What we saw is that there is a progressive rebound or step-by-step improvement in inventory level, but this level almost the levels that were seeing before.
Katy Huberty: Okay, and if you think longer term about a more hybrid workforce, would you expect page volumes and post sales revenue to return to pre-COVID levels or do you think we should contemplate post sales revenue that's maybe a little bit below where we were pre-COVID once the end markets stabilize?
Xavier Heiss: We have KPOs as John mention. It where when that the point, in a country which has a high vaccination rate, which is Israel and we are monitoring this country specifically here, and in Israel with more than 60% of the population being vaccinated we observe page volume coming back to pre, very close or slightly lower than the pre-COVID-19 level. What we observe as well is that even when you are in a environment we see I read being having different definition company-by-company, when we are model when employees return to the office, zero page volume is also page volume that will cover some of the pages they are not printing at home as well. So far, a little bit early to confirm all these cases here. But as I mentioned in March, we show page volume increasing, we clearly monitor on track the correlation between vaccination, office presence on page volume and this indicator correlates very strongly.
Katy Huberty: Great. And then just lastly, the $60 million of bad debt expense, is that largely coming from your small medium business customers, is that from channel partners, and was there any concentration by region?
Xavier Heiss: The $60 million KT was a provision we took last year across our entire XFS portfolio. And as I commented here, XFS has a very strict rule and strict ways of looking at the credit risk of partners. Our portfolio is diversified by geography, but also by customer type. And we have, we're like a AAA, AA on the high level type of ratings, rated company here. So the provision was put there in order to assess what could be impact we are running every quarter, what we call stress test on our portfolio and currently we are confident that this provision is at the correct level. Our lease contract, elaborate, heavy, not regular for U.S. payers , so it's too early at this stage to declare that as a provision is, I would say overvalued. Currently what we are just assessing is that this provision is sufficient to cover the risk we could have in the portfolio.
Katy Huberty: Okay, understood. Thank you so much.
Xavier Heiss: Thank you, Katy.
Operator: Thank you. Our next question comes from Shannon Cross with Cross Research. Your line is open.
Shannon Cross: Thank you very much. I have a few questions as well. John, just from a big picture standpoint, and some of your peers in Japan have started talking about this more. When you go out, say three or four years how do you envision Xerox? And what I'm trying to figure out is, what kind of revenue percentages would be coming from printing versus some of your more focus areas, software, PARC, XFS Services? And then how do you sort of, again, 50,000 foot level, see the margins shifting, because, obviously print is a very high margin business, but not growing. And some of the others, have more opportunities. So, I'm just trying to get an idea of maybe from the high level how you see the business shifting? And then I have a couple of follow ups.
John Visentin: Yes, Shannon, what excites us is our four pronged strategy. So one of them being monetizing innovation, and driving revenue and in there we've seen progress in our software business; we've seen progress in XFS, we've seen progress also in all our innovation. And we did just say we're going to be standing up these businesses before the end of the year. We're doing that for a few reasons. One is focus its flexibility, but also to provide transparency to our investors. But you can expect us to have an Analyst Day in the second half of the year where we will be going through this and explaining to our investors why Xerox is a good investment for now and for the future.
Shannon Cross: Okay, so we can't get it quite yet. I guess then, in terms of cash usage, you used $216 million during the quarter, you said you'll return at least 50% to shareholders and targeting $500 million at a minimum for cash. So, clearly, there's a little more room but you know, if I add in what you've done so far, plus keeping the dividends, you're going to be somewhere around 75% of cash usage already or free cash generation already. So how should we think about share repurchases? You go forward and, obviously, I'm assuming the dividend is solid? Thank you.
Xavier Heiss: Hi, Shannon, Xavier here. So, yes as we mentioned it, we will always look at the share repurchase in an opportunistic way here as you mentioned it. We repurchased $452 million of shares during the quarter. We mentioned in prior calls that we have an authority of $500 million. So there is still more than $300 million, which is currently left here. And we'll do that opportunistically for the year.
Shannon Cross: Okay, and then my final question is just, to some more extent going back decades, as you talked to customers these days, and now that we're a year plus through the pandemic, and people are kind of reevaluating how their offices are going to look and what they're going to do, what kind of changes are you hearing in terms of structure? Are people looking at more distributed printing? I would assume so given the growth in the low end, but and then and then how are they thinking about, what contract levels they're willing to sort of commit to, given there is still uncertainty in terms of who's going to be in the office, and how many people are going to go hybrid? Thank you.
John Visentin: Yes, Shannon, like, if we look at just surveys that were done with CEOs last summer, we had like 69%, on a senses with CEO, on a certain survey, that was CEO said, they're going to downsize their real estate footprint. This was just re-conducted recently and it's down to 17%. I think the focus is going to be at what rate and pace will the employees be going back to the office, and it's a direct correlation to vaccination and to safety. The other thing that we're starting to see a little trend on is that they go back to the office, even in a hybrid environment, the print volumes go up. For cost reasons, for security reasons, a lot less expensive to print at in an office than it is to print at home for security reasons. So we're seeing that trend and that's what gives us confidence with our guidance for this year to get back to revenue growth.
Shannon Cross: What's your plan for Xerox, when are you going back to the office?
John Visentin: April 19.
Shannon Cross: Thank you.
Xavier Heiss: Hi, Shannon, just to get back to your question on the customer, what customer are buying currently? They buy the multifunction as you know it is much more than a printer. The multifunction is a core of workflows that customers are looking at and there is something that we learned in COVID-19 is like, this concept of digital commission or enabling workflow, which is much more efficient for employees required device, which is able to support this process transformation, and multifunction are true then country by customer as a prime device in order to drive this.
Shannon Cross: Thank you.
Operator: Thank you. Our next question comes from Paul Coster with JP Morgan.Your line is open.
Paul Chung: Chung on for Coster. Thanks for taking our questions. So just on the OpEx side, we saw big decline on cost execution, lower discretionary spend in 2020 and 1Q run rate is pretty in line as well. Just want to get a sense for what do you think about OpEx in the back half as some of those costs come back? And then secondly, where are you targeting those investments and marketing spend when it does come back? Thank you.
Xavier Heiss: OpEx, you know, you need to look at it by looking at last year versus this year. We have had last year you know some tailwind. We declared the government subsidies what we benefit from. We also look at the whole cost opportunity we had why the concept at the highest point specifically in quarter 2, quarter 3.This year we resumed some of the benefits of the provision we had for compensation and also the tailwind rate, growth regards risks related to government subsidies are less as you know is here. Over here what we see is, from a cost point of view we have kept the month long the focus that we have with Project Own It. We declare that for this year we will run another $375 million of growth savings driven by this program and it is again across over the different areas of course different cost base here. We have a specific focus on the innovation and when I say innovation, automation on improving our current property making customer relationship and customer transactions easier and see through by bringing simplification here. So you should look at this as being like a maniacal focus that we have on cost. I mentioned it in formula of course, we have delivered positive EPS and positive free cash flow every quarter despite COVID-19 and this is key driver that we have currently.
Paul Chung: Thanks. This is very helpful.
Operator: Thank you. Our next question comes from Jim Suva with Citigroup. Your line is open.
Jim Suva: Thank you. I have a question probably for each of you and I'll ask them immediately at this time, so you can decide how to answer them in any order you want. But John or Xavier, can you talk about for the services that are being offered, there are so many services out there in the world, where's the success that Xerox is having on the type of services? Because I find it very intriguing and quite encouraging, it seems like it's on the small and mid size, but is it, help desk, is it robots or bot programming or what are some examples so we can kind of grasp and visualize it? And then my second question is this, has there been an impact from the semiconductor shortages globally, some sectors like automobiles or PCs have seen a very severe shortage of semiconductor chips? So I'm just kind of wondering if that has replicated or found its way into the sector's you deal with or maybe it hasn't? Thank you.
John Visentin: Yes, hi Jim. Look, our IT services is focused primarily on SMB and basically, our mission is to provide end-to-end professional IT solutions to them. We've introduced new offerings such as RPA as a service, but at the end of the day, we're not at war. Our design is to manage the IT stack of an SMB, the goal being virtual CIOs for them. And our customers are largely served by our XPS organization in the U.S. they're served by our channels in Europe. And these are direct sales organizations that have skills, and local touch points so that we can expand on our offerings, cross-sell, and into existing accounts and new customers. And we've seen a lot of good traction, even with our RPA products that we've been focused on and we've seen traction on the whole area of, the whole area of how do we help them be more efficient, as they're coming back to the office? And we've been very pleased with our results in all of that.
Xavier Heiss: Semiconductor?
John Visentin: Okay, semiconductor.
Xavier Heiss: Yes, Jim, also two other offerings where we see traction currently, everything around that digital confirmation, but behind content on capture, on customer engagement, services that we have as part of our Global Business Services offerings here is currently having a lot of focus on the customer interested in transforming digitalizing or making their process leaner and by combining both the print and the digital part of it. Another I would say highlight I would like to flag is CareAR. You need to be here, we made the acquisition of this company in December 2020. They're currently with augmented reality, supporting Field Service Management and customer service management, we see initial traction being confirmed or being developed by signing software with customers being interested in this technology on how we transform the way Field Service Management and customer service management is being delivered there. Your question regarding semiconductor shortage here, is -- we see it’s like, observing here, some shortages on certain components, also on certain raw material does not believe at this stage it is impacting us directly. We are monitoring it and we are looking at the potential backlogs that we could have related to it, but it's not addicted, high level or higher rate of contemporary.
Jim Suva: Great. And then a quick follow up on the bad debt reserve is it? It sounds like it was a release in that there was a positive that you reserved a year ago, a higher amount for potential uncertainty of customers, if they'd be able to pay given the pandemic uncertainties. And it turns out that you're collecting better than previously thought, am I correct on that? And is that kind of like an annual assessment or quarterly assessment where there could be some more positive releases?
Xavier Heiss: You'd be . So it's a difference, it’s a year-over-year compare. Last year, we booked around $60 million of provision for potential bad debt release across our leasing portfolio. As you know in this portfolio has an average maturity date of around four years, so this is regarding their current lead on the figure of event that could have happen this year. We did not release any provision. We kept this provision, because it's very early in the cycle for us to assess if or when we should really any of this provisions at this stage. Currently, our assessment is at the provision level that we have is sufficient to cover the potential rate.
Jim Suva: Thank you so much for the details and clarifications. It's greatly appreciated.
Xavier Heiss: Thank you, Jim.
Operator: Thank you and ladies and gentlemen, that does conclude our Q&A session for today. I would now like to turn the call over to John Visentin for closing remarks.
John Visentin: Thank you for your questions. Now, this past Sunday, we celebrated our 115 year anniversary. We believe today our future is filled with exciting possibilities that we are working to make reality. Xerox has repeatedly redefined how the world works and we are well on our way to doing it yet again. Be safe and be well.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.
