Xerox Holdings Corporation (XRX) Earnings Call Transcript & Summary

Good morning, everyone. Asiya Merchant here, Citi Research. I lead its day 3 of Citi's TMT Global Conference. I'm very pleased to have Xerox' management here with me Louis Pastor, the CEO; and Chuck Butler here, the CFO. This is an interactive session, so I do have some prepared commentary. And if you have any questions, I would just request that please bring -- please raise your hand, we'll bring the mic to you.

So Louis, let me just start off. Maybe I'll turn it to you. I do have some prepared comments he just asked -- I just want to understand about the revenues, right? I think that's been a key focus for a lot of investors. -- you're talking about revenue stabilization here. Could you just -- that has been a key priority for a lot of investors, and I know it's for you as well. So -- when investors monitor sort of the demand environment out there, we're looking at enterprise budgets getting tightened year or maybe spreading thin across server, storage, networking. When you think about print hardware and the fact you're guiding to revenue stabilization, help us understand why that's the case?

Yes, happy to. So maybe let's start by taking a little bit of a step back and looking at our business on the whole. So roughly speaking, I think we guided to, what, $7.6 billion this year of revenue. Let's just use really round numbers, call it, $7.5 billion. It's basically $1 billion of IT solutions and digital services. roughly $1 billion of production in print and then $5.5 billion of what you would think of as almost like traditional office print. Okay? And I use the term office there, but I don't love the term office because our hardware is in a multitude of environment. So it's not just offices, but it's actually retail locations distribution warehouses, manufacturing facilities, but call it the workplace, and that's predominantly what you think of as the low-end and midrange machines. So A3 -- A4 and A3. That is, I think when people look at our business and the industry, that's probably the area of facing the most secular headwinds, and it's also the biggest part of our business, okay? And I think when you talk about revenue trends and competition for budgets in the IT space, again, that is probably the area of largest concern, not just because it's the biggest part of our business, but because it's probably the area, again, with the most sort of secular headwinds. So how do we think about stabilizing that part of our business and also, frankly, getting it to growth? And how do we do that? And this is where we talked about this gain share mix shift strategy. And this is where the gain share component of it is so important because the only way to grow in a market that's secularly challenged is to take share from others. So -- how do we actually take that share? Why will we be able to take that share? And this is where the Lexmark acquisition is so critical because it's not just about scale. That was a very strategic acquisition, and we acquired a set of capabilities that enable us to differentiate in the 1 area of this market and of this industry that can actually move the needle. So what do I mean by that? So by acquiring Lexmark what we acquired was a full -- the full end-to-end control of our technology stack. So from early design, development, manufacturing, delivery, installation, service of our hardware, our print hardware for the office space end to end. Now why that enables us to -- so we are -- there's only 1 other player in the industry has that, okay? And what it enables us to do is differentiate on the service experience. So everybody in this industry because there's been virtually no consolidation, it's a highly commoditized, everybody is competing on price, okay? There's all you can compete on a reliability and price. And price is something we will never alone be able to compete on and to win on because we're not Japanese, we're American, and we need to operate with 10% operating margins, not 2% to 3% operating margins okay? So -- we -- the reason though that now we can take these set of capabilities, this end-to-end control and compete differently is because if you think about it, the laws of physics, okay? Prevent you from taking the cost of the equipment to 0. The laws of physics prevent you from taking the cost of the supplies to 0. These are physical products in a physical world. You have to make them. You have to send them places, right? The laws of physics do not prevent you from bringing the cost of service to 0. And the thing is everybody in this industry sucks at service because it's hard, and you have to build up these very expensive fleets of technicians and engineers who go out in the world and show up at a customer location and fix the machine when it breaks down, okay? But these machines can operate a whole lot more like your dishwasher or your washer dry it, which is to say, yes, you have to put detergent in and you have to clean the lint filter, but otherwise, you're going to buy it. And for 7 to 10 years, it's going to run and it's going to work. And when it doesn't anymore, you're going to replace it. Now in our case, you're going to replace it before it actually breaks down rather than when it breaks down to avoid that. But then, okay, so how do we actually make it so that these machines do that? So one is we have -- we buy the very electrical and mechanical engineering of our products, the design and development. We actually make products that come off the manufacturing line far more reliably and that perform far more reliably than anybody else in the industry. But on top of that, because of the sensors that we build into the technology and the fact that they're all connected, we have more data about how they perform than anybody else in the industry because we have more sensors, and we have a more robust fleet management capability. And now what we can do with AI is build algorithms. We used to have to do this with people, with data scientists, who needed to learn the industry and study the inputs that were coming back now, you can do it with AI. What we can do with this data that comes off the machines and now digitally intervene to proactively and predictively maintain the machines out in the world means we don't have to maintain this service fleet and the customers have a better experience. So now you have a better customer experience, so that's the reliability component. But we can actually use this to fundamentally change the economics of the model and to compete much more effectively on price, which is ultimately in this highly commoditized space, what the economic buyers are making decisions on more than anything else. Service actually is very, very important the experience of end users is very, very important, especially at the high end with your largest customers who have global deployments of our technology across many countries and huge volumes, but it's better on both ends. And that, for us, when we look at our portfolio end-to-end in that way and we think about revenue trends moving forward, this is why we're so confident in our ability not just to stabilize this biggest part of our business, but actually grow it because this will enable us to take share from others because it's the most differentiated value proposition in the industry while competing most effectively on price. And the reason why others in the industry won't do it is because they've built up -- so one, they don't own their technology end to end. There's only one other player that does and that player that does sells so much through third parties, other OEMs and partners, and they've built their business on top of those other people having to buy parts and supplies and carry all these replacement items. It's actually like not in their immediate near-term economic interest to do it. It requires a change in their model. And this part of their business exists solely to generate cash for investment in other parts of the business. So they're not interested in creating near-term profitable headwinds for long-term profitable growth, not here.

Okay. All right. So that's sort of where you're most focused on?

I think it's the biggest -- look, it's the biggest part of our business and ultimately gaining share there and while expanding our margins is the nearest term path to getting to a more sustainable leverage profile, which ultimately is the nearest term path for significant equity accretion and value creation for our shareholders.

Right. And you did talk a little bit about pipeline, right, that you were seeing some momentum. So is all these initiatives that you talked about focus on services, reflecting that in your pricing and your go-to-market. Is that what underpins the confidence that you're talking about the print pipeline momentum looks like it's improving. Is that what -- Okay. Is that about [indiscernible]?

100%. So it's like this value proposition, this vision for this part of the industry is part of what's fueling the increase in our pipeline. And what we're seeing in our pipeline as well is we sort of differentiate between kind of existing customer engagements and renewals versus competitive takeout knockout. And what we're seeing is this value proposition, it resonates in both. But it's allowing us to grow our pipeline and mature the pipeline for competitive knockout, and we're starting to see conversion there as well. And so those types of engagements you get a verbal on a win. We just got 1 more recently, like in earlier this week. That's a $5 million a year Global Managed Print Services engagement. But going from verbal to signing to actually installing equipment, verbal this quarter, it will sign next quarter. the rollout and the transition will be into next year. Like it takes time for that to convert through to revenue.

Okay. And is that -- and again, given that even the print market, like there is various segments, right? I mean there's the A3 market going through some declines, you have production print. So I don't know if these wins and the market share gains that you're talking about. Is it across all those? Or are they -- are you focused like on maybe certain ranges within the print market?

It's a great question. I would say predominantly what I was just talking about was A4 and A3 at the low end. And I would say there, there's definitely a mix shift as well sort of from the midrange to the low end -- and we see that and we see it especially with partners going through the channel, and there's a lot of reasons for that. That -- but everything I was just describing was not really about production. In production, our strategy is a little bit different because the economic buyer is different. The market dynamics are different. There's actually secular growth. There, it's much more about having the broadest sort of end-to-end portfolio and offerings and helping our clients who are predominantly commercial printers actually grow their business. And so expanding into new segments and verticals. And there was a great example of this actually more recently in the announcement we made about our new partnership with Zicon, where our technology is actually embedded in their machines and then we're going to be going to market together with them as well. But packaging and labels is, I think, a $1.8 billion market that's going to grow 15% a year for the next 7 years. So there's -- those areas of secular growth and being positioned to capture them the best where we don't really need to be vertically integrated because the economic buyer isn't just buying on price, they're buying an end-to-end solution that you need to be able to not just bring them the technology but deliver and provide the software that makes it run most effectively and efficiently with as little labor as possible. But as a high volume as possible, you need to have the distribution capabilities to ensure they have supplies and parts and because these machines are running constantly, and you have to have the ability to service it. That's where the end-to-end value proposition is very, very powerful.

And so just -- so again, back on the ones where you are gaining share. on the entry side. So there's a little bit of a mix shift like sort of happening from the mid-range, maybe even the high end towards more of the entry products. How does that market share gains? But then what about the margin profile across the mix shift?

It's another great question. So because the midrange historically, you had very profitable equipment sales and post sale. And in the A4 space, that's not the dynamic. You have -- in some cases, you may sell at a loss the equipment, but I think largely think of it as kind of flat like you basically sell the equipment at very little to, if any, margin. But the post-sale streams are 70%, 80% gross margin as opposed to something that was more balanced in the midrange. And so as this mix shift takes place from the mid to the A4, so from A3 to A4, there is a headwind on equipment margin because we're going to be placing more machines that come with effectively no margin. But over time, actually, the overall margin profile of these engagements with customers is actually higher.

Okay, the lifetime value. Okay. Right. And then there is a lot of concerns also on aftermarket whole sales? Like how do you kind of prevent that -- how do you kind of make sure that you maintain your margins here in post sale.

I'm going to let Chuck speak to that one because Lex had refined this model, yes, quite, quite well.

Yes. Post sales is the lifeblood of any imaging company, right? We want to get printers in the field and the installed base, and we want to keep them print for a long time because that's what drives the highly profitable annuities on the back end. Louis mentioned the difference in the margin profile between an A3 and A4, A4 especially is indexed toward that post-sale margin. You're in the 70%-plus range. And so it's important that we keep that, especially when you're placing your hardware at neutral to maybe even slightly negative in some places, you have to make sure you keep the post-sale annuities coming at the high margins. The way Lexmark did it and what Xerox acquired with that acquisition was they had really good security chips that they put inside their printers that allow only authentic supplies to work inside these printers for the first 5, 6, 7 and 8 years of a printer's life until an alternative comes in and cracks the security chip and then they bring an alternative to the market. We don't see that for a long time, Lexmark never has. They've had best-in-class in terms of the security chip that they put in place. And then once that happens, it's time to refresh your printer anyway. And then we put a new printer out there with the new chip inside it.

Okay. All right. talking about Lexmark, I know you guys have had some savings that you've identified as part of the synergies as you're bringing them in. Just help us understand like the targets for those synergies have increased. I think in the more recent one, you talked about 350, I think, in synergies. What's underpinning that? I mean why is this higher target? Why are you laying out a higher target? What are you seeing that's better than what you thought initially?

Yes. You may start.

Well, let me -- let me unpack maybe integration a little bit. So we closed on the Lexmark acquisition until July 1 of last year. So first 6 months post acquisition, which is actually the second half of last year was very much about sort of like core operational integration. Let's go get every dollar of duplicative cost out of this combined organization, right? And so -- that was the first 6 months. And by the end of last year, even within those first 6 months, we exited the year we had done -- I think the number was $146 million of run rate cost out just from the first 6 months. So of that $300 million that we had originally said. Great. Second 6 months, so the first 6 months of this year, very much about unifying the go-to-market. By the way, a lot of costs come out there, too, because what we had for the first 6 months was you can't share customer information ahead of an integration. So ahead of a closing. So you can't do that much mapping of your account coverage and things like that. So that's where the second 6-month period was let's take what was a legacy Lexmark sales force selling legacy Lexmark offerings to legacy Lexmark accounts, right? And the same thing we had on the Xerox side. We'll put them together and have a unified sales force with 1 coverage model, right, selling 1 portfolio. That's great. A lot of costs come out there, too, because you don't need as many sellers when you do that. So that was good. Now the second half of this year, which is kind of the third 6-month period is very much about transitioning product. So going from the OEM sourced kind of A3 product to our own internally developed technology, and I talked about the strategic importance of that because of the end-to-end value proposition. But again, a lot of costs come out as you do that because you're capturing margin on margin, and you've got the gross margin expansion because it's not sourced product. So each of these different periods, you have significant costs coming out and in each case, as you're doing the work, you identify new opportunities. So you set a target based on what you know at a moment in time, and for us, there's some conservatism there. And then as we go through it, we identify new and greater opportunities. And so as we think about next year, so that's sort of the genesis of how we got to a greater number for this year. But as we think about next year, we'll obviously get the full flow-through of every action that we've taken this year, right? But on top of that, we still have opportunities with respect to systems and culture and even those will generate more savings as we go forward. So I would say our confidence not just on hitting the number that we have now sort of taken up, but even what the benefits and impacts will be as we go forward continues to go up.

The only thing I'll add to it is, I don't think that we are surprised that there's more synergies there. That was the genesis of the question was what's changed in our thinking. I remember going through the process, I started out as Lexmark's CFO and then after the acquisition became the CFO of the combined company. And I remember going through that, and I was talking to Greg and I said, I think the synergy is $400 million plus. And Greg, so that's a huge number. There's no way, and I said that's kind of what I see here. So I don't think we're surprised. I think sometimes you have to start exercising the motion making sure you understand all the processes and how they align and then it's starting to come back to what we had originally thought anyway. But you go out with originally, this is what we have clear line of sight to right now. that's what we lead with, but now we're starting to see the other opportunities unfold.

And there are some investments though alongside as well, right, because you do have these cost savings, but then you're investing, whether it is, I think you talked a little bit about bringing manufacturing to Mexico. So just walk us through like when you talk about what impacts your income line or a net income line or operating income line, EBIT line, how are you thinking about those savings relative to the investments, so the net impact to the operating income line.