Xerox Holdings Corporation (XRX) on Q2 2021 Results - Earnings Call Transcript
Operator: Good morning everyone. I am David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation's Second 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 Q2 2021 earnings call. I hope everyone is safe and healthy. We saw growing demand for our products and services in the second quarter. Revenue totaled $1.79 billion, up 22.4% year-over-year or 18.1% in constant currency. Free cash flow was $198 million, up $183 million year-over-year, adjusted earnings per share totaled $0.47 up $0.32 year-over-year, and adjusted operating margin was 7%, up 280 basis points year-over-year. Increased equipment sales and print volumes are consistent with the continuing gradual return to the office and give us confidence to reaffirm our revenue and free cash flow guidance for the year. In the second quarter, we increased investments in our operations and targeted growth areas while generating greater free cash flow. Our reaffirmed full year cash flow guidance reflects our commitment to fund initiatives that will return Xerox to long-term growth. Our four strategic initiatives: optimize operations, drive revenue, reenergize the innovation engine and focus on cash flow and increasing capital returns, continue to guide us and serve us as the foundation of our transformation. The operating discipline instilled through Project Own It has enabled our team to navigate through an unprecedented level of uncertainty, including a pandemic and the resulting disruption of the global supply chain while continuing to deliver value to our clients. Increased demand and material shortages impacted the supply chain of certain products to our customers this quarter, creating a backlog of equipment, including IT product that's nearly doubled that of last year's. Despite these constraints, we delivered strong equipment sales results in the second quarter. We expected supply chain challenges to persist through at least the third quarter and possibly through the year. We are working with our global suppliers and transportation partners to mitigate the impact to both Xerox and to our clients. The team remains committed to further optimizing operations to make it easier for customers and partners to work with Xerox while reducing costs. Project Own It is on track to deliver $375 million of gross cost savings this year. At the same time, Project Own It has freed up cash allowing us to reinvest in targeted growth areas and digital transformation technologies. Robotic process automation and analytics were our initial areas of focus for digital transformation. Bots are now managing increasingly more complex transactions across the enterprise in every business and function completing 4 million transactions per quarter up 300% year-over-year. We have expanded our investment focus to include augmented reality and artificial intelligence.
Xavier Heiss: Thank you, John, and good morning, everyone. We are pleased with our Q2 results. We experienced significant year-over-year growth in all key financial metrics on sequential improvement in revenue, free cash flow and earnings. Revenue growth reflected strong demand for both equipment and supplies. On page volume, which grew sequentially from Q1 to Q2, continued to demonstrate a high degree of correlation with a gradual reopening of workplaces. Strong demand, along with ongoing supply chain disruption resulted in an order backlog for equipment, including IT product that is significantly higher than last quarter. Higher revenue and operating leverage drove significant growth in our profitability in Q2. Gross margin declined 219 basis points year-over-year due to higher mix of equipment sales, lower government subsidies, net of Project Own It savings, lower FUJIFILM Business Innovation royalty revenue and higher freight and delivery costs.
John Visentin: Thank you, Xavier. Now let's open the line questions.
Operator: Our first question comes from the line of Ananda Baruah from Loop Capital. Your question please.
Ananda Baruah: Hi, good morning guys. Thanks for taking the question. Just two quick ones if I could. I guess the first is on the free cash flow. You guys are tracking I think $300 million year-to-date and typically second half of the year; particularly December quarter is stronger than first half of the year. So is it just a healthy dose of conservatism? I know the guidance is at least $500 million, but it would seem like you guys are set up to do probably more than $600 million unless there is some puts and takes. And I have a quick follow-up. Thanks.
Xavier Heiss: Yes, thanks, Ananda. So, yes, you know that we are pleased with the result we deliver in quarter two both from a revenue but specifically as well from a free cash flow point of view. As you know, we have a plan to invest in the business in our different levers here, including XFS, that's the reason why we keep this guidance to $500 million. So it's important for us to leverage this strategy including the investment, not only cash, but also in a P&L that we'll have for the rest of the year.
Ananda Baruah: Got it. And then just with regards, John, to your remarks around the business environment, now that we're halfway through the year, how would you characterize sort of the tracking of the business environment? So what you guys are anticipating? Is it relatively in line? Or are there any meaningful differences, positive or negative, at this point?
John Visentin: Yes, good morning Ananda. I would say that look June had an uptick on – in Q2 in terms of employees going back to the office. And as we look at the rest of the year, you're hearing a lot of CEOs saying that in the third quarter everyone is going back to the office, the vaccination going on, and the way we see it is that – the way we're projecting it is probably near the end of the Q3 and then we'll start seeing more and more folks coming to the office in Q4. What gives us confidence is our ESR and our pipeline and our backlog in that area, so you can see that a lot of companies are setting up for this, in fact that we're gaining market share in that area gives us confidence. But yes, that's how we see it, Ananda.
Ananda Baruah: All right. That's helpful. I appreciate it. Thanks guys.
John Visentin: Thank you.
Xavier Heiss: Thanks, Ananda.
Operator: Thank you. Our next question comes from the line of Matt Cabral from Credit Suisse. Your question please.
Matt Cabral: Yes, thank you. I wanted to actually follow up on that last question. I guess, as we think about the correlation you guys called out between usage and the return to the office, just wondering if you could be a little bit more explicit on what you're seeing in terms of usage relative to the pre-COVID baseline, both overall within the base, and then within areas that have been a little bit quicker to return back to the office. And as we start thinking out longer-term, just curious for your impact on what COVID has done to the steady state for office print?
Xavier Heiss: Okay. Hi, Matt. So as you know it down there, we are monitoring it and there is – and we observe a strong correlation between vaccination, people returning back to the office and print volumes. And we track it day by day, month by month. We have a data point showing how this data is correlated here. So as you observe it, we don't have yet full population being vaccinated here, but we are encouraged by the progress that we have seen. And we are seeing sequentially progress in print volume and directly related to the presence in the office. We are not the only one reporting this type of indicator, but this give us confidence that for quarter three, backend of quarter three, specifically September, on quarter four, we will return to a better print volumes that we have here. Regarding your second point on the trend on how people are working, what we observe today is that there is a mix of different approach company by company around bringing employees back to the office certain number of days. But what we see is that when employees are back to the office, they print on some of the volume that they print up, some of the volumes they are either do not print at home or volumes that could be printed on, I would say, lower type or lower different types of decentralized solution. I won't call it the hybrid work, but what we see currently is that overall the print volume on the presence to office remain strongly correlated.
Matt Cabral: All right, that's helpful. And then shifting over to gross margins, just wondering if you could dig a little bit more into some of the pressure points that you're seeing, and I know you guys called out supply chain issues as one of the factors I'm wondering if you could quantify that impact. And I guess similar to my last question is as we look out longer-term, historically this business had been one that supported gross margins kind of around that 40% range prior to COVID. I guess I'm curious do you think that's still an achievable level going forward or as something structurally changes we think about emerging on the other side of COVID from a profitability standpoint?
Xavier Heiss: Yes. So I will start with your first question, which is around what has driven the gross margin different in this quarter here. So as you have seen it, the product mix which is more equipment sales revenue, by the way with very strong news on equipment sales revenue here. John mentioned it, but we gain market share on both what we call the base business, ESR type of business, but also on MPS. So we are leader on our segment in our territory, and this is quite important because it clearly show some correlation between employers wanted to have employees been back investing in their infrastructure, so they can operate when they are back in the office. Regarding the specific element or specific impacts that we have on gross margin, our product mix is the number one, the second one is we have faced, as a lot of industries, some increased freight on delivery cost, specifically related to certain tension in containers on cost of shipment here. As you know it as well, the third element is Fujifilm. We have lower royalty from Fujifilm, even if we have had some good news from a cash point of view in our free cash flow in Fuji, but from a profit point of view, we had lower royalty. On last item is more year-over-year compare, government subsidies were at the highest point in quarter two last year at the peak of the pandemic and they have been lowered as I mentioned it in my initial comment here. So now back to the gross margin, your gross margin question, what is the normalized view? Clearly, there is a straight correlation between revenue, our ability to drive the revenue growth and gross margin, specifically on post-sales revenue. So it is possible to go back to the gross margin with all the activity – gross margin we had before with all the activities that we are driving both from an Own It point of view and also supporting post-sales activity. Yes, the trend is going and will be favorable for the second half of the year.
Operator: Thank you.
Matt Cabral: Thank you.
Operator: Our next question comes from the line of Samik Chatterjee from JPMorgan. Your question please.
Angela Chan: Hi, good morning. This is Angela Chan for Samik Chatterjee. You reiterated that your full year guidance is $7.2 billion in revenue. Thank you for that guidance. So what do you see are risks to the upside and downside of that target?
Xavier Heiss: So we are quite confident in this – confident, Angela, in this guidance here. So, obviously, there are things that we can control and there are things that are more difficult to control. So the things we can control is the way we will execute the presence to the office is something that we feel, I would say, quite strong, however it is dependent on I would call that one element, which is the pandemic is still present on the Delta variant could have an impact, but so far what we have seen is that the impact on our – existing impact on the geography we are managing is quite manageable. The second element will be supply demand. So far we have a clear line of sight on how we can manage it here, but if the supply demand, and some of the tension on certain component on raw material will stay specifically in the fourth quarter, then we will consider the action. But so far we are managing, even in Q2, I mentioned it, we have had a little bit of supply chain tension here, we managed it. We find alternative ways on supplier to overcome the challenge and we feel confident that we can deliver the $7.2 billion.
Angela Chan: All right, great, thank you. And just a quick follow-up question. So what is your view on print market consolidation broadly speaking?
Xavier Heiss: Okay. So this is a trend that we have seen. This is like a historical. I always use this expression by saying in order to dance, you have – you need to have two parties. You know that we have been active on this one. And we are clearly open to; I call that, dance here on finding the right parties. But industry consolidation is a long items' in this print industry, and this is something that will happen over time.
Angela Jen: Great. Thank you so much.
Xavier Heiss: Thank you, Angela.
Operator: Thank you. Our next question comes from the line of Katy Huberty from Morgan Stanley. Your question, please.
Katy Huberty: Yes. Thank you. Good morning. With the return to the office in the fourth quarter of this year and the behavior of print in the office that you mentioned earlier, should we assume that post sales revenue in 4Q 2021 can look more similar to 4Q 2019 pre-COVID levels, obviously, assuming the Delta variant doesn't impact current return to office plans? I just want to understand how you're thinking about that.
John Visentin: Yes, Katy, in our model for our guidance, we're not assuming 2019 and to go back to 2019 numbers and 4Q. We're assuming a more modest return and then off to 2022.
Katy Huberty: Okay. And then in a normal environment, EPS is typically about flat in 3Q relative to 2Q? How should we think about the EPS trajectory in the September quarter this year?
Xavier Heiss: So normal environment, usually, first, EPS is mainly driven by revenue. So when revenue is coming, EPS is expanding. So, and then we manage via Project Own It, all the cost element of the company. Usually, quarter three is a softer quarter, usually prior to pandemic, a softer quarter than quarter two, the two highest quarter being quarter four and then quarter two. So this year is a little bit special, because we see this gradual recovery. As an example, schools and certain firms have not been open for quite a long time, open to present and the office or present in schools. And it will be one of the trends that we will monitor the quarter. So if I look at how we look at the quarter, we said gradual recovery. And specifically by gradual, we expect September to show clearly a pickup versus last year, and then quarter four to follow this trend here.
Katy Huberty: And just quickly, the tax rate was much lower in 2Q. Can that sustain into 3Q? Or should we assume that the tax rate comes up, and that's going to be a headwind to the sequential EPS?
Xavier Heiss: Yes. So you know, Katy, that we manage our tax rate on a global basis. We are present in a lot of different countries here. Here, we have an international, I will call that the exceptional items, which is related to a low change in one of our European countries. That give us the opportunity to get a one-off credit of a deferred tax asset. After this depending on how this low change are applied country by country, we will obviously follow the tax guidance here on the adjusted tax rate. But I do not expect quarter three to be as positively impacted as what we have in quarter two.
Katy Huberty: Thank you very much.
Xavier Heiss: Thank you, Katy.
Operator: Thank you. Our next question comes from the line of Shannon Cross from Cross Research. Your question, please.
Shannon Cross: Thank you very much. I wanted to see what's going on with regard to channel inventory. Xavier, I think you said something about some of the sales in the reseller channel was – were those companies looking to replenish probably in anticipation of demand, I would assume. But I'm just curious where you see inventory at right now? Thank you.
Xavier Heiss: Yes. So what we have seen on, this is mainly compared versus last year. If you remember, in quarter two last year, channel depleted their inventory mainly to protect their cash position. So we have seen it all across the industry. And step-by-step, this inventory has been rebuilt. What we are pleased with is that in quarter two, this inventory rebuild a little bit stronger than what we saw in former quarter. However, this is not like, I call that a very high number. I mean, our – we track what we call a week of inventory. On the week of inventory are still at this stage lower than some of the highest points we could have had pre-COVID. So channel are coming back, but step-by-step, gradual as well. As I mentioned it and you saw that, on SMB, on mid-entry which is mainly office type of activity, we gained share, and channel part of this share gain being able to drive our revenue up quarter-over-quarter.
Shannon Cross: Okay. Thanks. And then both of you, I think, during your script mentioned investments in growth areas, as use of cash and some impact on margin. Can you be a bit more specific on exactly where you're putting your investment dollars and how we should think about ways to track return on investment? Or how quickly you expect to see benefit from that? Thank you.
Xavier Heiss: So as you know, we invest in three, I would say, areas of business. And by the way this is the area of business that we informed you in the past, I think we will expand these businesses. This is XFS software on innovation. And I'm pleased to report that in each of these areas of business, we achieved milestone and we continue, despite the environment, we continue to invest in the business. I will give you two examples here. On the XFS, I believe we mentioned that in our presentation, in XFS, we grew originations and the portfolio is growing. When you do that, it means that you use free cash flow. And we have used this quarter, $60 million of free cash flow in order to support this activity. What does that mean? It means that we are building for the future of the portfolio because all this origination will drive future revenue and profit growth for XFS. In innovation, we carry on our investment. And I'm sure you remember that we announced in quarter Q2, Eloque. Eloque is this joint venture that we have with the Australian Victoria government here. And this joint venture is now running, has been enabled, and we have a commitment from the government to invest AUD50 million in the infrastructure and to set up more of this bridge sensor that we are developing here. So it's just example, sharing that in RD&E, some of our costs despite the current environment on free cash flow, we carry on investing in order to develop the future revenue growth of the company. And yes, in November, as you know Shannon, we announced that in November, we'll have an Analyst Day, and we will provide you more detail on each of these towers.
Shannon Cross: Okay. Thank you.
Operator: Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to John Visentin for any further remarks.
John Visentin: Okay. Thank you all for your questions. Look, the events of the past 18 months have tested the Xerox team in ways we never imagined possible. But these unexpected challenges make the team stronger. So the resiliency of this team, paired with our sound strategy, gives me confidence that Xerox's future continues to be bright. Be safe and be well.
Operator: Thank you. Ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
