Yahoo Finance Xerox Holdings Corporation (NASDAQ:XRX) Q1 2024 Earnings Call Transcript
Xerox Holdings Corporation (NASDAQ:XRX) Q1 2024 Earnings Call Transcript April 23, 2024
Xerox Holdings Corporation misses on earnings expectations. Reported EPS is $ EPS, expectations were $0.38. Xerox Holdings Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. Welcome to the Xerox Holdings Corporation's First Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this program is being recorded. And now I'd like to introduce your host for today's program, Mr. David Beckel, Vice President, Investor Relations. Please go ahead, sir.
David Beckel: Good morning, everyone. I'm David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation first quarter 2024 earnings release conference call, hosted by Steve Bandrowczak, Chief Executive Officer. He's joined by John Bruno, President and Chief Operating Officer; 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 express 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.
Steve Bandrowczak: Good morning, and thank you for joining our Q1 2024 earnings call. This past quarter, our organization implemented one of its most intense periods of structural change in recent history. As part of reinvention, we redesigned and restructured our organization from top to bottom, letting a lot of good people go in the process. This work was hard but necessary to position Xerox for long-term success as we navigate the secular challenges associated with print and repositioning our business for long-term sustainable growth. Summarizing results for the quarter, revenue of $1.5 billion decreased 12.4% in actual currency and 13.2% in constant currency. Excluding the impact of backlog reductions in the prior year quarter and the intentional de-emphasis of certain non-strategic businesses, revenue declined mid-single digits.
Adjusted EPS was $0.06, $0.43 lower year-over-year. Free cash flow was the use of $89 million, a decrease of $159 million compared to Q1 of last year, and adjusted operating margin of 2.2% was lower year-over-year by 470 basis points. Q1 results were below our expectations and are not representative of the operating improvements already observed following the organizational redesign. We experienced a short period of disruption associated with the reorganization, particularly as it relates to sales of equipment. But momentum in equipment orders and continued strength in services signings activity, along with enhanced operating visibility and speed of decisioning suggests the structural changes implemented this quarter can deliver the improved in-year revenue trajectory, operating margins, and free cash flow required to achieve our full-year guidance.
This past quarter, the employees of Xerox demonstrated the resilience and dedication required to enable a successful multi-year strategic repositioning of the Company. I have more confidence than ever that we have the right team and the right strategy in place to execute Xerox reinvention and deliver our three-year adjusted operating income improvement target. We will continue to build on early momentum following the reorganization, guided by a clear focus on the strategic priorities we established to start the year. Starting with a stronger core, a strong stable print business provides the financial foundation for investments in new digital and IT services capabilities and the strategic platform from which new services can be deployed. This quarter, we took important steps to strengthen our core business by deploying a business unit rather than geographic-led operating model.
This new model more closely aligns operations with the economic buyer of our products and services, which is critical as we navigate the risks and opportunities presented by an evolving hybrid workplace. As part of the realignment, we integrated go-to-market marketing, service delivery, product development, and engineering teams to ensure client feedback is quickly and accurately incorporated into key product and marketing decisions. We elevated a broader set of go-to-market leaders, representing key customer types to improve accountability and visibility into the effectiveness of our sales strategies, and we tasked one of the most senior sales leaders to establish a global partner ecosystem, improving indirect channel sales reach and ensuring broader access to Xerox products globally.
These organizational changes improve speed of product and marketing decisions and enhance opportunities to expand client wallet by enabling greater coordination in the sales of digital and IT services to print clients. We expect the new operating model will provide incremental tailwinds to the momentum currently observed in our services business. Print and digital services signings grew double digits again this quarter, and the revenue renewal rate among large clients remained above 100% on a trailing 12-month basis, driven by the cross-sell of digital services into existing print clients and vice versa. Our portfolio of digital services provides stability to our core print business and drives opportunities for growth as clients seek both digital and physical solutions to address their most important document workflow needs.
I'll share an example of the digital service signings we completed this quarter with a large print client in the medical devices space. At this client, we leveraged our print relationship to design a comprehensive, intelligent document process solution that streamlines and automates critical document workflow processes, resulting in expansion in annual contract value of 35%. The solution utilizes AI and RPA to digitize and classify and extract data for automatic integration with important client workflows, including the classification of device-related records, manuals, clinical records, and office documents. The solution also improves data and process accuracy while lowering the client's labor cost. This is one of the many case studies at Xerox that illustrate our ability to provide digital and print solutions that grow our share of wallet through improved client outcomes.
Moving to structural cost improvements. This quarter, we took significant steps to improve our cost structure, most notably through the implementation of reorganization that is expected to result in a 15% reduction of our employee base. Difficult decisions were made across the organization, but a streamlined employee base and simplified operating model positions us better to respond to market opportunities and provide incremental financial capacity to reinvent in our growth businesses. The financial benefit of these headcount reductions will build throughout the year with carryover benefits expected in 2025. Operating efficiency remains a focus throughout our reinvention. The newly formed Global Business Services organization will leverage advanced technologies like machine learning and AI to drive continuous improvement in productivity across the organization.
Examples already in-flight include the use of AI to optimize services pricing, reduce service technician resolution time, and improve the timing and quality of customer service responses. The financial benefit of these and other productivity initiatives are expected to grow as our business is further simplified through geographic and offering optimization. Accordingly, we took initial actions this quarter to simplify our product offering and global routes to market. We are exploring strategic options for our production, print manufacturing operations and sold or signed agreements to sell our direct operations in four Latin American countries. These and future simplification actions will be key to unlock operational savings throughout our reinvention journey.
John will discuss these actions in more detail. Finally, balance capital allocation. Capital allocation priorities for the year remain the payment of our dividend, reduction of debt, and investment in projects and acquisitions with high rates of return on invested capital. This quarter, we executed a series of refinancing transactions that extend the maturity profile of our debt. Xavier will discuss these transactions in more detail. When combined with free cash flow expected from a stronger, more operationally efficient print business, the refinancing enhances near-term flexibility to invest in growing our digital and IT services capabilities. I will now hand the call over to John to provide an update on reinvention.
John Bruno: Thank you, Steve. As Steve mentioned, we implemented a comprehensive and complex organizational redesign this quarter focused on building a stronger, more stable business aligned to the evolving needs of our clients. I'll provide context behind some of these more impactful changes, but thematically, they're all designed to provide our sales and delivery organizations more time with clients, reduce organizational complexity, streamline decision rates, and create investment capacity for future product development. The first change was the implementation of a business unit-led operating model, replacing our previous geographic focus. This solution-led model incorporates the voice of our clients and partners from initial engagement through service fulfillment segmented by the economic buyer profile.
To enable this alignment, we integrated all business groups responsible for the design, marketing, sales, development, and delivery of our products and services into one organization. We simplified organizational spans, layers, administrative reporting and supporting infrastructure formally needed to run the business. Bold changes of this magnitude designed to deliver global operating model simplification come with a high degree of disruption and we were no exception. We experienced disruption across our organization this quarter as our team acclimated to the changes, which primarily impacted equipment sales. I make no excuses for that underperformance and was disappointed with our results, as we did not meet our internal expectations. That said, I'm also proud of our team as they adapted to our new operating model better than I expected and are driving the intended outcomes to recover from the self-initiated but necessary disruption.
I'm pleased to report we are seeing early indications and positive results from our go-to-market teams in supporting functions as we improve client and partner engagement and drive sales productivity. After a slow start in January and early February, equipment orders were up double digits year-over-year in late February and March, growing at an expanded rate as we exited the quarter. The second major change this quarter was the establishment of Global Business Services or GBS. GBS will drive continuous enterprise-wide efficiencies and productivity gains by centrally coordinating internal processes through shared capabilities and platforms. GBS was built to complement and support our business unit-led operating model and its success will be measured through growth enablement and enterprise operating efficiency.
Among the more significant near-term savings opportunities identified by GBS is a reduction of the technological and administrative burden associated with a Company with hundreds of legal entities, 20 plus ERP systems, and more than a 1,000 business applications. The savings opportunity associated with a modern tech stack and a more efficient financial reporting structure are substantial and will be key contributors to our net savings target over the next three years. GBS will also be a key enabler of savings associated with a geographic and offering simplification. We began the process this quarter to systematically optimize the profitability and reach of our geographic distribution and narrow product offerings to those where sufficient rates of return on invested capital can be generated.
Starting with geographic optimization. In Q1, we sold or signed agreements to sell our direct operations in Argentina, Chile, Ecuador, and Peru, shifting to a partner-led distribution model in each country. We are in negotiation to enact similar changes to our distribution model in parts of Europe. Collectively, these arrangements will allow us greater focus on improving the print and digital services capabilities we offer channel partners who are best positioned to serve our clients in these regions. As a reminder, geographic simplification will cause a slight reduction in revenue over time as businesses are transitioned to a partner-led model. However, these actions are expected to generate absolute improvements in operating profit as the removal of overhead costs in place to support these geographies more than outweighs the potential reductions in revenue and associated gross profit.
On offering simplification, this quarter, we decided to explore strategic options for our production print equipment manufacturing operations, including exiting manufacturing of certain product families. By more closely aligning the mix of production products and services with the need of our production clients, we will have greater capacity to offer value-added services such as automation, intelligence assistance, and personalization. Our dedication to the production print market remains unchanged and we expect the rationalization of our offering to improve our differentiation and distinctiveness in this important market. Accordingly, we recently signed an agreement with a third-party provider of high-speed continuous feed inkjet machines to offer their family of inkjet presses for the printing and graphic art industries to our clients.
In summary, Q1 was pivotal for our reinvention and the actions taken this quarter solidified the path to achieve our three-year target of $300 million of adjusted operating income improvement above 2023 levels. Much of the expected improvement in 2024 is associated with the cost reduction actions already taken and improvement in sales productivity due to the timing of certain actions taken this year. A portion of the run rate benefits associated with 2024 actions will be realized in 2025, giving us visibility to another year of progress toward our three-year target. I'll now hand the call over to Xavier.
Xavier Heiss: Thank you, John, and good morning, everyone. As Steve mentioned, revenue profits on free cash flow declined year-over-year due mainly to a reduction of equipment backlog in the prior year quarter on the intentional reduction of non-strategic revenue. Excluding these factors, revenue would have declined mid-single digits. Revenue on adjusted operating profit were below expectations, due mainly to the effect of organizational change on our sales operations and constrained in a effort device, which affected equipment revenue as well as a more measured implementation of workforce reduction action within the quarter than originally anticipated. Turning to profitability. As part of our offering simplification efforts, we incurred $36 million of inventory charge associated with the exit of certain production print manufacturing operations.
All profitability commentary to follow excludes this impact. Adjusted gross margin declined 240 basis points year-over-year due to lower revenue, including the termination of Fuji royalty income on higher product on freight costs partially offset by the benefit of structural cost reduction. Adjusted operating margin of 2.2% declined 470 basis points year-over-year due to lower gross profit on higher bad debt expense reflected in part a reserve release in the prior year period, partially offset by the benefit of structural cost reduction actions. Non-selling G&A, excluding bad debt expense, declined close to 10% in Q1, reflecting the partial quarter of headcount reductions on the benefit of cost action implemented in the prior year. Adjusted other expenses net were $3 million higher year-over-year due to an increase in non-finance interest expense, partially offset by the reversal of previously accrued contingent consideration on favorable business tax settlements.
Adjusted tax rate is a 22.2% tax benefit as compared to 15.5% tax expense in the prior year period. The decrease in tax rates reflect additional tax benefit in the current quarter from the redetermination of certain unrecognized tax position on mix of earnings. Adjusted EPS of $0.06 in the first quarter was $0.43 lower than the prior year, driven by lower operating income on higher interest expense partially offset by the benefit of a lower share count on tax rate. GAAP loss per share of $0.94 was $1.37 lower than the prior year, reflecting lower revenue on gross profit, higher interest expense on non-service retirement costs, as well as roughly $100 million after-tax or $0.80 per share of asset impairment on restructuring-related charge associated with the Company reinvention, including activity relating to the exit of manufacturing for certain production equipment on the execution of geographic simplification initiative in Latin America.
Let me now review revenue and cash flow in more detail. Starting with revenue. Equipment sales of $290 million in Q1 declined around 26% year-over-year in actual and constant currency. So prior year effect of backlog reduction on geographic simplification contributed around 16 percentage points of the year-over-year decline. Equipment sales were also affected by the organizational changes implemented during this quarter, constrained in A4 devices on accelerated buying of competitive Japanese product in advance of communicated price increases for our competitor. As Steve noted, despite a slower-than-anticipated start to the year, we are seeing the intended benefit of our organizational change on equipment order, with year-over-year growth in order accelerating throughout the quarter.
Total equipment revenue outpaced installation activity due to a favorable product mix. Installation declined across all product due mainly to prior year backlog reductions on the effect of Salesforce organization changes which are now complete. Our sales revenue of $1.2 billion declined 8.5% in actual currency year-over-year and 9.3% in constant currency. Including the effect of non-strategic lower margin paper on IT endpoint device placement, which we plan to continue to reduce over time as communicated in January, as well as the effect of geographic simplification, the termination of the Fuji royalty and absence of PARC revenue, post-sales revenue declined modestly. Consistent with last quarter, I will provide additional commentary to help clarify underlying trend in our core businesses, which exclude the effect of certain non-recurring items.
For Q1, the prior year reduction in equipment backlog contributed around 400 basis points to the year-over-year decline in total revenue. Lower sales on non-strategic paper on IT endpoint device contributed around 200 basis points to the decline. The effect of no Fuji royalty revenue on strategic action taken to simplify our business, including geographic simplification, contributed another 200 points of the decline. When this combined effect are removed, revenue from our core business declined mid-single digits this quarter, mainly reflected the previously noted effect on equipment revenue and to a lesser extent declining printed page volumes. For the remainder of the year, we expect revenue, excluding the effect of backlog reduction on decline in non-strategic revenue, to be slightly higher on a year-over-year basis.
Let's now review cash flow. Free cash flow was the use of $89 million in Q1, lower by $159 million year-over-year. Operating cash flow was a use of $79 million in Q1, a decline of $157 million versus the prior year quarter. The decline was mainly driven by lower operating profit, higher use of working capital, higher payment for incentive compensation accrued in the prior year, restructuring payment associated with reinvention on higher pension contribution partially offset by higher net cash associated with a reduction in finance receivable. Finance assets were a source of cash this quarter of $188 million compared to a source of cash of $120 million in the prior year, reflecting the benefit of our forward flow program with HPS on lower origination.
Working capital was the use of cash of $135 million, resulting in a $69 million year-over-year decrease in cash, driven mainly by an increase in inventory related to a change in contractual term with a large OEM vendor. We expect inventory level to normalize throughout the year on working capital seasonality to improve during the next three quarters, in line with improvement in our operating profit trajectory. Investing activities were a use of cash of $17 million, consistent with the prior year quarter. Financing activities were a source of cash of $261 million, reflecting the issuance of $900 million of senior unsecured unconvertible notes, partially offset by around $450 million of cash used to repay outstanding notes, purchase of cap call option and paid for deferred issuance cost along with $132 million of secured debt payment on dividend of $37 million.
Turning to segment. Xerox Financial Services or XFS origination volume declined 35% year-over-year, reflecting XFS change in strategy to return its focus toward captive-only financing solutions. XFS finance receivable balance declined 10% sequentially in actual currency due to the runoff of existing finance receivable on HPS funding of XFS origination. As previously highlighted, we expect our finance receivable balance to continue to decline on normalized closer to $1 billion by 2027. In Q1, XFS revenue was down 11% year-over-year due to lower finance income on other fees associated with the decline in XFS finance receivable balance, partially offset by higher commissions from the sales of finance receivable assets. Segment profit for XFS was $18 million lower year-over-year, mainly due to higher bad debt expense reflecting a reserve release in the prior year period, which was partially offset by modestly higher gross profit on lower intercompany commissions.
Print and other revenue fell 13% year-over-year in Q1 due to lower equipment on post-sales revenue for the reason previously mentioned. Print and other segment profit declined $67 million versus the prior-year quarter, driven by lower revenue partially offset by structural cost efficiencies. Turning to capital structure. We ended Q1 with $772 million of cash, cash equivalent on restricted cash. Around $2.2 billion of the remaining $3.6 billion of our outstanding debt support our finance asset, with a remaining debt of around $1.4 billion attributable to the non-leasing business. Total debt consists of senior unsecured bonds, finance receivable secured borrowing, term loan debt on our new convertible note. During the quarter, we took advantage of favorable market conditions to refinance our near-term debt maturities, which resulted in an extension of our maturity profile at a slightly higher interest rate.
We raised $900 million of unsecured debt, comprised of $500 million in senior unsecured and $400 million in senior convertible notes at an effective interest rate of 6.6%. Proceeds were used to repay $83 million of outstanding 2024 notes on $362 million of outstanding 2025 notes and for issuance costs, including the purchase of a cap call option to raise the effective strike price of -- on the convertible note from $20.84 to $28.34. Unused proceeds from the debt issuance will be used to repay the outstanding 2024 notes in May on selectively repaid debt balance with higher rate of interest throughout the year. As a result of the refinancing transaction, we have no single maturity exceeding $400 million until 2028, greatly enhancing financial flexibility as we execute our reinvention and invest in our digital and IT services businesses.
As a result of the cap call purchase on our election of net share settlement treatment for the convertible note, economic or non-GAAP EPS dilution does not begin until our share price exceeds $28.34. Finally, I will address guidance. For revenue, we continue to expect a decline of 3% to 5% in constant currency in 2024. As a reminder, included in this guidance are around 400 basis points of effect from non-recurring headwind associated with backlog reduction in the prior year, the strategic exit or de-emphasis of certain businesses, lower paper sales, and other non-strategic actions. Excluding the cumulative effect of these items, 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 conditions.
The effect of geographic on offering simplification action taken to date are not expected to be material to 2024 financial results. As future strategic action involving product or geographic simplification are taken and become more material in the aggregate, we will update guidance accordingly. In terms of quarterly cadence, we expect sequential improvement in year-over-year revenue trajectory throughout the year. We continue to expect 2024 adjusted operating income margins to be at least 7.5%. A significant portion of the expected year-over-year improvement in adjusted operating income is associated with cost reduction already taken, including the reduction in workforce announced in January. Our pipeline of near-term operating efficiency initiative provide visibility to cost savings sufficient to achieve the full-year adjusted operating income target of at least 7.5%.
Similar to revenue, we expect quarterly sequential improvement in adjusted operating income margin throughout the year. Free cash flow is expected to be at least $600 million in 2024, aided by the reduction in our finance receivable balance. Free cash flow guidance is inclusive of around $130 million of expected restructuring payment and $50 million of incremental pension payment. In summary, Q1 results were affected by difficult prior year compare on the effect of strategic action taken to drive long-term improvement in our operation. We are encouraged by the momentum we see following the reorganization. An improved debt maturity profile and our capacity to generate substantial free cash flow position us well to fund the repositioning of our business toward opportunities with higher rate of underlying growth.
We'll now open the line for Q&A.
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