Xerox Holdings Corporation (XRX) Earnings Call Transcript & Summary

Welcome to the Xerox Holdings Corporation's Fourth 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'm David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation Fourth Quarter 2023 Earnings Release Conference Call hosted by Steve Bandrowczak, Chief Executive Officer. He's joined by John Bruno, President and Chief Operating Officer; and 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 are 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.

Good morning, and thank you for joining our Q4 2023 earnings call. I'd like to start by commending the Xerox team for delivering strong growth in full year adjusted operating income, EPS and free cash flow amid a challenging and uneven macroeconomic environment. We achieved 2023 adjusted operating income margin and free cash flow guidance despite slightly weaker-than-expected macro conditions in the second half of the year. Our ability to overcome top line headwinds and meet full year profit and cash flow targets is a testament to this company's culture of operating discipline, which has been forged and strengthened in recent years through operational and macroeconomic challenges. Summarizing results for the year. Revenue of $6.89 billion declined 3.1% in actual currency and 3.3% in constant currency. Our corporate digital and IT services businesses performed much better than this top line result would suggest, however. As Xavier will describe later in the call, revenue declined less than 1% in 2023 after adjusting for the effects of backlog reductions in the current and prior year, structural simplification efforts and the intentional de-emphasis of certain nonstrategic businesses. Adjusted EPS was $1.82, $0.70 higher year-over-year. Free cash flow was $649 million, an increase of $547 million over 2022 and adjusted operating margin of 5.6% was higher year-over-year by 170 basis points within our guidance range. 2023 was a pivotal year for Xerox and marked the first full year of a multiyear strategy to reposition our businesses for long-term sustainable growth in revenue and profits. Which we call our reinvention. We took structural and foundational actions to improve our core business and simplify operations, resulting in greater operational focus and a clear path for more transformative reinvention actions this year and beyond. All the while, we delivered key accomplishments towards the strategic priorities set out at the beginning of 2023, which provided momentum for our reinvention in 2024. Starting with client success. Client success is and always will be a point of competitive differentiation for Xerox and is foundational to maintaining a strong and stable print business. Since accepting the CEO position in August of 2022, I directed my team to put more emphasis on client outcomes and solutions-based products and services that address the productivity challenges of a hybrid workplace. Our rigorous focus on positive client outcomes solidifies our position as a trusted adviser as clients build workplace technology solutions for the future. It improves the predictability and repeatability of our business and expands total addressable market by ensuring we remain responsive to and take advantage of evolving market trends. Last year, we took actions to enable complete operational focus on the delivery of positive client outcomes in our core print, digital and IT service businesses. We divested PARC, Xerox Research Center of Canada and Elem 3D printing business. We signed partnerships with Peak Solution, an affiliate of HPS investment partners, allowing Fidel to focus exclusively on financial solutions that support the sales of Xerox equipment and services. We also reduced our presence in certain nonstrategic markets with lower levels of profitability, such as paper and certain types of IT hardware. In 2023, an enhanced focus on client success delivered the intended results, proving client centricity can drive revenue stability even in secularly challenged industry like Print. Xerox Net Promoter Score improved. We grew our share of equipment sales in the markets in which we compete, and we achieved revenue renewal rates above 100% across large account contract renewals, evidencing our ability to sell new print and digital services that more than offset reduction in traditional print spend. Moving to profitability. Transformation of the scope and scale contemplated by our reinvention requires a strong base of profits and margin profile from which to build. In 2023, we improved adjusted operating profit by more than $100 million and adjusted profit margin by 170 basis points year-over-year. Improvements stem from structural cost reduction efforts, pricing discipline and ongoing operational efficiencies and deliver reduction in nonstrategic revenue with low levels of profitability. These actions and the restructuring announced early this month put us firmly on the path to returning Xerox to double-digit profitability by 2026, while improving our capacity for a tactical reinvestment in growth areas. Finally, shareholder returns. It is important to our Board and management team that investors are rewarded while accompanying Xerox on its reinvention. In 2023, we achieved our shareholder return policy while reducing total debt while the $600 million of free cash flow when combined with excess cash on our balance sheet was used to pay our $1 per share dividend, lower our debt balance by approximately $450 million and reduced our share count by more than 20%. We will build on these achievements as our priorities evolved in 2024 year 2 of our reinvention. Our first priority of 2024 is the continued strengthening of our core print, digital and IT service businesses. These businesses form the bedrock of our strategic repositioning from which new capabilities and our client-centric mindset will be leveraged to drive incremental service opportunities and revenue diversification. Earlier this month, we announced a significant reorganization of our businesses, including the adoption of a business unit rather than a geographic led operating model, along with a greater focus on a partner-led distribution. These changes are expected to both strengthen our core business and position us to capture new ancillary revenue opportunities over time. John Bruno, our President and COO, will provide more details on the operating changes. In short, a business unit-led operating model sharpens our client-centric mentality by more closely aligning Xerox products and services with the economic buyers of today's hybrid workplace. And with the establishment of a global partner ecosystem, we will pursue new partner relationships to expand the reach of our core businesses. Stronger end market alignment and partner reach is expected to further improve equipment market share and print, digital and IT service penetration rates with existing and prospective clients, resulting in new client wins and higher rates of revenue as contracts renew. Our second priority is the successful implementation of structural cost improvements associated with our reorganization. Which build on efficiencies and improvements put in place in 2023 and are expected to drive profits meaningfully higher again in 2024. We announced last quarter that reinvention is expected to deliver $300 million of net adjusted operating income improvements above the 2023 levels through 2026. We expect to achieve more than 1/3 of that improvement in 2024 due in large part to organizational cost savings associated with the reorganization announcement earlier this month. Our newly formed global business service organization or GBS, which John will further describe, will catalyze these expected organizational savings in 2024. Beyond 2024, we expect GBS to be an engine for continuous cost improvement and improve client satisfaction as this group works to embed advanced technologies like machine learning and AI into key internal processes, making it easier to do business with and within Xerox. This year, we also began a more comprehensive optimization of our geographic footprint and product offerings, the savings of which are expected to further augment those associated with the recently announced restructuring program. Finally, capital allocation. As I mentioned, management and the Xerox Board of Directors believe it is important to directly reward shareholders as we execute our reinvention. In 2024, free cash flow is expected to be used to pay our $1 per share dividend and reduce leverage. Excess free cash flow is expected to be used to tactically invest in projects or acquisitions with high rates of expected returns on invested capital. Each of these 3 priorities puts us on the path towards achieving our long-term reinvention goals. I'll now hand the call over to John Bruno to provide more details on our recent organization announcement and our reinvention road map.

Thank you, Steve, and good morning, everyone. I appreciate the opportunity to speak to you today and provide more context around our multiyear reinvention journey. At its core, reinvention is about operationalizing a balanced strategy to improve our legacy business and build a foundation to address adjacent opportunities with existing and new clients. These adjacent market opportunities are available to Xerox today, but they require enhancements to our client coverage model and our service offerings. And by the market, I'm predominantly referring to the mid-market, where digital IT services remain underutilized by our clients. There is opportunity for Xerox to improve client penetration of digital and IT services within this market, an assertion be validated through primary and secondary research as part of our reinvention planning. Critical to more fully addressing these market opportunities is a core business that is stable, fit for purpose in today's market environment and capable of meeting the evolving needs of our clients. We understand the dynamics of the markets we're in and to win in a secularly challenged market like Print, we must be more competitive, easier to do business with and relevant to our clients as their needs evolve. As such, our reinvention is aimed at addressing the complexity of our business that was built over time and for a different time. In its place, we are designing a simpler, more operationally efficient organization to address our clients' most important hybrid workplace challenges now and into the future. I have been part of similar transformation efforts with other large companies, which like Xerox, have strong heritage. Pattern recognition tells me Xerox has what we need to successfully modernize and transform this business. In my first year, I've experienced very little resistance or lack of desire to change. Our people are eager to embrace and direct change, and they're asking for it. And that's a great place to be as the work to reinvent any company is complex and requires tenacity and discipline. As Steve noted, 2023 was a foundational year for Xerox. We narrowed our focus and removed competing priorities to reduce our operating costs and organizational complexity. We set up a strategic program management office comprised of 16 work streams with more than 200 initiatives. This team designed, defined and are currently executing organizational and business operating system simplification, spanning from reductions of legal entities, ERPs, payroll and invoice systems to just name a few examples. 2024 marks the second year of our journey. The focus this year is building on the structural and foundational changes made in '23 with an improved operating model. Earlier this month, we announced a new organizational structure that merges sales regions, flatten layers of management, streamlines our global offering teams and collapses our go-to-market offering and delivery teams all to one business unit. We moved from a geography to business unit-led operating model to align our groups responsible for our print, digital and IT service businesses from product development to sales and services as one team to empower fewer leaders with the information they require to improve decision rights and be more agile. We formed a new organization, Global Business Services, or GBS, that will drive enterprise by efficiencies and productivity gains by centrally coordinating internal processes, leveraging shared capabilities and platforms. The formation of GBS goes well beyond previous cost efficiency efforts at Xerox. It involves an end-to-end redesign of our operations to enable touchless internal and external customer experiences. GBS will leverage the success we achieve from Project ONC and embed leading technologies to drive continuous innovation, we see GBS as a key enabler of long-term sustainable profit improvement. In 2024, we will selectively optimize our geographic distribution to improve regional profitability and reach as well as narrow offerings where we lack sufficient competitive differentiation to generate required rates of return on invested capital. These strategic actions will have a negative effect on revenue initially but are expected to generate improvements in total operating profit. The overhead costs currently in place to support these geographies and offerings more than outweigh potential reductions in revenue and associated gross profits. In summary, the organization announced earlier this month is a key enabler of expected profit improvement in 2024. Progress toward our 3-year operating income target of $300 million above 2023 levels will be driven by 3 concurrent efforts. The first operating model simplification throughout the reinvention journey with continuous savings initiatives led by GBS. The second is geographic and offering simplification efforts, and they're going to continue into 2026, with net savings being generated from the replacement of direct operations in certain geographies with more efficient partner-led solutions and lower costs associated with a more simplified product portfolio. And finally, tactical investments in partnerships to grow our digital and IT services business will provide a more favorable revenue mix and profit profile through 2026 and beyond. I look forward to keeping you updated along our journey as our reinvention delivers improved financial results and shareholder returns. I'll now hand the call over to Xavier.

Thank you, John, and good morning, everyone. As Steve mentioned, important steps were taken in 2023 to simplify our business and improve Xerox balance sheet on profit profile. For the year, we delivered strong growth in earnings per share and free cash flow despite a modest decline in revenue, reflecting the successful implementation of a more flexible cost structure and rigorous operating discipline. Additional structural efficiencies enabled by our reorganization are expected to drive further profit improvement in 2024, our second full year of reinvention. In Q4, revenue, margin and profit declined year-over-year due mainly to a significant reduction of equipment backlog in the prior year quarter. Revenue growth was further affected by the intentional reduction of certain nonstrategic revenue. Excluding this factor, revenue would have increased low single digit year-over-year. Turning to profitability. Gross margin declined 130 basis points over the prior year quarter due mainly to lower activity, higher product costs on the termination of FG royalties, partially offset by strategic pricing actions, lower freight cost and the benefit of structural cost reductions. Adjusted operating margin of 5.4% declined 380 basis points year-over-year due to lower revenue and gross profit and higher compensation expense, partially offset by the benefit of pricing on structural simplification effort. Adjusted other expenses net were $45 million higher year-over-year due to lower sales of noncore business assets and an increase in nonfinancing interest expense. Adjusted tax rate was 15.2% compared to 21.9% last year. The decrease was largely due to the benefit associated with change to deferred tax asset valuation allowances and redetermination of certain unrecognized tax position. Adjusted EPS of $0.43 in the fourth quarter was $0.46 lower than the prior year, driven by lower operating income and higher other expenses, net, partially offset by the benefit of lower shares. GAAP loss per share of $0.50 was $1.24 lower than the prior year. This includes the EUR 78 million after-tax restructuring charge associated with the recently announced workforce reduction or $0.62 per share. Let me now review revenue and cash flow in more detail. Starting with revenue. Equipment sales of $458 million in Q4 declined 17.3% year-over-year in actual currency or 18.3% in constant currency. The prior year effect of backlog reduction drove more than 25% point of the year-over-year decline. Underlying demand for our equipment remains stable and order activity is gaining momentum as backlog on macroeconomic conditions stabilize. Total equipment revenue outpaced installation activity due to favorable product mix, installations of high-end color equipment, which were less affected by prior year backlog reductions, increased year-over-year, while entry on mid offerings declined. Declines in entry reflect prior year reduction to backlog on current year constraint, while declines in mid primarily reflect prior year reduction to backlog. Post sales revenue of $1.3 billion declined 5.8% in actual currency year-over-year and 7.5% in constant currency. Excluding the effect of nonstrategic and lower-margin paper on IT endpoint device placement, which we plan to continue to reduce over time as well as the exit of Russia, the termination of the Fuji royalty on the absence of park revenue, post sales revenue declined only modestly. Geographically, both region decline in actual and constant currency. Given the signipance of Span nonstrategic item on our revenue trajectory in recent quarters and for the full year, I will provide additional commentary to help clarify the underlying revenue trends associated with our core businesses. For Q4, the prior year reduction in equipment backlog contributed around 690 basis points to the year-over-year decline in total revenue. Lower sales on nonstrategic paper on IT endpoint devices contributed around 160 basis points of the decline and the effect of lower full royalty revenue and strategic actions taken to simplify our business contributed around 190 basis points of the decline. When this combined effect are removed, revenue from our core businesses grew low single digit this quarter, reflecting stable demand on growth in digital and IT services partially offset by decline in printed page volumes. For the year, this same item in the aggregate contributed around 230 basis points to the year-over-year decline in revenue. Therefore, core business revenue for the year would have declined a little less than 1%. Let's now review cash flow. Free cash flow was $379 million in Q4, higher by $211 million year-over-year. Operating cash flow was $389 million in Q4 compared to $186 million in Q4 2022. The improvements were mainly driven by a net source of cash associated with a reduction in financing receivables and improvement in working capital. Finance assets were a source of cash this quarter of $92 million compared to a use of cash of $169 million in the prior year, reflecting the benefit of our forward flow program with HPS on lower organization as expected. Working capital was a source of cash of $115 million, resulting in a $42 million year-over-year increase in cash driven mainly by a reduction in inventory. Investing activities were a use of cash of $8 million compared to a source of cash of $17 million in the prior year due to lower proceeds from the sales of noncore business assets, partially offset by lower CapEx. Financing activity consumed $383 million of cash this quarter, which includes a payment of around $300 million of secured debt and dividend totaling $34 million. During the quarter, we repaid a bridge loan with proceeds from the insurance of a term loan credit facility. Turning to segments. FITTLE origination volume declined 25% year-over-year, reflecting FITTLE change in strategy to return its focus towards captive only financing solutions. Captive product origination were up 2%. FITTLE finance receivable balance declined around 3% sequentially in actual currency, reflecting the runoff of existing finance receivable on HPS funding of FITTLE origination. As previously highlighted, we expect our finance receivable balance to decline and normalize closer to $1 billion by 2027. FITTLE revenue was down slightly year-over-year in Q4 due to lower finance income and other fees associated with the decline in FITTLE finance receivable balance, partially offset by higher commission from the sales of finance receivable assets. Segment profit for FITTLE was $7 million, up $6 million year-over-year, mainly due to lower bad debt expenses and lower intercompany commissions. Print and Other revenue fell 9.5% year-over-year in Q4 due to lower equipment and post sales revenue, reflecting the effect of prior year backlog reduction on declines in nonstrategic items mentioned in my prior comments. Print and Other segment profit declined 50% versus the prior year quarter, resulting in a 430 basis point reduction in segment profit margin year-over-year, driven by lower revenue, partially offset by structural cost efficiencies and pricing actions. Turning to capital structure. We ended Q4 with $67 million of cash, cash equivalents and restricted cash, around $2.4 billion of the remaining $3.3 billion of our outstanding debt support our finance asset with a remaining debt of around $900 million attributable to the non-leasing business. Total debt concept of senior unsecured bonds, finance asset secured borrowing on the new term loan. We maintained a balanced bond maturity ladder over the next few years. Finally, I will address guidance. For revenue, we expect a decline of 3% to 5% in constant currency in 2024. Included in this guidance are the effect of prior year backlog reduction on headwind associated with the deemphasis of certain nonstrategic businesses, all of which are unrelated to the performance of our core print and services businesses. More specifically, the reduction of backlog in 2023 is expected to contribute around 200 basis points to the year-over-year decline in revenue, with another 200 basis points attributable to the decline of certain nonstrategic revenue, including lower sales of paper. Excluding the cumulative effect of this item, core business revenue is expected to be roughly flat year-over-year, reflecting stable print demand growth in digital and IT services and neutral macroeconomic condition. As future strategic action involving product or geographic simplification are decided, we will update guidance on the respective effect of these actions accordingly. In terms of quarterly cadence, the headwinds previously noted, particularly the year-over-year effect of backlog reduction are expected to affect revenue growth most significantly in the third and second quarter of the year. Q1 revenue is expected to decline at a rate between that of Q3 and Q4 2023 with sequential improvement in year-over-year revenue trajectory expected throughout the year. We expect 2024 adjusted operating income margin to be at least 7.5%, an improvement of at least 190 basis points year-over-year, resulting in the realization of more than 1/3 of the expected $300 million improvement in operating profit above 2023 level expected from reinventions through 2026. The increase in profit and profit margin in 2024 will mainly be driven by structural simplification actions, enabled by our reorganization, including the effect of the workforce reduction decision announced on January 3. Operating margin will be lowest in Q1 due to seasonal factor on the timing of structural cost reductions throughout 2024. We are expecting slight improvement in Q1 operating margin from Q4 2023 level with more significant improvement throughout the year. To be clear, our ability to achieve profit guidance is not predicated on revenue growth as the expected savings associated with our reorganization far outweighed the reduction in profit associated with lower nonstrategic revenue. Free cash flow is expected to be at least $600 million in 2024. Free cash flow will once again benefit from a reduction in our finance receivable balance. Improvement in cash flow from underlying operations are expected to be offset by onetime restructuring payment, higher cash taxes and an increase in pension contribution. We plan to pay our $1 share dividend on outstanding debt obligation at Xerox. Excess free cash flow is expected to be deployed opportunistically according to expected rate of return on investment, including opportunity to strategically reinvest in the business and acquisition. In summary, we enter 2024 on solid footing, with stable demand for our product and services, momentum in orders and signing a simplified operating structure and clear line of sight to savings that will enable another year of meaningful improvement in operating profit. We will now open the line for Q&A.

Thirdly, one moment for our first question. And our first question comes from the line of Ananda Baruah from Loop Capital.

I guess a couple, if I could. The headwinds to revenue that you guys pointed out -- pointed out on the call, you sort of quantified in the deck as well. And I think they impacted last quarter as well. When what's the good way to think about how those roll off as we move through the year? And I guess at what point in time do you expect them to be fully rolled off and for the reported revenue to kind of be sort of apples-to-apples. Can I have a quick...

Okay. Ananda, Xavier speaking here. Yes, so the phasing of the headwinds that we have there, they are different by nature here. But the main one, as you mentioned it, if you look at the next year, our forecast here is minus 3% to minus 5%. And we said we have around 40 basis points that are, I would say, normal by nature. They do not impact the core business there. The first one is the backlog. The backlog is 200 basis points out of the 400 basis point impact. The backlog, we expect the end of the compare of backlog to end at the end of quarter 2 2024. So quarter 3 and quarter 4 should be normal compare because last year in 2023, we still have the impact of pressing the backlog. The other item, the 200 basis point item that we have there, we phase out during the year, there are some items related to we mentioned paper sales, IT endpoint. They will stay within the year there, but the full year royalty, for example, is an item that will end at the end of Q1. So -- but they are less important in nature. The largest one is the backlog and the backlog is and of quarter 2.

That's super helpful. And then just sort of like a sanity check here. It looks like this is the easy math to do, but it looks like you're forecasting op profit to be up year-over-year. And maybe nicely up, I'm getting like $80 million to $100 million or something like that, depending on what revenue you use. Is that accurate? Is that an accurate assessment?

Yes. And even higher. So the operating margin this year is 5.6%. After last year, it was 3.9%. So quite a nice progression that we have done in operating profit. And for next year, we are forecasting guiding at least 7.5%. So this is 190 basis points progress here that we're doing on operating margin. In absolute value, we are speaking about more than $100 million after this year, which has also been in operating income, adjusted operating income of more than $100 million as well. So a nice momentum that we are building -- and the other point I want to flag that is the dependency of delivering this operating profit or operating margin improvement is not entirely driven by revenue. We have given our revenue guidance, you understand the one-off impact there. But a lot of the actions that are supporting the operating profit, operating margin improvement are already actions that we have in play, one of this being the actions that we announced at the beginning of January, which is a large restructuring action that we have started now.

And that's super helpful. Just let me dovetail that into one last one. Can you remind us of the $300 million that you have for the 2026 goal incremental op income, how much of that is revenue driven versus things that are completely under the company's control? And then that's it for me.

On, one of the things we did, as you remember, we announced the very, very strategic structural changes and the launch of the reinvention and the combination of which drives an end-to-end simplification drives cost out and has a very strategic strengthening of our core business and make sure that we have the flexibility to adjust when the revenue goes up, our revenue goes down. So 2 pieces of it. One, reinvention will drive simplification. We talked about GBS and what we're doing there to drive our overall margins and drive improvements in our business. Second, we're going to take strategic actions in our geographies and our products. So the whole $300 million of operating profit independent of what happened to revenue so that we can adjust up and adjust down based on whatever decisions we make on nonstrategic revenue.

I got it. And so Steve, so any incremental revenue driven would be in addition to the $300 million? Is that accurate?

Yes. It should. We are very strategically targeting higher revenue that has higher profitability. And by default, you're absolutely right. We increased our revenue, we should increase our profitability.

Thank you. One moment for our next question. And our next question comes from the line of Samik Chatterjee from JPMorgan.

I guess if I can start with a clarification on your revenue guide for 2024, you're guiding to flat when we x out the backlog and the exit from certain nonstrategic businesses. How do I keep that in context of what you're referring to here for 4Q, which is a mild softening in demand in the European market. How are you sort of thinking about or baking in the macro impact you've seen in 4Q into your 2024 outlook? And I have a follow-up.