Xerox Holdings Corporation

Good morning and welcome to the Xerox Holdings Corporation first quarter 2020 earnings release conference call hosted by John Byzantine, Vice Chairman and Chief Executive Officer. He is joined by Bill Osborne, Chief Financial Officer. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com forward slash investors. 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. After the presentation, there will be a question and answer session. To ask your questions at that time, please press star one at any time during this call. You can withdraw your question by pressing the pound key. During this conference call, Xerox executives will make comments 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 would like to turn the meeting over to Mr. Byzantine. Mr. Byzantine, you may begin.

Good morning and thank you for joining our Q1 2020 earnings call. Hope everyone is safe and healthy. This is an unprecedented time for individuals, businesses, and governments around the world. None of us have lived through a global health crisis of this proportion. So we are learning fast, adapting, and making decisions in the best interests of all our stakeholders, including employees, customers, partners, shareholders, and society. While we saw an immediate impact to our business due to the rapid implementation of lockdown measures globally, The disciplined approach we implemented over the last two years provides a foundation to move quickly to preserve cash, continue operations, provide support to our many clients on the front lines, and apply our manufacturing and R&D expertise to help save lives. I'm incredibly proud of Xerox team's dedication and ingenuity during this extraordinary time. For the first quarter, we generated 173 million of operating cash flow from continuing operations, a decrease of 49 million from a year ago. Free cash flow was 150 million, down 57 million year-over-year. Adjusted operating margin was 4.7%, down 630 basis points year-over-year. First quarter revenue declined 13.9% in constant currency year-over-year. Gap loss from continuing operations was minus 3 cents per share, down 37 cents year-over-year. And adjusted earnings per share was 21 cents, down 45 cents year-over-year. These numbers are a direct reflection of the impact COVID-19 had on our business in the first quarter. All but two countries where Xerox operates experienced a full or partial lockdown in the first quarter. The absence of people from the office resulted in an approximately 50% decline in page volumes in March, which impacts our variable rate contracts. Delayed installs, whether because an office was closed or limiting vendors on site, lowered equipment sales revenue by approximately $100 million in the quarter. And the financial impact this global health crisis is projected to have on global GDP and our leasing portfolio required us to increase our bad debt reserve by approximately $60 million. As a result, we are withdrawing our 2020 financial guidance. While we have modeled and are prepared for a range of potential outcomes, We don't believe it is prudent to make assumptions given the number of unknowns related to the duration and magnitude of the disruption caused by COVID-19. We have been actively managing this crisis from early in the year. In February, our focus was on supply chain and ensuring we had what we needed to deliver for our customers. And we did. By early March, we had asked our employees to work from home where possible in many cases before governments had required it. The health and safety of our employees comes first. We also shifted the team's focus to those on the front lines, both supporting clients who rely on us in times of need and with new healthcare initiatives that address gaps in what is needed to treat the sick and stay safe. While there are some positive trends emerging in the fight against COVID-19, there remain important questions about how and when economies and businesses around the world will reopen while keeping their people safe. We are working closely with other companies, government leaders, and healthcare professionals to implement new work guidelines in line with recommendations. In the meantime, our four strategic initiatives remain at the core of how we operate. We have continued our intense focus on managing cash while streamlining our operations to do better for us and our clients. We are investing in innovation and continuing to examine M&A opportunities that strengthen us for the long term. We are better positioned to handle this crisis today because of the discipline and work we did over the last two years. Let's walk through each of the four areas. Project Donut, our enterprise-wide transformation initiative to optimize our operations, has instilled discipline across the company that enabled us to take swift action in response to COVID-19 pandemic. When we saw early warning signs about the spread of the virus in Europe, we immediately established a task force of senior leaders to monitor developments in real time and began planning cost-saving initiatives directed at discretionary spend and redirecting investments to the most critical areas, including innovation and digital technologies. We've increased already intense focus on cash and keeping our balance sheet strong through the crisis and resulting economic turmoil. Preserving cash is of paramount importance when we emerge from the crisis in a position of strength. Our employees are critical to our efforts and will be essential for when we come out of this crisis. We are investing in their development with increased training and opportunities to stretch into different areas that might be busier than their own. For the time being, our focus has been on keeping our employees whole during this crisis. We are participating in the government subsidy programs available in Europe and elsewhere that reduce our financial exposure, and we have chosen to pay whatever additional sum is required so impacted employees in those geographies continue receiving 100% salary and benefits, where permissible. From a revenue perspective, we expected to deliver results in line with our plan until we began seeing economies shut down. This ultimately resulted in an approximately 50% decrease in page volumes in March. While long-term contractual relationships and management services ensure certain fixed minimum payments, the current situation continues to have a significant impact on variable contracts, delayed decision-making and installs, and bad debt, among other things. We assess the impact on our business under several recovery scenarios. With stay-at-home orders still in place, we expect the most significant impact in Q2 with a gradual recovery in Q3 and performance closer to our planned level in Q4. Our clients are primarily large enterprise and small and medium-sized businesses, both of which had to shutter offices and move to remote working environments in March. On the enterprise side, we saw a mixed situation with some clients, such as federal and state governments, as well as healthcare providers continuing to operate and in need of additional resources to address the pandemic. Government and healthcare clients are investing in high-end production, such as the Baltoro Inkjet Press and the iGen5. Placements of our new black-and-white light production device were also strong among public sector clients and those in education. Our ability to offer a total solution that combines equipment and software remains a key differentiator. We responded to emergency requests for equipment and support from clients. Teams from Xerox supported the USNS Mercy and the USNS Comfort before they deployed to Los Angeles and New York, respectively. We rushed printers to pop-up field hospitals in the Midwest and on the East Coast. Clients such as Cleveland Clinic started using our recently launched cloud-based on-demand print platform to help support their overflow volumes and business continuity plans. We quickly developed an app for Imperial College Healthcare NHS Trust, one of the largest national health system trusts in the UK, to help them track doctors and nurses to manage workloads during the crisis. Even with all that was happening in terms of both business and personal concerns, we saw employees across the globe including in Italy, closing deals and winning back business from competitors. For instance, our Italian partner, EtiCube, closed a deal over video conference with a top global fashion company where a competitor had been an incumbent for 20 years. What sold the client was the power of our AltaLynx and VersaLynx, Kineki software, and us. And this is just one of many examples. In fact, pipeline and orders were up in March. strong signal demand for our technology and services remains high. On the SMB side, many of these companies took a much harder hit and have less leeway in their business to absorb a prolonged economic downturn. Many countries, including the U.S., have instituted financial plans to support smaller companies, and we are working closely with them to ensure they are aware of what safety nets are available and how to apply. With both SMB and enterprise clients, Xerox's leasing business are proving to be a key differentiator in winning and retaining business. Our strong balance sheet allows us to provide flexible financing to qualified customers and invest in competitive takeouts, which will be even more important when we begin to emerge from this crisis. We've also invested in additional partner support, including making favorable changes to Xerox's rebate structure and providing increased training and marketing support on offerings that can help their clients navigate through this crisis. Going forward, the extent of the COVID-19 impact on our business depends largely on when stay-at-home orders are lifted and what's required for businesses to return to the office while keeping their employees safe. In the meantime, we continue to invest in key growth drivers in our business and broadening our clients' understanding about what Xerox can do to support them, both in a crisis and out. Among the areas we are investing is software as a service, our IT services portfolio, with an emphasis on bundled technology packages for remote working and remote learning, and increased workflows through bots and other apps. This month, Xerox celebrated its 114th birthday, having survived many crises over that time, including the Great Depression. Interestingly, the company did well when others failed due to Xerox's ability to constantly innovate. We are still investing in our five innovation pillars and extending that work to new healthcare-related initiatives that allow us to help save lives during this crisis. While our labs may be physically closed, our R&D teams remain up and running, collaborating remotely, and continuing to make progress. The 3D engineering team has pulled forward two key work streams, software development using simulation tools and machine design documentation. They remain on track to launch the industry's first liquid metal printer by the end of the year. The team developing our first AI workflow assistance offering continues to expand the base of trial customers, helping to refine the core AI engine and the value proposition in preparation to make it commercially available in late Q3. In IoT, the engineering team working on our industrial predictive maintenance solution is advancing the core analytics capabilities, including underlying component models and simulation tools, all of which is being done remotely. In digital packaging, the team is engaging lead customers in how our technologies can deliver new levels of late-stage personalization and improve operational efficiencies in production environments. Our newest innovation area is clean tech, and we are focusing on identifying technologies that reduce humankind's negative environmental impact on the world. The team is refining the techno-economic model for one of our initial early-stage technologies focused on improving building energy and HVAC efficiency. This will help guide our technical team to test key assumptions in our work with the U.S. Department of Energy to develop a solution that could reduce energy consumption of air conditioners by up to 80%, improve indoor air quality in buildings, and reduce greenhouse gas emissions. Given our strong focus on innovation, we were able to quickly stand up a team of our smartest engineers, researchers, and scientists to think creatively about how to address the challenges presented by this virus. It was clear that we all had a role to play and our finest problem solvers were equal to the task. Within weeks, We are working with others to scale up production of a disposable, low cost, FDA approved ventilator and related airway pressure monitor. Also, we are now making hospital grade hand sanitizer at our facilities outside of Toronto, Ontario and Rochester, New York. We expect to produce and deliver up to 140,000 gallons of hand sanitizer in the second quarter. and our entire inventory was sold before we made the first batch. We will continue to make sanitizers and ventilators as long as there is demand. We have and will continue to run our business prudently when it comes to any expenditure. Our rapid response to early warning signs in Europe allowed us to move quickly to eliminate discretionary spending so we could continue to fund growth initiatives. Xerox has a strong balance sheet and liquidity. At the end of Q1, we had approximately $2.7 billion of cash and a $1.8 billion undrawn revolver. We have approximately a billion of debt maturing in 2020, which we plan to refinance over time as our core debt level remains within an investment-grade credit metric range. We are committed to our shareholders' return policy, including our current dividend rate and plan to return at least 50% of annual free cash flow. We will continue to be opportunistic about M&A despite the COVID-19 crisis. In Q1, we acquired four smaller companies, extending our strategy to grow in the SMB market in Canada and the UK. We are focused on implementing our three-year plan around the four strategic initiatives, We are making smart investments across our portfolio from core to adjacent to new markets. We believe the economic environment will present unexpected opportunities, and we will evaluate them with our established M&A criteria. As we have always done, we will evaluate the returns of any cash allocation strategy, including share buybacks, to achieve the best return for our shareholders. Now I'd like to hand it over to Bill to cover our financial results in detail. Thank you, John.

Before I start the review of our financial results, I'll take a few minutes to discuss the financial impact of the COVID-19 pandemic on our first quarter results. Until the late February timeframe, we expected to deliver results in line with our plan. But as the global economic disruption caused by the pandemic worsened, like many other companies, our business slowed. The lockdown in businesses resulted in delays in equipment installs and purchase decisions. and the variable components of post-sale revenue, such as managed print services agreements, where revenue is based upon the number of page clicks, declined. The third month of any quarter is typically our strongest, when the largest proportion of equipment is sold and profit is recorded. Therefore, our first quarter was significantly impacted by the ramping of office closures in March, which limited our ability to deliver and install equipment. Further, As more businesses required employees to work from home, the use of Xerox equipment declined, impacting our post-sale revenue. Most of our customer relationships are contractual, with contract terms that typically include a discharge as well as a variable component that includes service and supplies linked to print volume, and the percentage of fixed versus variable component varies by channel and geography. As a result, COVID-19 had a greater impact on equipment sales in Q1 as deliveries and installs, which would have occurred late in the quarter, were unable to be completed, while the decline in post-sale revenue was somewhat contained due to our contractual business. Through Project Own It, we have become a more agile operation, and we were able to react quickly as the pandemic became more widespread. Project-owned initiatives have been ongoing, and savings from these initiatives provided a partial offset to the sudden revenue impact from the health crisis. In addition, during March, we implemented an operational resilience plan focused on cash and expense management and preserving our strong balance sheet in order to mitigate the impact of the crisis on our operations and business. With regard to our customer financing operations, we have low historical bad debts. less than 1% of revenue in 2019, but it increased our bad debt reserve by approximately $60 million in the first quarter to reflect an expected increase in write-offs of customer lease receivables resulting from the pandemic. Our bad debt reserve is an estimate of losses that are expected to be incurred in the future and is calculated by applying a projected loss rate to our portfolios by country based upon historical trends and projected behavior, which takes into account global factors. In assessing the level of bad debt reserve in Q1, we looked at current and forecasted economic conditions, current portfolio credit metrics, as well as the level of write-offs on our portfolio during the credit crisis in 2008 and 2009. As of March 31, 2020, 4.4% of our finance receivables were reserved compared to 2.6% as of December 31, 2019. Our finance portfolio is diverse, with no significant concentration in any one name, industry, or geography, and we have a disciplined credit policy and are working with our customers and partners to preserve relationships over the long term. Importantly, we have a strong balance sheet and sufficient liquidity, with approximately $2.7 billion of cash, cash equivalents, and restricted cash at the end of Q1 2021. and a $1.8 billion undrawn revolving credit facility that matures in the third quarter of 2022. Now looking at the income statement. Total revenues in the quarter declined 13.9% in constant currency and 14.7% in actual currency. Until March, we expected revenue to come in closer to our plan, which would have been a decline in the mid-single digits. Turning to profitability, adjusted operating margin of 4.7% in Q1, with 630 basis points lower year over year, largely as a result of 190 basis point decline in gross margin and a 410 basis point increase in SAG as a percentage of revenue, including 330 basis points from the increased bad debt provision. The decline in gross margin is impacted by lower revenues, including higher margin post-sale revenue, primarily as a result of business closures due to the COVID-19 health crisis, as well as the impact of price reductions in line with historical trends, transaction currency and tariffs, which are partially offset by benefits from our project-owned transformation actions. Operating income was impacted by accelerated revenue declines resulting in lower gross profit that were only partially offset by expense reductions. and includes an approximate $60 million increase in bad debt expense, which as I mentioned, covers our projection of higher bad debt as a result of the pandemic. Last, RD&E as a percent of revenue increased 30 basis points and contributed to the decline in operating margin. However, RD&E expense declined by 8 million year over year, partially due to the timing of investments. Below operating profit, other expense net of $23 million was $16 million better than the prior year, primarily due to lower non-service retirement-related costs, lower non-financing interest expense, and higher interest income. The lower non-financing interest expense is a result of a lower average debt balance, and the higher interest income is due to a higher cash balance, which includes $2.3 billion of proceeds from the sale of our interest in Fuji Xerox and XIP to Fuji Film in November. Our adjusted tax rate in the quarter was 29.4% and compared to 26.3% in the prior year. The higher tax rate year-over-year is primarily due to geographic mix of profits as well as the impact of discrete items on lower pre-tax income. Adjusted EPS of 21 cents was down 45 cents compared to Q1 2019, significantly off our planned earnings level, which anticipated growth year-over-year. The decline was largely driven by the COVID-19 impact on operations, which offset the benefits from cost reductions and also a 20 cent impact from an increase in bad debt expense. Benefits from lower net interest expense, lower shares, and other cost reductions were offset by the negative impact from higher taxes, tariffs, and transaction currency. The gap loss of 3 cents per share was 37 cents lower year-over-year, including the aforementioned 45-cent decline in adjusted EPS, partially offset by a net benefit of non-GAAP-adjusted items related to lower non-service-related pension expense and higher transaction costs related to the HPE transaction. Non-GAAP adjustments to EPS include restructuring and related costs, the amortization of intangible assets, non-service retirement-related costs, transaction and related costs in debt, and contract termination costs, as well as the income tax on those adjustments. In Q1, we recorded $41 million of restructuring and related costs, and for 2020, we still expect restructuring charges of approximately $175 million for the full year. Moving now to slide eight, I'll discuss cash flow. As you are aware, this management team is focused on cash. John and I remind you of this fact every quarter because it is our priority and we have a detailed cash management process in place which in a macro environment such as this has become even more detailed. We are monitoring cash inflows and outflows daily. We are reducing discretionary spend and we are redirecting investments to the most critical areas. I'll discuss more in our view of cash and liquidity shortly and we'll now look at our first quarter cash flows. In Q1, we generated $173 million of operating cash flow from continuing operations, which was $49 million lower than the first quarter of 2019, primarily driven by lower income. Working capital was $133 million better than the prior year, reflecting the higher cash from accounts receivables due to lower revenue and higher cash from payables due to the timing of payments partially offset by a lower level of purchases. The higher cash generation from accounts receivable and accounts payable was partially offset by higher inventory levels. Inventory levels were impacted by equipment installation delays and lower demand for post-sale, primarily caused by office closures in March. The year-over-year change in cash in the other category is primarily in other current and long-term liabilities, which reflects lower accruals, particularly incentive-related accruals associated with indirect channel partners in the current year, and the timing of payments for restructuring-related costs in the prior year. Restructuring payments of $35 million were in line with prior year, and we continue to expect full-year restructuring payments of approximately $175 million. CapEx was $23 million in the quarter, and free cash flow was $150 million. We still expect CapEx of approximately $100 million for full-year 2020 primarily related to investments in our IT infrastructure. In investing cash flow, acquisition spend of approximately $193 million includes three acquisitions in the UK and one in Canada, all to further our SMB strategy internationally. The spend is above the $100 million that we guided to for Tuck and acquisitions in 2020. However, we did spend well under our $100 million in 2019 as a couple of the acquisitions that closed in Q1 were originally expected to close in Q4 of last year. We now expect our full year 2020 tuck-in M&A to be in the $200 to $300 million range. As John mentioned, we will continue to be opportunistic about M&A despite the COVID-19 crisis, and we'll continue our disciplined approach, evaluating the returns on any cash allocation strategy. Lastly, within financing cash flows, We returned $58 million in dividends to shareholders in the first quarter, and we did not have any share repurchases in the quarter. We had no payments on debt and ended the quarter with $4.3 billion of debt and approximately $2.7 billion of cash equivalents and restricted cash on our balance sheet. Let's now turn to slide nine for more detail on revenue. First quarter revenue declined 14.7%. or 13.9% in constant currency. As I mentioned earlier, as of the end of February, we had been on path to deliver revenue within our planned level. But as our first quarter business is largely skewed to March, the expansion of the pandemic disproportionately impacted our first quarter revenue. Geographically, America's revenue declined 11.8% in constant currency, while EMEA was down 17.6% in constant currency. Our European operations were more heavily impacted due to the earlier onset of the pandemic, which resulted in business closures the entire month of March. While in North America, business shutdowns impacted our operations largely in the second half of the month. In addition, a large proportion of our business in Europe is through indirect channels, which was heavily impacted in March as channel partners lowered purchases to manage their cash and inventories. While in the U.S., we have a larger direct business for SMB and large enterprise customers. Equipment sale revenue was down 27% in constant currency in the quarter, with every product segment impacted. However, equipment sales grew in our U.S. enterprise operation, which among other industries covers government, healthcare, education, pharmaceuticals, and food industry clients, all essential industries during this pandemic. These customers are continuing to invest in new equipment and in certain areas are developing applications that are increasing print volume. For example, In education, remote learning is driving more print flowing to production facilities either in school districts or in print service providers for workbooks and worksheets to support teachers and students embarking on remote learning to navigate school closures. Looking at activity in the quarter, the decline in sales in our high-end devices is primarily in the lower end of the range, which was impacted by office closures and lower indirect channel activity. This was partially offset by the demand for our Baltoro inkjet press, iGen, and continuous feed color systems. In the mid-range, we experienced a significant decline in our European indirect channel partners, as well as in our U.S. indirect channels and XPS organization that primarily serve SMB customers and were significantly impacted by the March slowdown in activity. In our entry segment, lower channel sales in EMEA and the U.S. were partially offset by a large order in Eurasia that occurred earlier in the quarter. Post-sale revenue declined 11.4% to actual currency or 10.5% in constant currency. Post-sale was impacted by the industry trend of lower volume devices and page volumes, but in the first quarter, page volumes dropped further as offices closed and more employees began working remotely. While our post-sale revenue is largely contractual, Our bundled contracts have a fixed component as well as a variable component that is based upon print volume. In addition, we had lower activity in unbundled supplies, which are largely in indirect channels and developing markets. Xerox services revenue declined approximately 8% year-over-year in constant currency, also impacted by March closures. Services declines were found significantly more in European operations as compared to the U.S. However, signings in both Europe and the U.S. were very strong. We had significant growth in renewals, with the highest renewal win rate in over two years, and the new business signings rate of decline improved significantly compared to 2019. We have implemented revenue actions that are focused on maintaining stability in our core markets while building capabilities to capture new opportunities. We are continuing to invest in our top line in areas that are central for today, and in our innovation areas that are key for our longer-term future. John talked about some of the offerings that support a flexible work environment, such as digital mail services and IT services supporting remote workers and learners. Our investments in Topline, in addition to improved signings in Q1, and our mostly contractual business gives us confidence in our revenue rebounding as businesses resume operations. Now turning to slide 10. I'll review our profit and earnings. Adjusted operating margin was 4.7% in the quarter, well below our target, due to the significant decline in revenue caused by the pandemic. As a result of the discipline we have developed through our Project Own It Transformation Program, we quickly implemented actions to reduce discretionary spend in response to the pandemic. These actions are in addition to our plant and initiatives in our program to achieve at least $450 million of gross savings in 2020, which we are on track to deliver across seven targeted functional cost areas with a goal of simplifying our operations. In 2019, we achieved $640 million of gross cost savings and, importantly, began the transformation to make our operations more agile, which will help us through the current crisis. Adjusted EPS of 21 cents declined 45 cents year over year, well below our plan in which we expected an increase year over year. As I mentioned earlier, the decline was largely driven by the impact of COVID-19 on operations and the 20 cent impact from an increase in bad debt expense, as well as the negative impacts of higher taxes and transaction currency, which were partially offset by lower net interest expense, lower shares, and other cost reductions. Moving on to slide 11 and a review of our capital structure. We ended the quarter with $4.3 billion of debt, of which $3 billion supports customer financing activities, and therefore we break down our debt between financing debt and core debt. Financing debt is allocated by applying a 7 to 1 leverage to our financing receivables and equipment on operating leases, which together comprise our total finance assets. Core debt was approximately $1.3 billion, and we ended the quarter with approximately $2.7 billion of cash, cash equivalents, and restricted cash, which puts us in a net cash position of approximately $1.4 billion when netting cash against core debt. In 2020, we have approximately $1 billion in bonds maturing, which we plan to refinance over time through the debt capital markets or other alternatives such as securitization. Our liquidity position is strong, with approximately $2.7 billion of cash, cash equivalents and restricted cash, and a $1.8 billion bank revolver, which is fully available to us. As of December 31, 2019, our net unfunded pension liability was $1.2 billion, which is comparable to the net balance at the end of 2018. as the increase in pension obligation as a result of lower discount rates was offset by asset returns and contributions. The net balance includes approximately $815 million of unfunded pension liabilities for plans that by design are not funded. In 2019, we contributed $141 million for worldwide pension plans and expect to contribute approximately $135 million in 2020. Last, on slide 12, the balance of 2020. During this unprecedented time, we are focused on the health and safety of our employees, customers, and partners, and we are actively engaged in supporting the fight against this pandemic. We are also focused on mitigating the effect of this crisis on our business and operations. However, as John advised, the uncertainty around the containment of the pandemic and the business resumption makes it difficult to predict the full impact on our business operations and financial performance. As a result, we are withdrawing our previously issued full-year 2020 financial guidance for revenue, EPS, adjusted operating margin, and free cash flow. We've assessed the impacts on our business under several recovery scenarios, and we expect the most significant impact in Q2, with a gradual recovery in Q3 and performance closer to our planned level in Q4. As we've stated, our revenues are largely contractual, and we have demand built in from the Q1 delayed installations. Therefore, we believe we will be able to rebound once businesses reopen. On capital allocation, we are committed to our dividend and our policy of returning at least 50% of free cash flow to shareholders. Our debt level is within our targeted leverage for an investment-grade credit metric, and we have a strong balance sheet and liquidity, which supports our dividend policy. We have a disciplined process for evaluating returns on cash allocation strategies, including share repurchase, to determine the best returns for our shareholders. I will now turn it back to John for some additional comments before going to Q&A. Thank you, Bill.