Welcome to the Xerox Holdings Corporation Third Quarter 2022 Earnings Release Conference Call. After the presentation, there will be a question-and-answer session. [Operator Instructions] At this time, I'd like to turn the program over to Mr. David Beckel, Vice President and Head 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 Third Quarter 2022 Earnings Release Conference Call, hosted by Steven Bandrowczak, Chief Executive Officer. He is joined by 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 we'll 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 Q3 2022 earnings call. I want to stop by saying how owned I am to lead this great company and team of people as we embark on Xerox next phase of growth. Since being named Xerox permanent CEO in August, I have spent a large portion of my time with our stakeholders, employees, clients, partners and investors. On a recent international road trip, I spoke with dozens of clients and thousands of employees in more than 20 different cities. The goal for my meetings with clients was to hear about their current needs what they expected from Xerox and what we can do to improve our business. It was clear that Xerox brand and legacy are meaningful, and we have earned our clients' trust over time. And from that position of trust, clients are asking us to do more to help them streamline, optimize and improve the overall productivity of their information workflows. We have the solutions today to help them do just that, including solutions like Workflow Central and digital mailroom, to name a few. And by focusing more on client solutions rather than product offerings, I believe we can maximize our relevancy and share of wallet with existing clients. We also have the reputation and credibility the right to win to build new solutions for our clients that leverage our institutional knowledge of client processes and integrate leading technologies such as AI, AR, RPA and machine learning. These new solutions can provide intelligence, value-added services and automation to workflows we already process for our clients as well as new workflows we can and will process in the future. You will hear more from me in coming quarters about how we plan to become a more customer-centric business, one that is…

Thank you, Steve, and good morning, everyone. As Steve noted, quarter three results reflect continued strength in demand for our products and services. We saw an acceleration of revenue growth in constant currency and delivered the highest rate of constant currency growth in over a year. Currencies, notably euro and British pound, negatively impacted revenue by more than 500 basis points this quarter. Equipment revenue grew for the first time since Q2 2021 in both actual and constant currency, driven by healthy demand and modest improvements in product availability. Equipment backlog of $429 million declined slightly quarter-over-quarter, but remain well above historical level as improvement in supply chain conditions did not materialize to the extent expected. We continue to expect backlog to decline in Q4 and throughout 2023 as supply chain conditions ease. Our sales revenue grew again in constant currency due to strong growth in consumables, such as paper and supplies and IT and digital services, including benefit from recent acquisitions. Consistent with prior quarter, we continue to see a strong correlation between return to office trends on page volumes. We are encouraged to see another quarter of paid volume improvement relative to 2019 levels. However, page volumes are recovering slower than we expected, as employers' effort to bring employees back to offices have been slow to gain momentum. Turning to profitability. Profits were lower year-over-year due to a slight decline in revenue at actual currency, the effect of persistent high inflation on cost of goods sold on the slower-than-expected improvement in supply chain conditions, which negatively impacted product geographic mix. These factor along with the release of bad debt reserves in the prior year drove adjusted operating income margin lower on a year-over-year basis. However, adjusted operating margin improved 170 basis points sequentially due to benefits associated with…

[Operator Instructions] And our first question comes from the line of Ananda Baruah from Loop Capital. Your question please.

Thanks for taking the question and a lot of really, really useful detail. So I appreciate that. I guess the big one for me is really [Technical Difficulty] on revenue, which has held up really well. Any customer context that you can share that would be useful, and I guess even including any sense you guys have for how much of the revenue that you've been putting up is driven by backlog relative to fresh organic demand coming on as you've been moving forward? And I guess what's your -- without giving a guide sort of a '23 guide, what would you convey as your expectation for us with regards to how you see macro kind of manifesting on your customer base and on demand? I appreciate that.

Thanks, Ananda. So as we noticed it, so our demand for product and services remain very, I would say, resilient. You understand the macro environment is challenging. But, at the same time, what we have seen is the demand for our product remains strong. Our backlog moderately reduced. It was only 8%. As we mentioned it in quarter two, we are expecting the backlog to tail and then to reduce around quarter three, quarter four. We have still seen a high demand of product, I would say, all product range and specifically a suite. And what we see from the macro on the amount is that -- we are not pursuing a reduction in IT investments related to our product. And our product support the resolution or how our customers are currently looking at addressing some of the challenges that they had specifically when you speak about workflow solution, everything which is around digital services, where we have a set of solutions that address some of the challenges. So in a nutshell, we don't see demand decrease. And the backlog is steady. We are expecting to absorb some of the backlog as well in Q4. And what we are facing currently is mainly related or the challenges we faced during the quarter was mainly related to supply chain and inflation pressure.

And then I would say the other thing is...

Yes, go ahead, Steve.

The other thing I would say is on productivity. Customers are facing the same headwinds that everybody else is doing on the macro side and our products and services are really helping to drive productivity inside of their infrastructure. So, we see strong demand where we've got clients that are trying to deal with inflationary costs as well as we are and our products help us significantly there.

And Steve thanks for that. And Xavier, I believe you may have mentioned you expect you guys expect to grow in 2023? Is that accurate? And I guess what underpins that? Was it really just sort of the stuff you talked to just a moment ago? Or is there anything incremental to that?

Yes. So, I would say, I will give you two data points. First data point is on equipment revenue. Equipment revenues, the backlog still remains strong. We have $429 million of backlog. It was down only 8% during quarter three. And if you compare this backlog compared to the total equipment revenue we are used to generate, it's close to 1/4 of the full year revenue. So still a strong backlog here. On the -- I will call that as well a healthy backlog. I gave a data point by saying that less than 50% -- or more than 50% of this backlog is less than 90 days old. So, it does not mean that this backlog is aging. We do not see cancellation of oldest from customers. So this is healthy on the customer clearly waiting the supply chain challenges to be fixed there. Regarding post-sales, as you have noticed it in quarter two, by the way, both on equipment and post-sale since Q2 2021. So, this was the first time where we started to face some of the supply chain challenges there. But equipment revenue on post-sales, both revenue -- both these two revenue grew in constant currency since more than a year, which is as well a good indication that we saw the gradual recovery of paid volume, but we saw also other revenue stream in post-sales taking shape and generating additional revenue here. We mentioned into the call IT services was growing, the supply business was growing. So, it's a post-sales trend year so quite a good indication. I also call that 80% -- when you compare to 2019, post-sales revenue is now at 80% of where we were in 2019. So if you take all this component on your project is for next year, we are expecting revenue to grow. Year sale will be a key driver, but IT services as well on other revenue streams in post-sales will drive the growth.

Thank you. One moment, and our next question comes from the line of Erik Woodring from Morgan Stanley. Your question please.

This is Maya Neuman on for Erik Woodring. Thank you for taking my question. Maybe just to start, you highlighted that project deployments are taking a little bit longer and that page volume commitments are slower. When did you see this behavior start to change? And how should we think about what linearity looks like in the quarter?

Yes. So these two indications is to address one question we often receive around how do you see the post-sales revenue stream going there? So as I mentioned it, process was a growth in the quarter and it was at constant currency growth of 4.1%. So still, I would say, a healthy stream here. However, we have noticed, in some occasion, customers are taking longer to deploy a certain project. This could be related to return to the office, but also, I would say, budget decisions that they are making. This delay in project does not mean it has a direct impact, and we're not losing revenue because offline this customers are currently using our solutions. So this is an expansion of the current contract up to next contract. Commenting on the page volume, we have seen in quarter three over quarter two, a sequential growth increase of page volume. We have -- we are not yet at 80%. Some of our geography at 80% of what we were in 2019, but it's a gradual recovery. To be, I would say, transparent here, in our expectation, we were expecting a higher recovery during this quarter, but this just reflects some of the challenges a lot of firms are currently facing in bringing employees back to the office. However, despite this, it was still a growth. So this is not like page volume going down. This is still growth quarter-over-quarter and a sequential improvement here and still the correlations that we flagged in the past between present to the office and page volume.

Great. Thank you. And so just a follow-up question. Can you provide a little more color on what exactly the goodwill impairment charge relates to? And then, yes, I'll let you go. Thank you.

Okay. No, it's very, I would say, simple on technical. So every year, we conduct, at this time of the year, an assessment of our goodwill. The goodwill is mainly related to prior goodwill being booked on acquisition. You have mainly two components when you make this adjustment. One key component is, what is the interest rate assumption that you have when you build the case? So discount rate and how you calculate the WACC. And I would say, the vast majority of the big chunk of this goodwill impairment is driven by this due to the current macro environment. The second element is related to the way we look at our forecast on how we just adjusted. It's one of the components that help us to assess how the goodwill should be sustained in the future. This is -- I want to reiterate this point there. This is a non-cash item and you have noticed this is treated below the line. So, this is something that we are doing every year. I am uncertain that this is challenges after other companies are facing as well.

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

I guess I wanted to go back to the comment about page volumes again. And I think I heard you say page volume recovery has been slower than expected. And I wanted to see if you can dig into that a bit, is that -- is it the understanding that, that's driven by less return to the office? Or has printing behavior sort of been different even as employees have come back? And as you're starting to sort of see some budget considerations from your customers, why isn't that more of where we would -- you would expect sort of your customers to take certain budget decisions or priorities based on the page volumes that you're seeing, why weren't there sort of priorities and their budgets change around print? Why shouldn't we think of that into 2023? And I have a follow-up, please.

Thank you, Samik. So, the main point that we observe here is that the return to the office has been slower than the compare where either expected or incented employees to. When employees are in the office, and you remember, we commented this during the prior quarter, we see employees using the devices on printing, even if they are on a working pattern of -- you remember, I was giving this example of three days out of five. Three days out of five could mean 60% of our page volume. We are getting our trajectory to go to 60%. We are getting closer to this number. As I mentioned, some geographies are already above 80%, but we are not yet there in every place there. So getting closer, gradual improvement, but we do not observe like a significant shift or changes in the printing pattern of our employees. Another point is we still have a strong demand around our NPS, managed print solution around working from home or when an employee wants -- company wants to support the working from home. And the A4 business of the demand that we have seen on A4 businesses on the solution that we are leveraging here was quite strong in the quarter here. And finally, I would like to add a point because page volume is one indicator, but another indicator is how the devices have been used by our customers. I would like to flag that if you remember, we launched earlier this year, I would say, a suite of software that customers are using, which is called Workflow Central, which can do, I would say, a lot of things much more than printing for customer like they can do translation, reduction or conversion to audio. And this quarter, we have seen the sales of this solution for workers that are either working from home or in the office, rising significantly, and being very close to the sales that we are seeing on the apps that we are selling on the product here. So this is encouraging because what does that mean? It means that page volume is an indicator, but we see also other revenue stream around the multifunction devices being generated.

Got it. And for my follow-up, if I can ask on the cash flow, the change in guidance here from $400 million to $125 million for the year. Can you just outline how much of that is just the different sort of endpoint related to inventory given some of the supply challenges that's more one-off versus more underlying sort of profitability? And then you mentioned you were looking to scale back on investments in bar, I believe you had updated us that you spent looking at a cash flow or cash investment about $250 million or so annually. But maybe just update us in terms of what you're thinking there. As you go forward, what the run rate could be in terms of cash investment on an annual basis?

Yes. So, the way to look at it and to simplify it. So, the reduction between $425 million to $125 million is related to working capital. One item of working capital, as you describe it, is more of a one-off, it is related to inventory. And this is later arrival of product in Q3, which is a good news because it will help us as well to deliver strong quarter four from a ESI point of view. The second part of this working capital is what I call the good collateral is the use of cash in order to fund FITTLE growth. And FITTLE is a business where you borrow money, and then you sell this money back to customers as part of our financing arrangement with customers here. And the fact that FITTLE is growing, it's a good thing because what does that mean, you have heard it. The portfolio of FITTLE now at constant currency is flattish on the start has a trajectory to reverse the trend that was a trend down. What does that mean that FITTLE is able, outside of Xerox, to grow and to generate origination new businesses with non-Xerox equipment, which is exactly the strategy that we built for FITTLE. So that the working capital, it's more than $150 million of decline, free cash flow declined or difference versus guidance. The remainder, which is around $125 million, is mainly related to profitability and beyond profitability. This is supply chain challenges that we face on the fact that the mix of products that we are receiving and the inflation we see on supply chain, we won't be able to correct the trajectory this year. However, I want to repeat this message because I think it's important. We expect sequential improvement in margin on free cash flow in Q4 and in 2023. And the reason why, it's mainly related to the fact that we have put in place price increases on cost action to address some of the inflation pressure. We are also seeing improvement in supply chain, as I mentioned it, late delivery in Q3 means good delivery in quarter four or good in-store in quarter four. And we have also taken actions on -- we mentioned it during our call there, reducing some of the R&D on the innovation project. Some of these projects have a longer recession period. So, we are focusing on the better return on investment on some of these projects here. And, as always, Project Own It is one of the drivers of our cost base adjustment. So again, I want to repeat and reinforce this message here, improvement in margin sequentially on free cash flow in Q4 and 2023.

Thank you. One moment for our next question and our next question comes from the line of Shannon Cross from Credit Suisse. Your question please.

I was wondering, can we take a step back and just talk a bit, I mean, if we went back to the Analyst Day, and there was all this focus on growth businesses, which obviously aren't working out or are costing too much, I guess, I don't know if you can talk just a bit about what you think will be the drivers of growth going forward since there was so much of a focus on 3D print and the Bridge business and the HVAC business in that? And how should we think about the value, or how to track the minority ownership that you retained in those businesses? And then I have a follow-up.

Shannon, it's Steve. Thank you for the question. So when you think about macroeconomic conditions, the cost of capital and valuations of high-growth businesses, they've evolved since Investor Day, right. Current, opportunities in favor investments out businesses over investments in long deep tech technology. So if you really think about it. Some of these early-stage technologies require a longer lead time, require a significant amount of capital, and what we've decided to do is to take a look at, given the macro conditions, to reevaluate how we deploy capital. So we've shut down Eloque as we think about the amount of investment that it would take and the long lead time for return. We have scaled back 3D. But importantly, we've made sure that two businesses, specifically NAVI and our HVAC business, Mojave, have been spun out and they will get cash investments and see that growth. We have a minority position in that. So those are two good assets that we see have potential to grow, but we didn't want to use our cash as you think about long-term return on those investments, and we reallocated our capital towards things like, if you think about digital services, you think about IT services, all the things that we have in front of us that we think can grow our revenue near term.

Okay, so the two spun out businesses, what percentage you retain of them?

So, it's a minority position, and we don't disclose the specific details here.

Okay. So there's no way to get a valuation on that just so we can watch how it goes? Okay. And then I guess, thinking about Project Own It, and you talked about some structural changes. I'm just curious if you could provide some more details on exactly what you're going to do to change costs? Are you looking at massively shrinking your technicians or going more to inside sales? Or how should we think about how you're going to morph this given sort of the end market dynamics as well as the macro challenges?

Yes, I think there's a couple of things there, Shannon. First of all, large opportunity in our supply chain in terms of looking at what we do at our inventory, location inventory, supply chain, significant optimization there using technology, artificial intelligence, et cetera. As you look at our go-to-market opportunities, I've talked about a couple of times now where we can penetrate existing clients with expanding our products and services inside of our current client base. In other words, growing the TAM inside of our clients, looking at how we think about technology in and around our service delivery, talking about CareAR. We talk about artificial intelligence, the ability to do more remote solve, less truck rolls, meaning second calls to our customers, and the ability to drive productivity in our service delivery and our field service delivery using technology and significant technologies. We also will look at a variety of other things within our portfolio to think about how we optimize the costs in and around SG&A.? How we go to market, et cetera. So, there's lots of opportunities that we can drive supply chain, field service, go-to-market as part of Project Own It. And obviously, as we get to end of Q4, we'll give you more color on that.

And then just my final question is on cash flow. I know you're confident in driving higher cash flow numbers, but I'm just trying to figure out how you can maintain the dividend that you're at? And what you thought -- what you're doing given you're going to have some payments in December, I think, on the debt side. And maybe if you can just let us know what the minimum level of cash is that you need to run the business?

So Shannon, we have no issue with paying the dividend and maintaining the dividend here. From a debt point of view, we have, as you know, it's $650 million to pay in March 2023. As part of the covenant, the revolver covenant that we have $350 million will be paid in December will be entirely funded by securitization, and this is in flight. So we have no concern on this point here. Regarding free cash flow, again, in quarter four, what I mentioned here, the vast majority of the Q3 use of free cash flow was related to petal growth, it is a good thing to have, on the other side, inventory. I clearly expect the inventory situation to reverse. As you know it, Q4 is always the strongest quarter, and we are still sitting with a backlog of $420 million. So, we should have a strong quarter four from a near term point of view that will be played in the ESI inventory and reduces inventory down.

And our final question for today comes from the line of Jim Suva from Citi. Your question please.

Can you help me better understand how to bridge with more investment in the FITTLE? And you just are reducing your sales outlook, is it your customers are asking you to finance more? Or is it the cost of capital more? Or are you like building or expanding something within FITTLE because if sales are being challenged, and you have a more cautionary outlook on macro concerns, building FITTLE just seems kind of interesting? If you can help me bridge that, that would be great.

Yes. So Jim, I will step back a little bit on the described FITTLE strategy. So FITTLE has been, for a long time, a captive operation. And this as a captive was behaving as what you described, which was completely linked, connected, correlated with Xerox equipment revenue. When Xerox equipment revenue was up, the originations were up and then the financing scope was up and the opposite was true as well. Since, I would say, two years now, and since we reinitiated reinvigorated FITTLE, due to the fact that FITTLE has a strong credit assessment capability, a good platform and the ability to expand beyond Xerox, the FITTLE team, management team has expanded well beyond the pure Xerox product on the what we have noticed in quarter three and what we are expecting from the team is growth outside of the Xerox, what I call, captive activity. So this is what did happen in Q3. As I described it, I call that the good quality because this is a use of cash that will have a strong return, double-digit return in the future. And this is as well an activity that helped to strengthen and keep a good relationship with our partner and with our resellers and the end customers here. So back to your question, precise question, this was mainly related to non-Xerox equipment or solutions growth, not correlated to the pure Xerox equipment.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Steve Bandrowczak for any further remarks.

Thank you for listening to our earnings conference call this morning. The past few years have tested the resolve of our people I'm one to lead this company that is filled with great people who have proven time and again their ability to overcome incredible challenges. When I meet with our clients and our employees, I am filled with optimism about Xerox ability to do more with our clients, and about the team we have in place to deliver more value to our key stakeholders, including shareholders, clients, partners and employees. Thank you for listening to this call, and have a great day.

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