Xerox Holdings Corporation

Good morning, everyone. I am David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation second quarter 2021 earnings release conference call hosted by John Vizentin, Vice Chairman and Chief Executive Officer. He is joined by Xavier Heiss, Chief Financial Officer. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com slash investor. 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 1 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 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 would like to turn the meeting over to Mr. Vizente.

Good morning, and thank you for joining our Q2 2021 earnings call. I hope everyone is safe and healthy. We saw growing demand for our products and services in the second quarter. Revenue totaled $1.79 billion, up 22.4% year-over-year, or 18.1% in constant currency. Free cash flow was $198 million, up $183 million year-over-year. Adjusted earnings per share totaled $0.47, up $0.32 year-over-year. And adjusted operating margin was 7%, up 280 basis points year-over-year. Increased equipment sales and print volumes are consistent with a continuing gradual return to the office and give us confidence to reaffirm our revenue and free cash flow guidance for the year. In the second quarter, we increased investments in our operations and targeted growth areas while generating greater free cash flow. Our reaffirmed full-year cash flow guidance reflects our commitment to fund initiatives that will return Xerox to long-term growth. Our four strategic initiatives, optimize operations, drive revenue, re-energize the innovation engine, and focus on cash flow and increasing capital returns, continue to guide us and serve us as the foundation of our transformation. The operating discipline instilled through Project Onus has enabled our team to navigate through an unprecedented level of uncertainty, including a pandemic and the resulting disruption of the global supply chain while continuing to deliver value to our clients. Increased demand and material shortages impacted the supply chain of certain products to our customers this quarter, creating a backlog of equipment, including IT products, that is nearly double that of last year's. Despite these constraints, we delivered strong equipment sales results in the second quarter. We expected supply chain challenges to persist through at least the third quarter. and possibly through the year. We are working with our global suppliers and transportation partners to mitigate the impact to both Xerox and to our clients. The team remains committed to further optimizing operations to make it easier for customers and partners to work with Xerox while reducing costs. Project Onus is on track to deliver $375 million of gross cost savings this year. At the same time, Project Own It has freed up cash, allowing us to reinvest in targeted growth areas and digital transformation technologies. Robotic process automation and analytics were our initial areas of focus for digital transformation. Bots are now managing increasingly more complex transactions across the enterprise in every business and function, completing 4 million transactions per quarter, up 300% year over year. We have expanded our investment focus to include augmented reality and artificial intelligence. Utilizing these technologies internally will improve the service experience for customers, make us more efficient, and create additional opportunities for project-related savings in the future. The gradual return of workers to the office, combined with strong demand for our products and services, positions Xerox to return to growth this year. The correlation between greater levels of in-office work and increased page volumes continued in the second quarter, as page volumes increased slightly compared to the first quarter. Based on what we know today, more customers are planning to bring employees back on-site beginning in the third quarter, building to a more fulsome return by the end of the year. With this, we expect page volumes and post-sale revenue to improve. driving higher margins in the second half of the year. In preparation for bringing more employees back on site, customers are investing in more office technology. This is demonstrated by our year-over-year growth in equipment sales revenue for office-centric devices. ESR in every category grew compared to Q2 2020. In print, taking market share is an important part of our strategy to return to growth. Enhancements to our print portfolio, coupled with investments in security, cloud, and automation, are enabling us to capture share. According to the latest data available from research firm IDC, our market share performance for the first quarter was our best in the past three years, having taken share in all product segments in the region Xerox serves. Managed print services also benefited from these investments. According to the most recent IDC MPS 2020 market share report, Xerox continues to be the global and U.S. leader, and we expanded our lead in the U.S., where we grew our share to 21%. In fact, we were the only provider to grow market share in 2020. MPS remains an attractive market for Xerox. MPS spend in both the enterprise and SMB markets is projected to grow over the next three years. The SMB market continues to play a key role in our strategy to return Xerox to growth. To accelerate our expansion in this market, we acquired two document solution providers in the second quarter, one in the U.S. and one in Canada. Each acquired company is well established in a growing local market giving us an opportunity to knock out competitors and provide MPS and adjacent offerings such as IT services. In the second quarter, IT services sales and signed deals continue to be strong. Our managed IT services includes high-growth offerings such as advanced security services and RPA. RPA launched in February and is already seeing early success with SMBs in various industries, including legal, healthcare, and financial services. Earlier in the year, Xerox Financial Services expanded its leasing platform to provide customers and OEMs with a total solution for financing equipment, software, IT services, and other office needs. In the quarter, we used $60 million of cash to fund Originations growth. XFS grew Originations compared to last year and the first quarter, up 54% year-over-year and 7% compared to last quarter. We expect XFS to carry this momentum throughout the remainder of the year. In software, we are revolutionizing the way service technicians and customers solve technical challenges. At the same time, we are helping businesses solve three of their biggest challenges, the skills gap, talent shortages, and greenhouse gas emissions. Companies are looking to technology to overcome these challenges, which is why the total addressable market for next generation service delivery software is expected to reach 80 billion by 2027. Our software solution makes expertise instantly accessible for customers, employees, and field workers through live visual interactions, instructions, and insights as part of a seamless digital workflow experience. To deliver this experience, we integrated augmented reality from CareAR, DocuShare's content management system, personalization software from XMPy, and artificial intelligence from Park to create the industry's first service experience management platform. Making any user and expert capable of solving technical issues means companies can service their customers with fewer dispatches of highly experienced technicians. This is why blue-chip companies, such as Verizon, are starting to use our service experience management platform. PARC continues to execute on its commitment to monetize innovation. Part of our strategy includes working with strategic partners to accelerate the commercialization of new technologies in our focus areas, 3D printing, industrial IoT, and cleantech. Collaborating with partners provides several benefits, from speeding up product development to expanding our reach. One example of this is our partnership with Victrack, a state-owned enterprise in Victoria, Australia. Together we announced EloQ, a joint venture to commercialize Park-developed industrial IoT technology that will remotely monitor the structural health of critical infrastructure assets such as roads and railway bridges. This solution tackles a global secular challenge, the world's crumbling infrastructure. In the U.S. alone, 42% of bridges are at least 50 years old, and nearly 231,000 bridges are in immediate need of repair and preservation work. The recent closure of the I-40 bridge over the Mississippi River demonstrates the fragility of the world's aging bridges, the safety issues, and the economic impact that results when they fail or need to be closed. The bridge has now been closed on an emergency basis for more than 75 days since a cracked steel beam was first discovered, and there is no reopening date yet set. The U.S. trucking industry loses $2 million every day the bridge is closed, and this ongoing closure further strains the country's already fragile supply chain. Our LQ solution uses tiny fiber optic sensors that attach to a bridge to accurately measure its structural health. Advanced analytics are then used to evaluate the sensor's data and deliver insights directly to the bridge owners and operators in real time. revealing if the bridge has structural problems or damage that needs repair. As a result, infrastructure operators can rely on technology and data to prioritize repairs rather than waiting until a physical inspection reveals a major problem. The Victorian government has already committed $50 million Australian dollars to deploy LOQ's technology on bridges across the state, including several of its high priority bridges by year-end. The team is now engaging public officials and infrastructure managers in the U.S. and other countries about deploying this new technology elsewhere. For the quarter, free cash flow was $198 million, up $183 million year-over-year. We delivered strong improvements in free cash flow while investing in our operations and our targeted growth areas. such as XFS, software, park innovation. In the quarter, we also repurchased $251 million of outstanding shares, demonstrating our continued commitment to shareholder returns. In the second half, we expect free cash flow to grow as revenue and margins improve. This gives us confidence in our ability to generate at least $500 million of free cash flow for 2021 and while we continue to make investments that position the company for long-term sustainable growth. Before turning it over to Xavier, let me recap a few key points. We expect the return to the workplace around the world, and increasing demand will enable Xerox to return to growth in 2021. Along the way, there will be challenges we can predict, such as supply constraints, and challenges we cannot predict, such as the impact of the Delta variant. but the Xerox team has demonstrated it can navigate through difficult periods full of unanticipated challenges. Long-term sustainable growth will be driven by taking share in print and growing our adjacent offerings, as well as XFS, software, and park innovation. We plan to provide more details on our strategy at our November Investor Day. Now I would like to hand it over to Xavier to cover our financial results in detail.

Thank you, John, and good morning, everyone. We are pleased with our Q2 result. We experienced significant year-over-year growth in all key financial metrics on sequential improvement in revenue, free cash flow, and earnings. Revenue growth reflected strong demand for both equipment and supplies. And page volume, which grew sequentially from Q1 to Q2, continued to demonstrate a high degree of correlation with a gradual reopening of workplaces. Strong demand, along with ongoing supply chain disruption, resulted in an order backlog for equipment, including IT product, that is significantly higher than last quarter. Higher revenue on operating leverage drove significant growth in our profitability in Q2. Wealth margin declined 219 basis points year over year due to higher mix of equipment sales, lower government subsidies, net of project-owned savings, lower Fujifilm Business Innovation royalty revenue on higher freight on delivery costs. Adjusted operating margin of 7% increased 280 basis points year-over-year, reflecting the flow-through of higher revenue, lower bad debt expense on savings from product on it, which were partially offset by the impact of lower government subsidies increased R&D investment supporting our targeted growth areas on higher compensation accruals. SAG expense of $434 million increased $8 million year-over-year, including a $15 million negative impact from translation currency. This increase was partially offset by lower bad debt expense of around $10 million, which included a $6 million reserve reduction. RD&E grew year-over-year, yet improved IT basis points as a percentage of revenue. We remain committed to investing in Parks Innovation Towers, KSAR's next-generation service experience management platform, on enhanced product and solution for our print-on-IT services clients. Other expenses, net of $1 million, were $6 million lower year-over-year, primarily driven by a reduction in non-service retirement-related costs, partially offset by higher net interest expense. Second quarter adjusted tax rate was 9.7% compared to 23.4% last year. The 13.7% year-over-year decrease primarily reflects a 16 percentage point benefit from a change in tax law, resulting in the re-measurement of deferred tax assets as well as a geographical mix of earnings. Adjusted EPS of 47 cents in the second quarter increased 32 cents year-over-year. This increase reflects higher profit from operation, lower taxes, a reduced share count on lower bad debt expense, partially offset by higher net interest expense. Gap EPS of 46 cents was 35 cents higher year-over-year, due to a decrease in adjusted items, including lower year-over-year non-service retirement-related costs, partially offset by higher restructuring charges. Turning to revenue, we continue to see improving trends across geographies on customer segments, and solid demand drove increased sales in the quarter. Sales were particularly strong through indirect channel partners, which have begun rebuilding inventory level in anticipation of a recovery. EMEA has a larger indirect channel compared to the U.S. and grew 33.2% in constant currency year over year compared to 12.7% in the America. Both geographies had strong growth in equipment and supply sales. Despite growth in revenue, we, like many other businesses, have experienced supply chain challenges. As a result, Our backlog for equipment, including IT products, in the June quarter was almost double that of the prior year, and our equipment backlog is well ahead of pre-COVID levels. We expect supply chain disruption to continue in the third quarter, but we are actively working with current and alternative suppliers to mitigate any potential disruption to our customers. Equipment sales of $429 million in Q2 increased 38.4% year-over-year, or 34% in constant currency. Similar to Q1, sales increased across entry, mid-range, and high-end products, and in both North America and EMEA. This quarter, sales of office-centric devices led the increase, indicating a trend toward businesses planning for a return to work. Post sales revenue of 1.4 billion increased 18.1% year over year, or 13.8% in constant currency. Page volume modestly increased sequentially in quarter two, with economies such as UK, France, and Germany beginning to come out of partial lockdown in the quarter. While we are seeing a correlation between return to office trend on print volume The pace of employees returning to office has been gradual. We expect continued improvement in page volume throughout the remainder of the year, consistent with the pace of workplace and school reopenings. Both cells also include unbundled supplies, which grew significantly, reflecting increased demand, particularly through resellers. IT services, which is included in other cells, was impacted by global supply constraints that affected hardware technology install. Demand for our IT services offerings, including our RPA solutions for the small and medium-sized business, is growing across industry verticals, and signings continue to be strong. Last, our services signings grew in the quarter, as did our renewal win rate. Our services pipeline is strong. Next, turning to cash flow, we are pleased with our free cash flow result. Free cash flow grew significantly in the quarter, from 15 million in the prior year to 198 million this year. Importantly, we generated this solid growth in free cash flow while continuing to invest in our operations on targeted growth area. We generated 214 million of operating cash flow in the quarter, which was an increase of $180 million compared to prior year. Working capital was a use of cash of $35 million, but was $12 million better than prior year. This reflects year-over-year improvement in inventory on accounts payable, which was partially offset by an increased use of cash from account receivable driven by revenue growth. However, DSO was significantly better than Q220. Other notable cash-related items in the quarter include a $100 million one-time payment from Fujifilm Business Innovation related to the two-year extension of a license for the continued use of our brand in Asia-Pacific. This increase was partially offset by a $60 million use of cash to grow the lease portfolio of our XFS business. I will talk more about XFS shortly. Cash from investing was a $55 million use and includes the acquisition of dealers in Canada and the U.S. to support our SMB growth strategy. CapEx was $16 million in the quarter. CapEx primarily supports our strategic growth program on investment in IT infrastructure. Within financing cash flow, $115 million of securitization debt was repaid. This debt amortized monthly, and we expect to issue additional securitizations in support of XFS growth in 2021. Finally, in the quarter, we repurchased $251 million of shares and paid $54 million in dividends, resulting in a return of cash to shareholders of $305 million, well in excess of free cash flow of $198 million. Looking at profitability, the second quarter improvement in adjusted operating margin reflects the flow-through of higher revenue, disciplined expense management, and cost savings generated by Project ONIT, which is on track to deliver $375 million of gross cost savings this year. Further, we are managing supply chain disruptions impacting our business, including increased delivery on freight costs. We are confident in our ability to mitigate this impact from both a price and cost perspective. We expect continuing improvement in operating margin in 2021, driven by improvement in revenue as more people return to the office, and we execute on our strategy to gain share in print and grow our XFS IT services and software businesses. Turning to XFS, we are progressing on our growth plan and look forward to providing more financial and operating detail about this business at our investor day in November. XFS leads origination increased in the quarter, both sequentially on year over year, mainly driven by XBS. We expect the portfolio will continue to grow throughout the year, and we execute on our strategy to expand XFS presence beyond Xerox equipment and services. Cash-wise, XFS portfolio growth created a 60 million use of operating cash compared to a source of cash of 74 million in the prior year's quarter. Continued growth of XFS portfolio is included in our cash flow guidance for 2021. Next, looking at capital structure, we ended June with a net core cash position of 1 billion. $3 billion of the $4.2 billion of debt outstanding is allocated to and supports the XFS List portfolio. The remaining debt of around $1.2 billion is attributable to the core business. Debt primarily consists of senior unsecured bonds on asset securitization. We have a balanced bond maturity ladder with no bonds maturing in 2021 and $300 million maturing in 2022. We also had 2.2 billion of cash, cash equivalent, on restricted cash at the end of the quarter. We have spent 413 million on share repurchase since the beginning of the year, which contributed to the 300 million decrease in net core cash since the end of 2020. Finally, we will move to guidance. Growth in install activity, our backlog, on print volume indicate our customers are planning for a broader return of employees to offices in the back half of the year. Accordingly, we expect to see an increasing level of in-office work more weighted to the end of Q3 and Q4 on a gradual recovery in our business. We remain focused on executing our strategy to grow revenue on cash flow. We are maintaining our full year guidance of at least 7.2 billion of revenue. And despite ongoing supply chain disruption, we remain confident in our ability to generate at least 500 million of free cash flow in 2021. Thank you. And now back to John.

Thank you, Xavier. Now let's open the line for questions.

Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchstone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Ananda Baruja from Loop Capital. Your question, please.

Hi. Good morning, guys. Thanks for taking the question. Just two quick ones, if I could. I guess the first is on the free cash flow. You guys are tracking, I think, $300 million year-to-date, and typically second half of the year, particularly December quarter, is stronger than the first half of the year. Okay. Is it just a healthy dose of conservatism? I know the guidance is at least $500 million, but it would seem like you guys are set up to do, you know, probably more than $600 million, unless there's some puts and takes. And I have a quick follow-up. Thanks.

Yes, thanks, Amanda. So, yes, so, you know, so we are pleased with the result we delivered in quarter two, both from a revenue but specifically as well from a free cash flow point of view. As you know it, we have a plan to invest in the business in our different levers here, including XFS. That's the reason why we keep this guidance to 500 million. So it's important for us to leverage this strategy, including the investment, not only cash, but also in a P&L that we'll have for the rest of the year.

Got it. And then just with regards... John, to your remarks around the business environment, now that we're halfway through the year, how would you characterize sort of the tracking of the business environment to what you guys are anticipating? Is it relatively in line, or are there any meaningful differences, positive or negative, at this point?

Yeah, morning, Amanda. I would say that, look, June had an uptick in Q2 in terms of employees going back to the office. And as we look at the rest of the year, you're hearing a lot of CEOs saying that in the third quarter, everyone's going back to the office, the vaccination going on. And the way we see it is that the way we're projecting it is probably near the end of the Q3, and then we'll start seeing more and more folks coming to the office in Q4. What gives us confidence is our ESR and our pipeline and our backlog in that area. So you can see that a lot of companies are setting up for this. In fact, that we're gaining market share in that area gives us confidence. But, yeah, that's how we see it, Ananda. Okay. All right.

That's helpful. I appreciate it. Thanks, guys. Thank you. Thanks, Anil. Thank you. Our next question comes in the line of Matt Cabral from Credit Suisse. Your question, please.

Yes. Thank you. I wanted to actually follow up on that last question. I guess as we think about the correlation you guys called out between usage and the return to the office, just wondering if you could be a little bit more explicit on what you're seeing in terms of usage relative to the pre-COVID baseline and both overall within the base and then within areas that have been a little bit quicker to return back to the office. And as we start thinking out longer term, just curious for your impact on what COVID has done to the steady state for office print.

Okay. Hi, Matt. So as you know, we are monitoring it, and we observe a strong correlation between vaccination, people returning back to the office, and print volumes. And we track it, you know, day by day, month by month. We have data points showing how is this data current here. So as you observe it, you know, we don't have yet, you know, full population being vaccinated here, but we are encouraged by the progress that we have seen. And we are seeing sequentially progress in print volume under, you know, directly related to, you know, the presence in the office. We're not the only one, you know, reporting this type of indicator. But these give us confidence that for quarter three, back end of quarter three, specifically September, and for quarter four, we will return to better print volumes that we have here. Regarding your second point on the trend on how people are working, what we observe today is that there is a mix of different approach company by company around bringing employees back to the office a certain number of days. But what we see is that when employees are back to the office, they print. On some of the volumes that they print, some of the volumes they either do not print at home or volumes that could be printed on, I would say, lower type or lower, different type decentralized solution. I won't call it the hybrid work, but what we see currently is that overall the print volume on the presence to office remains strongly correlated.

Kevin, that's helpful. And then shifting over to gross margins, just wondering if you could dig a little bit more into some of the pressure points that you're seeing. And I know you guys called out supply chain issues as one of the factors. I'm wondering if you could quantify that impact. And I guess similar to my last question is as we look out longer term, historically this business had been one that supported gross margins kind of around that 40% range. prior to COVID. I guess I'm curious, do you think that's still an achievable level going forward or has something structurally changed as we think about emerging on the other side of COVID from a profitability standpoint?

Yep. So I would start with your first question, which is around, you know, what has driven, you know, the growth margin difference in this quarter here. So as you have seen it, the product mix, which is more equipment self-revenue, By the way, with very strong news on equipment self-revenue here. John mentioned it, but we gain market share on both what we call the base business, the ESR type of business, but also on NPS. So we are a leader on our segment in our territory, and this is quite important because it clearly shows the correlation between employers wanting to have employees being back investing in their infrastructure. you know, they can operate when they are back in the office. Regarding, you know, the specific element or specific impacts that we have on gross margin, so product mix is the number one. The second one is we have faced as a lot of industry some increased freight on delivery cost, specifically related to certain tension in containers on the cost of shipment here. As you know it as well, a third element is Fujifilm. We have lower royalty from Fujifilm, even if we have had, you know, some good news from a cash point of view in our free cash flow in Fuji. But from a profit point of view, we had, you know, lower royalty. On last item, on this more year-over-year comparison, government subsidies were at the highest point in Q2 last year, at the peak of the pandemic, and they have been lowered, as I mentioned it in my initial comment there. So now back to the growth margin, your growth margin question, what is a normalized view? Clearly, there is a straight correlation between revenue, our ability to drive the revenue growth, on the growth margin, and specifically on post-sales revenue. So is it possible, you know, to go back to the growth margin with all the activities, growth margin we had before, with all the activities that we are driving, both from an ONIT point of view and also supporting, you know, post-sales activity? Yes, the trend is going and will be favorable for the second half of the year.

Thank you. Thank you. Our next question comes from the line, from JP Morgan. Your question, please.

Hi, good morning. This is Angela Jin for . You reiterated that your FOIA guidance is $7.2 billion in revenue. Thank you for that guidance. So what do you see are risks to the upside and downside of that target?

So we are quite confident, you know, in this confidence, Angela. in this guidance here. So obviously, you know, there are things that we can control and there are things that are more difficult to control. So the things we can control is the way we will execute the presence to the office is something that we feel, I would say, quite strong. However, it is dependent on, I would call that one element, which is the pandemic is still present and the Delta variants could have an impact. But so far, you know, what we have seen is that the impact on our existing impact on the geography we are managing is quite manageable. The second element will be supply-demand. So far, we have a clear line of sight on how we can manage it here. But if the supply-demand on some of the tension on certain components on raw material will stay, specifically in the fourth quarter, then we will, you know... we will consider the action. But so far, we are managing even in Q2. I mentioned it. We have had a little bit of supply chain tension here. We manage it. We find alternative ways on supplier to overcome the challenge. And we feel confident that we can deliver the $7.2 billion. All right.

Great. Thank you. And just a quick follow-up question. So what is your view on print market consolidation, broadly speaking?

Okay, so this is a trend that we have seen. This is like historical. I always use this expression by saying in order to dance, you need to have two parties. You know that we have been active on this one. And, you know, we are clearly open to, I call that a dance here, on finding the right parties. But industry consideration is a long item in this print industry. And it is something that will happen over time.

Great. Thank you so much.

Thank you, Angelo.

Thank you. Our next question comes from the line of Kathy Huberty from Morgan Stanley. Your question, please.

Yes, thank you. Good morning. With the return to the office in the fourth quarter of this year and the behavior of print in the office that you mentioned earlier, Should we assume that post-sales revenue in 4Q21 can look more similar to 4Q19 pre-COVID levels? Obviously, assuming the Delta variant doesn't impact current return to office plans. Just want to understand how you're thinking about that.

Yeah, Katie, in our model for our guidance, we're not assuming 2019 and to go back to 2019 numbers in 4Q. We're assuming a more modest return. and then off to 2022.

Okay. And then in a normal environment, EPS is typically about flat in 3Q relative to 2Q. How should we think about the EPS trajectory in the September quarter this year?

So normal environment usually, you know, first, EPS is mainly driven by revenue. So when revenue is coming, EPS is expanding. So on then we manage, you know, via project on it, you know, all the cost element of the company. Usually quarter three is a softer quarter. I say usually prior to a pandemic, a softer quarter than quarter two. The two highest quarter being quarter four first and then quarter two. So this year is a little bit special because we see this gradual recovery. And, you know, as an example, schools and, you know, certain, you know, firms have not been open for quite a long time, open, you know, to presence in the office or presence in schools. And it will be, you know, one of the trends that we will monitor into the quarter. So if I look at how we look at the quarter, we said gradual recovery. And specifically by gradual, we expect September to show, you know, clearly a pickup versus last year. And then quarter four, you know, to follow this trend here.

And just quickly, the tax rate was much lower in 2Q. Can that sustain into 3Q, or should we assume that the tax rate comes up and that's going to be a headwind to the sequential EPS?

Yeah, so you know, Katie, that we manage our tax rate on a global basis. We are present in a lot of different countries here. Here we have an international, I would call that exceptional items, which is related to a low change in one of our European countries. That gives us the opportunity to get a one-off credit of a deferred tax asset. After this, depending on, you know, how this law change are applied country by country, we will obviously, you know, follow the tax guidance here on the adjusted tax rate. But I do not expect quarter three to be as positively impacted as what we have in quarter two.

Thank you very much.

Thank you, Cathy.

Thank you. And as a reminder, ladies and gentlemen, if you have any questions at this time, please press star then 1. Our next question comes from the line of Shannon Cross from Cross Search. Your question, please.

Thank you very much. I wanted to see what's going on with regard to channel inventory. Xavier, I think you said something about some of the sales in the reseller channel was, you know, were those companies looking to replenish probably in anticipation of demand, I would assume. But I'm just curious where you see inventory at right now.

Thank you. Yes, so what we've seen on this is mainly compared versus last year. If you remember in quarter two last year, Channel depleted their inventory mainly to protect their cash position. So we've seen it all across the industry. And step by step, this inventory has been rebuilt. What we are pleased with is that in quarter two, this inventory rebuilt a little bit stronger than what we saw in former quarter. However, this is not like, I call that a very high number. That means our, we track what we call week of inventory. On the week of inventory, are still at this stage lower than, you know, some of the highest point we could have had pre-COVID. So channels are coming back, but step-by-step gradual as well. As I mentioned it, and you saw that, on SMB, on the mid- mid on entry, which is mainly office type of activity, we gain share. And the channels are part of this share gain on being able, you know, to drive our ESL revenue up quarter over quarter.

Okay, thanks. And then both of you, I think, during your script mentioned investments and growth areas as use of cash and some impact to margin. Can you be a bit more specific on, you know, exactly where you're putting your investment dollars and how we should think about ways to track return on investment or how quickly you expect to see benefit from that. Thank you.

As you know, we invest in three areas of business. By the way, this is the area of business that we informed you in the past by saying we will stand up these businesses. This is XFS software on innovation. I'm pleased to report that in each of these areas of business, we achieve milestones and we continue, despite the environment, we continue to invest in the business. I will give you two examples here. On the XFS, I believe we mentioned that in our presentation, in XFS, we grew origination and the portfolio is great. When you do that, it means that you use free cash flow. and we have used this quarter 60 million of free cash flow in order to support this activity. What does that mean? It means that we are building for the future of the portfolio because all this origination will drive future revenue and profit growth for XFS. In innovation, we carry on our investment, and I'm sure you remember that we announced in quarter two LOQ, And LOQ is this joint venture that we have with the Australian-Victoria government here. And, you know, this joint venture is now running, has been enabled, and we have a commitment from the government to invest $50 million in Australian dollars in the infrastructure and to set up, you know, more of this bridge sensor that we're developing here. So it's just example sharing that in RD&E, some of our costs, despite the current environmental amount on free cash flow, we carry on investing in order, you know, to develop the future of the growth of the company.

And I'll say, well...

And, yes, in November, as you know, we announced that in November we'll have an analysis day, and we will provide you more detail on each of these towers.

Okay, thank you.

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to John Vistentine for any further remarks.

Thank you all for your questions. The events of the past 18 months have tested the Xerox team in ways we never imagined possible, but these unexpected challenges made the team stronger. The resiliency of this team paired with our sound strategy gives me confidence that Xerox's future continues to be bright. Be safe and be well.

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