Q3 2024 Xerox Holdings Corp Earnings Call

John Bruno

As Steve noted, this quarter equipment sales fell short of expectations for two main reasons. We had higher expectations of global product launches that were impacted by poor product transition planning and execution. Through our postmortem, we’re taking deliberate steps to optimize price and marketing programs by specific go-to-market areas to ensure improved demand to supply chain readiness that will complement market-specific launches.
We also had higher expectations of our sales productivity initiatives in Q3, given the improvement we realized in Q2 after the Q1 organizational changes. We were essentially flat quarter on quarter on activity basis, and that was not sufficient to offset the reduction in sales headcount. We have analyzed these points of friction from lead generation, quote to order, and order to install. We’ve aligned process improvement teams, and we are course correcting these areas of underperformance.
We are seeing a positive impact of that work, albeit more slowly than originally forecasted. While productivity stalled in Q3, we do expect these operational process improvements to drive sales productivity higher in Q4 and into 2025. We make no excuses for our underperformance in equipment sales, and these operational misses overshadow broader strategic improvements elsewhere.
On balance, I’d like to highlight other strategic areas of reinvention where we are seeing the forecasted results of our efforts. Starting with geographic simplification, this quarter, we transitioned two additional countries, Hungary and Bulgaria, from a direct to an indirect distribution model. We also signed an agreement to sell our paper business in EMEA to a leading global paper supplier, Antalis.
These transactions and others expected in quarter four allow us to provide partners in EMEA with the products and services clients demand most and with greater operating efficiency.
Moving to offering simplification, with the recent launches of our A4300 series and refreshes of our A3 AltaLink and PrimeLink products, we are streamlining our offerings in the office and light production categories. For example, the updated 300 series printers share a common engine with our 400 series reducing spare parts SKUs by 20%.
Software enhancements included with the updated AltaLink products eliminate the need for physical installation kits and simplify the installation process. And our new PrimeLink machines offer a wider range of engine speeds, features, and capabilities, improving competitiveness and marketability. The consolidated configurations and enhanced capabilities of these respective products make them more competitive, and improved order and inventory management, as well as marketing efficiency.
Additionally, we continue to refine our production print equipment portfolio. We’ve engaged with leading print engine manufacturers to broaden our production print ecosystem. And this quarter, we announced our planned collaboration with Taktiful Software to integrate their digital embellishment technology for our clients. We anticipate revealing more partnerships within the production print segment in the coming year as we invest in a platform featuring services-led and software-enabled products.
For example, our pipeline includes cloud-hosted versions of FreeFlow Core to include an AI framework for workflow automation, application expansions into adjacencies like packaging and labels, as well as SaaS-based offerings. And finally, operating model simplification. Our global business service organization, or GBS, is performing as intended and finding ways to leverage a simpler operating model to drive long-term enterprise-wide efficiencies.
A key driver for long-term reinvention savings will be the optimization of our technology and support infrastructure. Last quarter, we signed agreements with multiple technology partners to transform our operations with technology-led process improvements. And building on that announcement, this quarter, GBS restructured an agreement with a key business process outsourcing partner, creating a mutually beneficial incentive structure to save costs through operating efficiencies.
This new service structure is expected to yield a double-digit improvement in contracted rates and will serve as a blueprint for driving sustainable organizational savings. Collectively, these savings are expected to drive more than $700 million of cumulative gross reinvention savings over the next few years, putting us on a path to achieve double-digit adjusted operating income margins over the course of our reinvention. We will continue to exercise balanced execution in the implementation of these initiatives to minimize operational disruption.
And finally, revenue mix. Beyond cost reduction, an equally important tenet of our reinvention is an improved revenue mix that enables better client outcomes. To that end, two weeks ago, we announced the acquisition of ITsavvy. The acquisition of ITsavvy expands our portfolio of IT service offerings and our addressable market coverage.
With ITsavvy, we acquired an accomplished management team with a demonstrated ability to deliver positive results through its suite of lifecycle deployment and managed services across IT infrastructure pillars of cloud hosting, network and security, collaboration, and the hybrid workplace. We expect to leverage this platform and improve scale to drive increased penetration of IT services across a client base who increasingly look to Xerox to provide these types of solutions.
The acquisition will be funded with cash on hand and a combination of seller notes. We expect to quickly realize more than $15 million of cost synergies as we consolidate IT service operations and adopt ITsavvy’s operating platform. Along with revenue synergies from expanded client penetration, we expect an enhanced IT services offering.
This will improve client satisfaction and stability in our core print business, as clients are able to realize more value from a services partner that can be a one-stop shop for their most critical print and IT infrastructure needs. The acquisition is expected to be immediately accretive to earnings per share and free cash flow, and we look forward to welcoming the ITsavvy team to Xerox at the end of this year.
I’ll now hand the call over to Xavier.

Xavier Heiss

Thank you, John, and good morning, everyone. In Q3, total revenue declined 7.5% in actual currency and 7.3% in constant currency on a year-over-year basis. As Steve described, equipment revenue this quarter fell short of expectations. However, the trajectory of post-sales revenue improved, as expected, reflecting growth in digital and managed IT services.
Turning to profitability, gross margin was flat year over year as higher freight costs, unfavorable equipment mix on lower print volumes were offset by the beneficial impact of reinvention savings on favorable currency effect. Adjusted operating margin of 5.2% was 110 basis points higher year over year due principally to reinvention-related cost reduction on lower incentive compensation expense, partially offset by the effect of lower revenue on gross profit.
Total operating expenses in Q3 declined $53 million year over year, or more than 10%, reflecting headcount on other non-labor expense reduction associated with recent reinvention action. Adjusted other expenses net were $55 million higher year over year due to an increase in non-finance interest expense reflecting higher interest rate on a lower portion of debt allocated to our financing business. The increase also reflects a gain on the sales of non-core business assets recorded in the prior year.
Adjusted tax rate of 27.7% compared to 7.2% in the same quarter last year. The increase in rate reflects non-recurring tax benefits associated with uncertain tax position on the establishment of a valuation allowance against the current year of deferred tax asset. Adjusted EPS of $0.25 was $0.21 lower than the prior year, as the benefits of higher adjusted operating income on a lower share count were more than offset by higher non-financing interest expense, a higher tax rate, on the prior-year gain on sales of non-core business assets.
GAAP loss per share of $9.71 included an after-tax non-cash goodwill impairment charge of approximately $1 billion, or $8.16 per share, on a charge to tax expense related to the establishment of a valuation allowance of $161 million, or $1.29. Regarding the goodwill impairment, it was determined, following a sustained period in which our market value fell below book value, that the fair value of our print and other segment has fallen below carrying value. The valuation allowance was established against deferred tax assets that are not expected to be realized in certain international jurisdictions.
Let me now review revenue and cash flow in more detail. Starting with revenue, Q3 equipment sales of $339 million declined around 12% in actual and constant currency. The effect of backlog fluctuations in the current and prior year on reinvention action accounted for around 400 basis points of the decline. The remainder of the decline mainly reflects the delayed global launch of two new products, lower-than-expected improvements in sales force productivity, delays in the timing of installation associated with Hurricane Helene, unfavorable mix on large production equipment sales in the prior year.
Total equipment activity increased 17% year over year due largely to entry-level equipment. Entry revenue declined despite higher installation due to an increase in the mix of low-end black-and-white multifunction printers. Mid-range installations were slightly lower year over year, but revenue declined faster than installations due to unfavorable A3 product family mix.
High-end revenue decline reflects the ongoing evolution of our production print portfolio on offering rationalization action taken this year. Post-sales revenue of $1.2 billion declined mainly 6% in actual and constant currency, a roughly 200 basis points sequential improvement. Excluding a reduction of non-strategic, lower-margin paper on IT endpoint device placement on the effect of other reinvention actions, post-sales revenue declined 2% in actual currency, reflecting lower activity, partially offset by double-digit growth in digital and managed IT services revenue, as well as higher services pricing.
Consistent with past quarter, I will provide additional commentary to help clarify underlying trends in our core businesses, which include the effect of backlog fluctuations on reinvention action. For Q3, lower sales of non-strategic paper, IT endpoint device, and decline in finance revenue, reflecting the change in our finance receivable strategy, contributed around 200 basis points to the decline.
Other strategic actions taken to simplify our business and improve profitability, including geographic and offering simplification, contributed around 200 basis points to the decline. Finally, the effect of equipment backlog fluctuations in the current and prior-year quarters contributed less than 100 basis points to the year-over-year decline in total revenue. When these impacts are removed, total revenue declined low single digits in actual currency consistent with the prior quarter.
Let’s now review cash flow. Free cash flow was $107 million, lower by $5 million year over year. Operating cash flow was $116 million, $8 million lower than the prior-year quarter due to lower contribution from working capital on higher pensions payment, partially offset by higher adjusted operating income on cash from finance receivable. Investing activities were a use of cash of $7 million compared to a source of cash of $25 million in the prior year, largely reflecting a prior year’s sales of non-core business assets.
Financing activities consumed $74 million this quarter, reflecting $42 million of net debt repayment on dividends of $36 million. Turning to segments, in Q3, XFS revenue was down around 10% year over year due to lower finance income on other fee revenue associated with the decline in our finance receivable balance, partially offset by higher commission from the sales of finance receivable assets in line with our forward-flow strategy.
XFS finance receivable balance declined roughly 3% sequentially and 23% year over year in actual currency, mainly due to XFS change in strategy to return its focus to captive-only financing solutions. Q3 XFS segment profit increased by $9 million as a reduction in bad debt expense on lower operating expenses more than offset reductions in gross profit associated with lower revenue. Print-on-order revenue fell roughly 7%, and segment profit increased by around 5% for the reasons previously mentioned.
Focusing on capital structure, we ended Q3 with $590 million of cash, cash equivalents, and restricted cash. Around $2 billion of the remaining $3.3 billion of outstanding debt support our finance assets, with the remaining debt of $1.3 billion attributable to the non-financing business. I now provide an update on reinvention savings. For 2024, we expect to realize close to $200 million of incremental gross cost savings.
Since the prior quarter, we have operationalized an additional $20 million of savings, much of which will be realized in 2025. We maintain a pipeline of more than $400 million of gross cost savings that are expected to be realized by 2026 with around $125 million related to actions already implemented or expected to be implemented in the near term.
Finally, I will address guidance for the remainder of the year and comment on expectations for 2025. All 2024 commentaries exclude the effect of the pending acquisition of IT savings. For revenue, We now expect a decline of around 10% in constant currency versus a decline of 5% to 6% in constant currency previously. Around 75 basis points of the decrease in guidance is attributable to incremental effects associated with intentional reduction in non-strategic revenue. The remainder of the decline reflects the delayed launch of two new products on lower-than-expected self-force productivity improvements.
Full-year revenue guidance now includes around 625 basis points of effect from non-recurring headwinds associated with backlog fluctuations in the prior year on current years, reduction in non-strategic revenue on other reinvention actions. For the year, the roughly 4% of expected year-over-year decline in core business revenue indicates a mid-single-digit decline in normalized equipment sales on a low to mid-single-digit decline in normalized post-sales revenue.
We expect a return to revenue growth in 2025, supported by the inclusion of revenue associated with the pending acquisition of IT savings, new product launches, improved sales productivity, and growth in digital and IT services. Inorganic revenue benefits from ITsavvy are expected to more than offset reduction in revenue associated with ongoing reinvention action, as the impact of strategic reduction in revenue are expected to be lower in 2025 than they were in 2024.
For full-year adjusted operating income margin, we now expect a margin of around 5% versus our prior outlook of at least 6.5%, reflecting the effect of gross profit decline associated with a reduction in our equipment revenue outlook, and to a lesser extent, delays in the implementation of certain cost-reduction initiatives to 2025.
Due to lower-than-expected revenue in 2024, we no longer expect to grow adjusted operating income $300 million above 2023 level by 2026. However, we continue to expect growth in adjusted operating income on a return to double-digit adjusted operating income margin over the course of our reinvention. In 2025, we expect growth in adjusted operating income on margin supported by a return to revenue growth on the benefit of additional growth cost savings associated with cost reduction action implemented in 2024 or expected to be implemented in 2025.
Finally, full-year free cash flow guidance was reduced from at least $550 million to a range of $450 million to $500 million, reflecting the previously noted reduction in adjusted operating income guidance. In summary, 2024 has presented unexpected challenges. However, in Q3, we grew adjusted operating income on margin year over year despite a reduction in revenue, a trend we expect to continue as we implement further reinvention action aimed at simplifying our organization on driving closer alignment to the economic buyers of our products and services.
We’ll now open the line for Q&A.

Operator

Ananda Baruah, Loop Capital.

Ananda Baruah

Yes. Hey, guys, good morning. And thanks for taking the question. I guess two, if I could, on the product. The first is on the product delay and on the sales productivity dynamics that you guys talked to, and you did give a lot of good context around it. I guess the question is, can you — if you mentioned, I missed it. Specifically on the product delay, what was it that you guys saw as occurring?
And I guess, sort of in that context, what did you learn that can have — that can sort of have sort of these dynamics not pop up again? And then I guess also on the sales productivity, any greater specificity around — what actually occurred that surprised you guys that sort of led to the diminished sales productivity? And then I just have a quick follow up as well. Thanks.

Steve Bandrowczak

Hey, Ananda, it’s Steve. Thank you for the question. And I’ll turn it over to John in a minute for some specifics, but I just want to remind you, look, the reinvention is a multi-year journey. And inside that multi-year journey, the ultimate strategy is to get to sustainable revenue growth and get to double-digit operating income.
As part of that, we’ve made some progress in each of the areas. You think about what we’re trying to do in our revenue mix. ITsavvy gives us a great platform for seeing IT services growth over the next couple of years. We also saw good impact of operating expense reduction quarter over quarter and year over year. My point is that inside of reinvention, we have multiple workstreams, some of which will exceed, some of which will be set back, but we will ultimately get to our end goal.
Specifically to the product launch and to revenue in terms of productivity, we made very large organizational changes at the end of Q1, very specifically realigned almost 6,500 new jobs in terms of new alignment, and we had a very large reduction in our workforce, which is basically the premise of what caused the reduction. We saw quarter-over-quarter productivity improvement from Q1 to Q2 and from Q2 to Q3.
John, other color you want to give?

John Bruno

Sure. Ananda, let me go start with the product transition issue first. It’s a forecasting issue more than anything else. When we look at carried inventory of predecessor products, the timing of the release of new products, and the forecasting of that mix. There’s a lot of intricacies between the demand to supply signaling. We had higher expectations that we were going to flush through the older product and then the timing of the release of the new product, not only to our direct business, but also into the channels.
As that started to get subsequently through the quarter, we would have a decision to make. And the decision, clearly, what we don’t want to do is leave a lot of working capital and inventory behind. We want to sell through and make those transitions. That is a skill and something that we typically do as a company better than we perform. And a lot of that is attributed to the points that Steve has made.
We just did not have a really good sense of the timing of each of those issues. And it left us with a little bit of time towards the end of the quarter to actually make the effective change. At the start of the quarter, we were more bullish that in the last six weeks, we would have a higher ramp than we actually received. And so that really comes down to the transition period between the demand to supply signaling.
And then I think Steve addressed the issue on sales force productivity. Coming out of — we look at it from a quarter-bearing sales headcount perspective. And we were down double digits in the number of sellers year on year coming into the year. And we’ve settled that down with new territory assignments, new remapping, new account coverage and all of that. And as all of these things come in, that really also comes down to the forecast and the timing and the knowledge of your clients.
And a lot of that, we saw, which was a more aggressive view of where we thought equipment sales revenue would be at the start of the quarter. And then as the quarter continues to progress, we were taking a lot more of our upside and replacing it with some of the forecast at the beginning of the year, which is a good thing on balance. But when you’re as close to the pin as we are, you just need a few misses here and there. And it’s the difference between tens of millions of dollars and nothing more on that when you really come down to it on a quarterly basis.
So really, what gives me the confidence is, is when I look at that, we had — we did not have a good Q1, as you know. In Q2, we had a much better productivity basis from an activity level. When I looked at Q3, I had expectations that Q3 was going to build off of Q2, and it was essentially flat over Q2.
And so we dissected the programs necessarily to what caused that flatness. We certainly didn’t go down, but it kind of gives me confidence that we’ve stabilized. So now it’s all about the incremental activities that we’re doing around the sales force, demand generation, and all the forecasting accuracy that gives us the confidence that we’re moving forward.

Xavier Heiss

Yes, Anand, I also would like to —

John Bruno

Yes, we’re all jumping on this one.

Xavier Heiss

Yes. Sorry. Just also to [introduce] one point, so you know that our revenue is made of [ESA], which is roughly 25% of the total revenue. 75% is coming from post-sales. So when you look at it during this year, the ESA revenue trajectory from a growth point of view, quarter over quarter, sequential growth, the trajectory has improved, despite the challenges that, generally, Steve articulated in Q3. It was still an improvement versus what we have seen in Q1 and Q2.
On the post-sales revenue, we are also pleased to see that the post-sales revenue stream, despite and related to all the reinvestment activities that we are driving, is improving quarter over quarter. So the key message behind this is that the reinvention play is at play currently. And we are delivering, specifically on the post-sales line. The nature of the equipment revenue is that it could be cyclical. And here we have an example, and we face it during quarters.

Ananda Baruah

That’s all super useful context, and I really appreciate it. So just a quick follow up to that, and then I’ll see you on the floor. Any sense of sort of macro or the general market demand backdrop? Was it a bit softer? And if that was also a contributor to the sort of, John, the flattening, Q over Q, and sort of efficiency progression — sales efficiency progression?

Steve Bandrowczak

Yes, no, I would say minimal. Most of it is just execution issues.

John Bruno

About the same. I’d love to blame the macro. It’s about the same.

Ananda Baruah

Got it. Thanks, guys.

Operator

Erik Woodring, Morgan Stanley.

Erik Woodring

Great. Thanks so much for taking my questions this morning. I have two, if I may. Maybe just to start, Steve, if we step back, you guys are doing a lot, right? You’re exiting businesses, you’re changing the delivery model in several regions, you’re reducing headcount, you’re launching new products, you’re acquiring new businesses, and this is all happening at the same time while your end markets do face demand headwinds.
That’s tough, and I credit you for taking all these actions. But as I think about your preliminary comments on 2025, you’re setting an expectation for revenue growth, operating income growth, and margin expansion. And I’m just wondering why you think that is the right expectation to set today, given everything that’s happened in the background, and obviously given some of the challenges that you run into this year, which some you could theoretically face next year as you continue to go through this reinvention.
So just — maybe the question is, amidst all of these changes and moving pieces, what gives you the confidence to say we can get back to growth and margin expansion next year? And then I have a follow up, please.

Steve Bandrowczak

So thanks for the question. I got to give you a couple of things. First of all, it’s the management team that’s done it over and over through the history of our careers. We’ve got pattern recognition that the things that we’ve put in place, we can see the future; things you can’t see internally that we see around the program execution, around the signs of what we’re building and how we’re executing.
So overall, if you think about the reinvention, very similar to [owning it], by the way, where we had 10, 11 workstreams. You see seven or eight, they’re going to exceed; three or four, they’re going to under-exceed expectations. But overall, you deliver the end results. And so what we’re seeing is the strategical things that we’re doing.
Go back to what we did with our free cash flow, what we did with PARC. All these things are very specific to set up the strategic long-term revenue growth and get us to the operating income that we desire. As we look at each of the workstreams, we’re seeing it on the expense line, the cost coming out. You see it definitively. You see on the acquisition, working that in the background to be able to acquire ITsavvy.
You see what we’re doing in terms of dramatically changing our sales coverage and what’s that doing in terms of building new pipeline, building new customers. And so I’m confident that what we’re doing is working. It’s not linear and it’s not straight.
That’s the challenge with trying to do this, taking a three-year program and then looking at it in an isolated quarter. But I can see the long-term returns over the next couple of years and what we’re trying to do, the evidence and the things that we’re trying to do, and more importantly, the pattern recognition of everything we’ve done across our careers that says we’re on the right track.

Erik Woodring

Okay, super. Thank you, Steve. And then maybe just as a quick follow up or just point of clarification, so you guys have adjusted EBITDA margins close to 9%. I believe that just with the disclosures that you provided on ITsavvy, EBITDA margins are around 7%, so you guys talked about this asset being dilute, excuse me, accretive immediately.
Can you just help us understand some of the math that you’re getting to that accretion in terms of either revenue synergies? I know you alluded to some cost synergies, but if you could just kind of in totality help us understand the assumptions around this being accretive, that would be super helpful. Thank you.

Xavier Heiss

Erik, I will give you some insight on the ITsavvy, the size of the acquisitions, the revenue, and also the expected synergy here. If you remember in the press release, we mentioned it in the earnings call as well. This is a company which is around [$450 million] in revenue, LTM, and around $30 million in EBITDA, as they are currently here. We’re expecting to deliver around $15 million of synergy here.
So when you include this year, then you will see what type of EBITDA they can bring on the EBITDA margin versus the revenue, which would be above 9% here. So it will become accretive immediately versus our current number.
They are also — from a pure free cash flow point of view, they will be accretive to us there. And obviously, EPS will follow directly here. So a point I want to flag there, from a gross margin point of view, so business model is different, less gross margin, but also less OpEx. So at the end of the day, EBITDA is a metric to look at bottom line. This is what we will see, and it will drive an improvement in our financial that we will capture immediately, so starting as soon as this transaction is closed, which we are expecting to happen quite soon.

Erik Woodring

And Xavier, maybe just one final point of clarification. As we incorporate ITsavvy into the model, is that — I assume it flows through services, maintenance, and rentals line, just as we think about our model. I just want to make sure we’re kind of incorporating that correctly. Thanks.

Xavier Heiss

Yes, we will distribute it in the same way we do it today. So there is an element of hardware, which is going in a different line, but the bulk of the revenue here. David on the team — the IR team can help you with this one on how we will do the pro forma, but it is very similar to the way we will do it.
As you know it as well, next year, we are planning to have a segment reporting, and this is an important point because at the end of the day, ITsavvy is just a proof point that our reimbursement strategy is at play. With ITsavvy, this IT and digital services here for the total company will become 15%.
So we will move — we’ll jump by 5%. Currently, this is 10%. We have an additional 5%. And remember, the trajectories that we have guided for is that during the re-invention program, we want to achieve 20% of revenue, which are not print related. And this is literally a first step in this direction, significant step here.

Erik Woodring

Awesome. Thank you so much.

Operator

(Operator Instructions) As it appears that we don’t have any further questions in the queue at this time, I’d like to hand the program back to Steve Bandrowczak for any further remarks.

Steve Bandrowczak

Thank you. Recapping today’s call, equipment sales fell short of our expectation this quarter and for the year, but we are confident we have identified and addressed the factors that contributed to these shortfalls. We expected an improved equipment revenue trajectory and the pending acquisition of ITsavvy to drive a return to revenue growth in 2025.
This quarter reminds us no single performance indicator or quarterly results defines our reinvention. Consistent progress in operating efficiencies, client perception, services signings, and expected sales force productivity gains gives us confidence we are on the path to enabling long-term profitable growth through reinvention. Thank you very much for attending this call.

Operator

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.