Xerox Holdings Corporation (XRX) Earnings Call Transcript & Summary

Hello, everyone. It's so great to see you today. I'm Jim Suva, the IT hardware analyst here at Citigroup Investment Research. We're at day 3 of our Global Technology Conference, where we are bringing you over 200 technology companies. This fireside chat is with Xerox, stock ticker, XRX. A few housekeeping items before we get started. First, no media and no press are allowed. This is for institutional investors only. If you are subject to MiFID II, please ensure you got the research applicable agreement into place. If you do want to ask a question, and if there's time at the end, please hit the submit button on your screen. And in doing so, I'll get e-mailed the question, and I'll try to aggregate those if there's time permitting. But given that there's so much going on with Xerox and so many changes, I assume that a lot of our time will be taken up by the prepared interactive discussions that we already have. A couple of other things I do want to note is I want to introduce, we have both the Chief Executive Officer, John Visentin, as well as the Chief Financial Officer, Xavier, who are joining us here today live on camera. I also do want to mention that Xerox has a safe harbor statement that they would like us to read for them. During this conference call, Xerox executives will make comments that contain forward-looking statements, which, by their nature, addresses matters that are in the future and are uncertain. Actual future results -- financial results may be materially different than those expressed herein. Now I do want to talk a little bit about Xerox made a big announcement a few weeks back. And we are getting ready for going back to school. And so some people may have missed it, but it was a big announcement about the formation of its software business now called CareAR. Before we dive into some of the questions on the transaction and the fundamentals of your business and the investment by ServiceNow, I think, we have a video that provides some helpful context around how CareAR works because it was recently newly announced, and you put together a great video. So can we please queue the video? [Presentation]

Well, that was quite insightful. I feel like I need to walk around my house with that in my hand and finally fix some things, but for a field service representative, that's quite impressive. Many of us, like me, who've been following Xerox for years or even decades had no idea this was within Xerox.

So John and Xavier, can you talk a little bit about how this fits within Xerox' strategy and framework?

Yes. Jim, thanks for having us. The way to look at it is how it fits is that we've always said that there's innovation. In the last 4 years, we would be monetizing innovation. And we would be looking at our PARC, what's in research as well as the rest of our business, on how we could work on solutions that can breakthrough and solve industry solve human issues, solve human needs. And in this case, when we formed the software group of CareAR, it's solving a few things. It's solving the aging workforce that's out there with technicians. It's solving exactly what you brought up, Jim, is how do we get speed to resolution quickly. And how do we go about having a technician or having even a consumer at home with no experience or barely any experience when they started, act like they have 30 years' experience. So what we did with CareAR when we formed the software business unit is that we not only took the -- our augmented reality software, but we added our content management to it as well as our visual content -- our visual management to it. And then we use AI from PARC. So we have AI from PARC and we created it and we created a CareAR solution. And that's how we set up our software business. But that's where Xerox is going -- we think of all the businesses, we're standing up, if we think of all standing at PARC with the solutions we have in there. We're not only focused on what we do today, but we're also focused on the future.

Speaking of the future, ServiceNow did give you a $10 million investment into CareAR. Can you talk about what does this mean as far as future funding? And as you remember, I'm a CPA. So I believe there's 80% rule of ownership and control that may be important. But it appears that the $10 million wouldn't even come close to hitting 20% and you're still keeping way more than 80%. But how should we think about additional future funding and flexibility? It seems like there's a lot more flexibility still around this.

Yes. Do you want me to go? Yes. So when we're standing up our businesses, flexibility is key. So focus and flexibility. Yes, we're aware of the 80% rule. The investment of ServiceNow and $10 million gave us an evaluation of the software business of about $700 million, as we had announced previously. And what it does is, it allows for flexibility going forward with the company as we continue to show the growth of the company, what options can we do with standing up this software business. And I guess the key is flexibility. The ServiceNow investment of $10 million, think of it like, what, Series C...

Series C, series D.

Series C, Series D type of investment. And given their experience in field service management, it's where you have an $80 billion market opportunity, the fact that they've validated that our solution, which is part of now also their solution, they validated that this is a solution that is breakthrough and that could help in this marketplace to go even faster. Overall, that's how we're looking at this business. But we're leaving ourselves all the flexibility.

And if I could add, John.

Sure.

Jim, you did the math right because, yes, it's $10 million, but the evaluation that we got from this business here is around $700 million. So we are far from the 20%. But the important thing here is that this business currently, this software business here, has a potential valuation of $700 million, and with revenue growth coming on the trajectory we are planning for this revenue. This will give upside on the -- obviously, drives a sum of the part analysis and valuation that we want to obtain not only looking at the print business.

And if my memory is correct, I believe you mentioned that you're probably going to have an Investor Day in Q4, and hopefully, with COVID, we can actually meet in person because I think that there's a lot of value to understanding our products and things like that. But if my memory is right on that, can you -- and being conscious of if it happens or hopefully it comes up, there'll be some good insights. But can you give us some insights about progress of standing up? I think you'd mentioned 3 businesses you planned to. And if my memory is right, it's like financing, software and your PARC R&D center. Is that right or help investors remind them of that?

Yes, that's correct. What we want to do on Investor Day and again, hopefully, in the November time frame is that we want to show a little bit the investments that we've been making and look at show the P&Ls of these different businesses because today, everything is looked at -- as you've mentioned to me, Jim, more than once, all we really see a Xerox holdco with a little bit of snippets. And what we want to do is stand up these businesses. So you can see the true investments that are going on. In some cases, where the cash drains and why -- where the cash drains and what's the potential that's going on. And in PARC, specifically in PARC, it's that under PARC, we have some investments in some major breakthrough areas and give investors a perspective of where we are with these investments, not just in a revenue but in also a -- and also a cash flow version, a P&L version, but as importantly, also in a development. So when we talk about HVAC, our HVAC system that we're working on in terms of having air conditioning, utilize 80% less energy than they do today. That's a huge major breakthrough. So where are we with that? There's investments. Where are we with the partnerships? And that's what we want to go through with you. So it's not just PARC, but inside of PARC, you'll be seeing what we're doing with IoT, what we're doing with HVAC and of course, our 3D system. On XFS, our financing system, same thing, what's going on with originations, what's going on with profit, what's going on with partnerships. We just got to -- we're looking now to do financing outside of our usual realm of business, and we're starting to get some progress on that side as well. And then CareAR software group, same thing. Where is the growth? Where is it coming from? How are we going about it? What are the partnerships? We've signed some major clients already in its infancy. So -- and where are we going with that? So it's really giving pretty much a lot of information with a lot of data on these businesses. And then I don't want to lose sight of our hardware, our core business, how we invest in digital services and MPS and ITS inside of that business, and how is that going to help us get us back to growth over time, and how do we have differentiated offerings in those areas. So we'll -- that's the idea of the Analyst Day is really to go through in detail of the 4 areas of our business. We'll be...

And I do sympathize with that about PARC. Is this in the background of Xerox in that physical park with green trees, but it actually stands for the Palo Alto in California Research Center. So for those of us who haven't been there and because I live in California, I have been there, can you help investors understand kind of what it looks like, what's inside the doors a little bit? I remember seeing things like 3D printing, air conditioning or what you'd mentioned, HVAC. Kind of some of the innovations and what's kind of unique there? Because I'm not sure everybody realizes that it's kind of a research and engineering center, not your traditional copiers.

No, Palo Alto Research Center has been with us for over 50 years. And we're known for having created the PC as an example that apple took from us, and we're known for having created technologies. And what's different now is and it's made up. It's really simple. It's made up of scientists and engineers, some of the smartest in the world, and their mission in PARC was always to incubate ideas that would make the world better. And that's what we've asked them to do. Now what we've done is, we've taken it from let's incubate these ideas and which ones do we, Xerox, want to monetize whether it's in print or not. So I won't speak about print because there are areas in there where they're print. But the example of AI and being able to take that engine, known as Alto AI that we call it, we coined it, that was our company and bringing it into the CareAR software was the game changer because it was able to now dissect information that is able to help technicians understand problems before they even occur or frankly, consumers. And that -- those are the kind of things that Palo Alto -- in digital that Palo Alto did. If we think of the HVAC system, it's not just the HVAC system we're working on. We're working on a lot of metrics to help reduce carbon footprint. We're working on a battery that could be 20% more efficient. These are all at different stages of the R&D cycle. We're working on microfluidics in the pharmaceutical area. So the way to look at PARC for us is it's an incubator of scientists that are working on ideas, and then you take it through the TRLs, they're called TRLs, and you say, where are you. If you're at the incubation stage, you're focused on the ideas. And then you move it forward to saying, how do I get this then to a prototype, how do I get this to a client installation, and then how do I get this to a commercial business. So we've been looking at PARC for 4 years now as doing just that. And there's been a lot of cash investments that we've made. And we're looking for returns. We're starting to see some of it. The example of in IoT, where we announced a partnership with LOQ that's focused on bridges and the infrastructure of pretty much every country where their bridges are either expired in terms of their existence of life or they're pretty badly -- they're in pretty bad shape. And one of the biggest issues most governments have is trying to figure out which bridges need care at which time. And we started a partnership with LOQ. We created LOQ a partnership with the Victoria government to do just that with our technology to say we can easily install our technology on bridges. And that will give you the data and the AI able to say which bridges need to be fixed first. And I don't know, whatever country you're in, everyone knows that when a bridge is in trouble or a bridge falls, there's a lot of lives that are lost. And then frankly, there's a lot of productivity that goes away because of not being able to use that bridge. So that's what you're going to see when we're going to show you Palo Alto is a little bit where are we investing the dollars, what does it look like, and then how do we move forward. We -- some people, they think of it like a stand up. I look at it as a stand up that's well funded to start with, with a balance sheet of Xerox. The that's how you -- that's how we look at it.

Can we shift now away from PARC maybe to your core business of office copiers?

Yes.

The past couple of years, John, it's actually been coming up on 18 months or 2 years since I've physically been in the same room as you and Xavier, it's just been pretty surreal. I've kind of adjusted my behavior. I do some printing at home, but a little bit less printing at home. Going back to the office has been a bit of a stutter. What's your view about people coming back to the office and their behavior for office printing on your core business?

Yes. The conversations that we're part of or I'm part of is, it's not if, it's when. What we found over the last 12 to 18 months is that while we were all working from home, we realized quickly the productivity wasn't where it needed to be 12 months later, and that could be in any industry, any role you're in, and most CEOs face that. What we see is that when employees come back to the office -- so let me step back -- one thing that, I guess, CFOs are realizing quickly is printing from home is not only not as secure, but it's also much more expensive than printing from the office. So what we're seeing as people come back to the office is, yes, we're seeing an uptick in our print because most companies will be asking if you're printing print in the office, even if you're only in their hybrid. If you're there 3 days a week or 2 days a week and Monday, Fridays, you work from home, more and more companies for security reasons, frankly, cost containment. Now they're back to cost containment, saying, we want you to print more from home. What we can't control, Jim. So we're dependent on the offices. We are dependent on the offices. And we've done a great job focusing on our clients that were open, and we see it. We see that when our clients are open, we see that the print is there and some of it all the way back to 19 print and all that. What's important is that -- and our team knows this, we can't control when we'll go back to the office, that we think earlier in the year that by now, we would all be back in the office. Yes, we did. I'm not the only CEO that thought that. And then Delta variant shows up, and there's some offices that are open. There are some that are opening faster. Others are saying not before October, not before September, it's delayed. So we try not to control that. We try to work with our clients on how do we prepare them, how do we prepare them for when they open the office. And one thing we saw in the second quarter, and I'll stick to the second quarter because I can't -- I won't speak to the third, is the amount of backlog and help our clients needed to get back up after 12 months or after 18 months, whether it's replacement of the product, the actual printer, whether it's some workflow solutions that we have. And when we talk about ITS and the SMB marketplace, they're in a world of hurt where they need help. They need help not only in installations, but they need help in support and in services because they were shut down for a certain amount of time. And in a lot of cases, they don't have the employees they had starting it back up. So these are all areas we're seeing in terms of trend. But at the same time, we don't control when the office is open. We try to make sure that we have everything available. And the fact that in the second quarter, we saw a headwind of demand even prior to some openings of clients, gave us perspective of it's going to come back, the question is when, not if.

Yes. And then how should we think about the competitive industry? You have semiconductor, part shortages. You have higher shipping costs. You have an industry that's facing some secular headwinds. What about pricing in the competitive landscape? Has it changed during COVID to where we are now versus pre COVID?

Yes. We're facing the same supply chain issues as not only our industry but other industries are facing, whether it's resin, whether it's chips. And it's hand-to-hand combat every day to try to get as much supply as possible. In terms of the marketplace, there has been some price increases out there. And we've had some price increases. But the -- but we've also had costs that have increased. Our shipping costs, I'll use my term, are ridiculous, but I get like I said, I don't think we're the only ones and that's not only our industry, but it's a law of supply and demand, unfortunately. But yes, so we've done some price increases. Our competitors have done some price increases in mostly products that we have shortage in and that's where we're at. But what we said in the second quarter, it didn't get any better in the third quarter in terms of supply chain.

Well, I'm glad that there's not like an aggressive competitor out there who's just pricing ridiculously low to gain share. It seems like that people are -- companies are behaving relatively rational. Is that fair?

Yes. Yes, the way I would look at it is you also have that product. So I'm going to go under the assumption that competitors are going to have a backlog of product but I won't speak for competitors. We will have -- we had a backlog of over $100 million in the second quarter that we couldn't install because we didn't have the product to install it. So that got delayed. So that's -- those are areas that you have to balance with your price increase versus you want to give it away now and not have the product to sell. That's not a strategy that we're using right now.

And Jim, back to your point on market share, we gained market share in quarter 1 on both of that traditional equipment printing here in quarter 1 and in quarter 2. But also, we gain market share on -- [ across our ] digital solutions, managed print services and all other solutions supporting the employee and the company bringing employees back to the office. And there are plenty of offerings here that makes a difference in the current environment.

So both of you kind of talked about coming back to the office, and I want to go back to the office, too. But I'm also very mindful of -- I work for a very large company, Citigroup. What about the small and midsized business? Can you talk a little bit about that market? Because whether it be restaurants or movie theaters or things like that, it seems like the small and midsized businesses have really had some challenges economically during this pandemic also. So what are you seeing for SMB?

What we're seeing for SMB is how do we help them start up again quickly. And that's where our ITS business comes in. So in our ITS business, we offer everything from implementation of full solutions to supporting it, whether it's the security or the network operation to bots to simplify their applications. One of the issues you have with SMB today is that they can't get enough employees. I don't know about you, but whenever I walk by every SMB shop I see, it says we're hiring. So what we're doing with our ITS solutions is how do we make them more productive and up and running as fast as possible in a situation where they just don't have the IT resources or the resources to be able to do that. And that's where our investments in our ITS business come in. We've seen we've seen some good growth in both our ITS business in the U.S. We've now made acquisitions earlier last year, and we're seeing investments in ITS in the U.K. all of it mostly towards SMB. SMB, schools, wherever help is needed. We play less in these large companies like the city banks of the world just because we chose to focus on where the help is needed, and there's a lot that's going on there right now. So that's what we're seeing in SMB. And SMB wants to open as quickly as they can. So when they're allowed to open, they want to like be live because, again, it's a few employees, anything from a few employees, and they have to get the pay -- should have to pay for the paychecks, they got to get the employees working.

Yes. I will mention Citigroup does have Xerox office copiers globally, and it's pretty impressive, the software innovation you've done it behind it. Where I can be in my house in Silicon Valley and print in London or Hong Kong, and it is a secure print that sits in the buffer and just doesn't sit there for the cleaning staff to read. And I can print globally, it's pretty impressive, the innovation that has happened.

Yes. We've won some awards with that. And I don't want to take that lightly to security because for a city bank to approve our security, there's a -- you have a whole group yourself of security that's probably larger than my whole company that works on security at Citibank, that has to look at our technology, look at our innovation and say, yes, this is approved in this work, and that's exactly what we want to do. And then we want to take those solutions and bring it to SMB that don't have the means of having that secure -- the secure type of print and all that. So that's a little bit what we're doing.

Can we now take it kind of one notch below the overall macro and sales and maybe take it, say, to profitability and talk a little bit about profitability? Is there anything in the second half of this year that we need to be mindful of versus the first half, whether it be COVID costs or spacing out people or body temperature scanner, their shipping costs? Or how should we think about profitability?

Yes, we're -- let me say it this way. Second half, we're continuing our investments in all our businesses to stand it up. And we're also continuing our investments in IP and all of that. Do we face some secular challenges of supply chain costs and carry the things you know? Yes. And we're managing it the best we can with our Project Own IT solutions and what we're doing in Project Own It, and we're trying to manage it the best we can as we did, honestly, in the last 18 months. We went through quarters where we were cash -- we were never cash flow negative. We were always cash flow positive, and we're continuing in the second half. I don't know if you want to add something, Xavier, but...

So we -- as John mentioned, Own It is a lever that we have. Own It is literally a day-to-day and it's not like a high directional type of management, day-to-day management. And the purpose for us is still coping carry on the investment that we are doing and being able to fund the future growth of the company here and at the same time, protect and generate your cash and protect the assets of the company.

And Xavier, anything we should be mindful about this kind of unique to Xerox, whether it be joint venture income or IP royalty income or anything that's a little unique to Xerox that we should be mindful of as we look ahead versus in the past?

We disclosed earlier on the Fuji Xerox royalty agreement that we have. So it's a number that we have communicated here. This is a headwind. But as John mentioned here, we have, at the same time, Own It. And the Project Own It will drive and offset some of the impact that we have from a headwind point of view.

And then on shipping costs, can you walk us through, is that something that Xerox just has to work with the shippers and be more efficient internally? Or when Citibank orders 5 new printers in our San Francisco office, do you have a line item that just has like a delivery cost and you can toggle that up and down? I'm just kind of curious how shipping costs play out with your customers and your profit and loss statement.

So shipping cost is part of the cost of goods sold that we have and when we saw the pressure. May be the Asian pressure coming. But by the way, on shipping, I just would like to clarify, there are 2 things. There is a cost dynamic and there is also a capacity dynamic and both play together. John mentioned backlog. The backlog is mainly related to capacity and being able to get the product from the supply chain, but also being able to get the product being installed to the end customer. And we see this tension, not only on the container, everybody knows the story of the sea container coming from Asia. But also, I would say, locally, geography by geography, you have some tension due to the high demand and supply and the impact it could have on cost. For us, it is reflected from a P&L point of view, it's in cost of goods sold, and as much as what we can, we want to reflect some of this either to the price on if we have to offset it from a cost point of view, we put in place the relevant action. But you saw some of the increase, I would call it exponential increase of certain cost here and I say, okay, some of them is harder to manage so like a BAU type of cost increase.

Yes. John, you mentioned earlier when you walk around town or whatever you see help wanted signs for labor shortages everywhere. I do, too, in San Francisco. And in fact, the shipping docks where the giant cargoes come in, those docs are filled and they're unboxing that as fast as possible and they're still trying to hire people. So has the shipping costs gotten worse or stabilized? Because I'm just shocked at how many boats are just anchored in the harbor waiting to be unloaded. Is it getting better or worse or stabilized?

At a macro level, shipping cost was increasing or were increasing during the first half of the year, and I'm speaking mainly container cost, seaside container coming. It seems to stabilize but it has stabilized currently at a cost which is higher than what we had pre COVID. So it's not a lack of capacity because the capacity is there. You have seen some consolidation happening currently as well as the industry. There is a big demand of Q4, with the holiday season coming. So there is a lot of Asian request here on having shipment coming into U.S. or into Europe there. We hope, I will say, when we forecast it, we hope it will stabilize. Currently, we know it is at a higher cost than what we have had pre COVID.

And I would like to ask a little bit about your capital allocation. I cover 40 companies. Some of them stopped their dividends, some of them went cash flow negative, you didn't. Your cash flow continue to print money and you continue to pay your dividend. Can you talk about cash flow and the priorities that investors should be mindful of?

Yes. So...

God ahead.

So our capital allocation has been transparent and very clear. So we are committed and it's something that we have done for years is to at least deliver 50% of our free cash flow back to shareholders. And we have done it. I mean if you look simply at this year, dividend has been paid and we have a dividend of $1 per share that has been distributed quarter-by-quarter. But at the same time, we had a share repurchase program in place here. And this year, we had a program of $500 million of share repurchase. We have executed the vast majority of this program, but $88 million coming after the end of quarter 2. So this commitment and this strong commitment is there generated or supported by our ability to generate free cash flow but also the fact that after having done our capital allocation prioritization on strategic initiative, we want also to redistribute 50% back to the shareholder.

And the only thing I would add, Jim, is that the 4 initiatives that we've had in place that not only got us through COVID, but 4 years ago, got us on the right track to the point where we were acquiring a company and then COVID hit as a lot -- one of them is cash flow. So cash flow is not a CFO or a CEO, it's a total company discussion. So on a weekly basis, when we have our EC discussion, my geography leaders, not my CFO, are taking us through what's net working capital looking like, what's DSO looking like, what's looking DPI looking like, what's happening with inventory, what parts of inventory are aged, where are we going with that. And what that does is it puts a mentality in place of every dollar matters. It doesn't matter if it's in the balance sheet or if it's on the P&L. And frankly, that's what got us through also during COVID, where we didn't have to go -- we didn't have to -- we did not go negative cash flow in any quarter. And that's always been our maniacal focus in the hard times or in the easy time. And we never saw a reason to reduce dividend given that back, given the fact that we were still generating cash flow in the toughest times.

I actually got a couple of questions from investors on the same topic, so I'll put them on that. And that is, has the Delta variant changed your outlook at all?

Right now, we have guided for revenue and guided for cash flow, and we're not changing our guidance, as of our last discussion, not changing our guidance. But again, it's Delta variant or COVID, we went through COVID and still managed to deliver 400 plus of free cash flow. So we're confident in delivering our cash flow assessment.

Okay. Now to wrap it up, I guess, John is Chief Executive Officer. Can you maybe leave investors with 2 or 3 points about why you're excited to be CEO of Xerox? And a couple of reasons why you think they should be buying and owning Xerox shares in their portfolio?

Yes. I would say a couple of things. This is not -- I use a term, this is not your grandmother's Xerox anymore. And the reason is all the investments we're making in standing up the different businesses. If you think of software, where we've put a lot of investments in an offering that is a breakthrough technology where you have a ServiceNow, basically agree with the fact that this is breakthrough technology and gives us a $700 million valuation. That's something to look at. If you're going to look at our XFS business and you're going to look at what we have as assets under management, and then try to tie what you think that is there. And at an Analyst Day, we'll give you more information, that will give you an idea of what that valuation is. And then go into PARC and going to PARC, and I talked about -- quickly about LOQ and about IoT, how we are seeing not only technology, but we're starting to commercialize it with revenue and partnerships, with valuations you want to put on that. We're not a simple story. And what we're trying to do by Analyst Day is simplified for all of you to say, here's a sum of the parts, what's the company worth, and why is it worth this amount. And so that's what I would ask you to do is with the information today, look at the sum of the parts, look at the valuation, look at where our stock price is today, and you make the assessment if it's worth investing or not. I'm excited. I'm excited with the future. I'm excited about where we are in progressing with PARC, with XFS with our business because even our core business where we are reliant on offices reopening, we still manage to gain market share everywhere. And in a lot of cases, we're #1. And that's our core business with our ITS business in there that's growing. And that's how you -- and that's how I'd ask you to look at it and come Analyst Day, you'll get more information.

I sincerely want to thank the Chief Executive Officer and Chief Financial Officer for joining us here today virtually, and we hope in person -- this can be done in person in the future. And thanks so much for the insights because it is a lot more insightful than just what people know from the outside the company. And we thank you for your wisdom and intellect and insights to the company. This now concludes it. We hope to see you all at the Xerox Investor Day, which is planned for some time in Q4.

Thanks, Jim.