Xerox Holdings Corporation

Welcome to the Xerox Holdings Corporation third quarter 2022 earnings release conference call. After the presentation, there will be a question and answer session. To ask a question at that time, please press star 11 at any time during this call. 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 Steve Bandersack, Chief Executive Officer. He's 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 express permission of Xerox. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com slash investors. and will make comments that contain forward-looking statements which, by their nature, address matters that are in the future and are uncertain. Actual future financial results may be materially different than those expressed herein. At this time, I'd like to turn the meeting over to Mr. Bandrzak.

Good morning, and thank you for joining our Q3 2022 earnings call. I want to start by saying how honored I am to lead this great company and team of people as we embark on Xerox's 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 a 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 capable of expanding and capturing more of the addressable market within our existing client base by further embedding our offerings into our clients' end-to-end processes. Summarizing results for the quarter, revenue of $1.75 billion grew 4.7% in constant currency and and declined 0.4% in actual currency. Adjusted EPS was $0.19, $0.29 lower year over year. Free cash flow was a use of $18 million compared to a source of $81 million in the prior year. An adjusted operating margin of 3.7% was lower year over year by 50 basis points. Revenue growth this quarter accelerated in constant currency. reflecting strength in demand for our products and services amid an increasingly challenging macroeconomic environment. Equipment revenue grew 6.7% in constant currency or 0.8% in actual currency, marking the first quarter of equipment revenue growth since supply chain constraints began last year. As expected, backlog declined slightly sequentially reflecting sustained order flows offset by a gradual but lower than expected easing of supply chain constraints. Post-sale revenue increased 4.1% in constant currency and decreased 0.7% in actual currency. Post-sale growth was driven by another strong quarter for consumables such as paper and supplies. Growth in consumer roles reflects the early benefit of recent pricing actions and for supplies an ongoing gradual recovery in print-related activity. Page volume continued to closely correlate with return-to-work trends. Postale revenue also benefited from strong growth in IT and digital services, including contributions from recent acquisitions. Adjusted operating margin declined slightly year-over-year but improved sequentially, reflecting the benefits of price and cost actions taken year-to-date. Improvement was slower than expected, however, due to persistent high rates of inflation across our cost base, an unfavorable geographic mix in equipment sales, and a slower-than-expecting easing of supply chain constraints. Xavier will discuss our outlook for profitability in more detail. The global macroeconomic outlook has become increasingly somber over the past three months. The current outlook notwithstanding, we believe our prospects for continued revenue growth are strong. We see resiliency in demand for our products, particularly our A3 devices. We have a sizable and healthy backlog. and we have visibility into the realization of benefits from recent pricing actions. However, the adverse effects of Western European currency on full year revenue are now forecasted to be significantly larger than expected. Therefore, we are lowering our revenue guidance for the year from at least $7.1 billion to a range of $7 billion to $7.1 billion in actual currency. While our revenue outlook declined only slightly, we are lowering our 2022 free cash flow guidance from at least $400 million to at least $125 million, both of which excludes $41 million one-time product supply termination payment. The reduction to our outlook is in part due to persistently high rates of inflation across our cost base and slower than expected supply chain improvements, both of which are expected to inhibit margin improvements this year relative to our expectations. Most of the reduction in free cash flow guidance, however, is a function of larger than expected use of working capital, which has no earnings impact. including our decision to utilize more capital to fund fiddles, origination, and operating lease growth. We continue to expect operating margins to improve going forward as supply chain conditions ease and previously enacted pricing actions are realized. When combined with additional plans to streamline our operations, we believe our 2022 free cash flow performance will be an anomaly and not a trend. I am often asked by investors if we are planning a significant strategic shift now that I have been made permanent CEO. I alluded to some of our longer-term strategic plans a few moments ago, but In the near term, we remain focused on the execution of our print and services strategy and improving operating efficiencies amid a challenging macro backdrop. As in the past, the successful execution of our strategy rests on four strategic priorities, optimize operations, drive revenue, monetize innovation, and focus on free cash flow. Operational efficiencies and flexibilities have taken on a new level of importance in light of the current macroeconomic environment. We remain on track to achieve our targeted $450 million of gross cost savings from Project Own It in 2022. Our target was designed to completely offset the effects of inflation for the year, but in the past few months, inflationary pressure has outpaced our initial expectations. With less than three months remaining in the fiscal year, we will not be amending our savings target for 2022. We will provide an update on 2023 savings target when a full year guidance is provided next quarter. Along with this update, we will provide additional details about changes to our business structure that are expected to drive greater operating efficiency and enable further penetration of services at existing clients. Our print and services products continue to resonate strongly in the marketplace as we deliver the most advanced services and solutions portfolio for our clients. I am pleased to announce that we grew our leading share in managed print services in 2021 per IDC's recent MarketScape report. In further support of our leading position in managed print, Cucerca recently named Xerox as a leader in managed print services in its 2022 landscape report. According to Cucerca, Xerox maintained the highest position overall other vendors in the market in both strategic vision and depth of service offerings. To ensure we continue gaining share in print and managed print services, we are focused on consistently improving the customer experience to meet clients' most pressing needs. To that end, in Q4, we'll be launching the Xerox Customer Experience app, which will help our clients streamline the installation of our products, better monitor supplies, and help clients self-troubleshoot our A4 product. In IT services, we are seeing traction in newer markets like Canada as we realize synergistic benefits from the recent acquisition of PowerLand and greater collaboration with our existing print and managed print services sales force. And then our robotics process automation offering once again grew signings double digits quarter over quarter. In Q3, Xerox automation expanded its presence to retail, sports and entertainment, and manufacturing verticals. In digital services, our recently acquired GoInspire business won a Breakthrough with Data Award from DataIQ for its partnership with the UK home goods company, Lakeland. GoInspire uses Lakeland's customer data to deliver a hyper-personalized experience for each of its members, resulting in a strong uptick in revenue and triple-digit return on investments. Xerox Digital Services recently launched an intelligent document processing platform which leverages AI, ML, object content recognition, and natural language tools to automate document and data processing. Born from our legacy of innovation and service excellence in this domain, the platform will help our clients recognize a variety of languages classified documents, and validate customer identities without human intervention, providing significant time and cost savings. We see the evidence of value being delivered through our integrated solutions offerings each quarter. For example, this quarter we assisted a European commercial banking client with a digital transformation project in which our devices were used to digitize document workflows and improved the client's onboarding process. For a large Brazilian insurance client, we added services to help them automate invoicing and medical claims reimbursement, improving processing time from days to hours, and reducing manual processing performed from 150 employees down to 40. Moving forward, we'll enable more of these types of success stories as we place a greater focus on holistic client solutions rather than discrete product offerings. Regarding our newer businesses, we are adjusting our approach to capital allocation in response to changes in the macroeconomic environment. As a result, we have taken recent actions to streamline our innovation portfolio by closing EloQ, scaling back our 3D print operations, and re-evaluating research priorities at PARC. Separately, we continue to see promise from Navity, an industrial predictive maintenance company created at PARC, and Mojave, an energy-efficient HVAC business leveraging PARC technology. We recently spun both companies out as a separate independent business, with Xerox continuing to hold minority share. These actions will help us preserve free cash flow while maintaining the opportunity to realize value from their future success. Meantime, we continue to invest in commercialization of Fiddle and Carry Off, both of which are executing on their strategic plans. Fiddle made significant progress this quarter in its effort to diversify its lending operations away from captive sources towards new customer and product lines. Non-captive originations grew 33%, including a more than 150% increase in originations for third-party equipment and services. Carryout completed a soft launch of Experience Builder, an intuitive, no-code toolkit which allows users to quickly self-publish instructional content at scale. We believe the Experience Builder toolkit will provide a unique point of differentiation for CareAR and further its leading position in rapidly growing service experience management market. At Xerox, we are accelerating our own use of CareAR as a means of approving operating efficiencies and client service. Our remote resolution rate is better by 9% when CareAR is used, which greatly improves equipment availability and avoids sending technicians on site. Carrier helped Xerox reduce site visits by more than 21,000 in just one year, saving more than 269,000 metric tons of CO2 as a result. Among our technicians using the product, calls escalated to higher-level reps are resolved on an average one business day sooner. We expect further efficiencies and progress towards our sustainability goals as we more fully introduce the platform to more of our clients. Free cash flow was a use of cash of 18 million in the quarter. In the first nine months of the year, free cash flow has been a use of 66 million or 25 million, excluding a one-time contract termination payment of 41 million in Q2. To be clear, our cash flow generation year-to-date has fallen well below our expectations due to our strategic decision to invest in Fiddle's growth, a slower-than-expected improvement in supply chain conditions, and persistent inflation. I do want to emphasize that free cash flow remains a key tenant of our strategic priorities and an enabler of our future growth. We expect a significant improvement in free cash flow next year as supply chain conditions improve further and benefits of additional price and cost actions are realized. To recap, the current macroeconomic environment presents risk to all businesses, but I see far more opportunity in the coming quarters and years for Xerox. I see opportunities to expand our penetration of existing products within clients and as we are doing with managed print, IT, and digital services. And I see opportunities to expand our TAM with clients by leveraging our unique position as a trusted partner to deliver value-added digital solutions to our clients' workflow processes. In the near term, we remain laser-focused on profitability and free cash flow generation. I will now hand over to Xavier.

Thank you, Steve, and good morning, everyone. As Steve noted, quarter three results reflect continued strength in demand for our product 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 on modest improvements in product availability. Equipment backlog of 429 million declined slightly quarter over quarter, but remained 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 so how 2023 as supply chain conditions is. For sales revenue grew again in constant currency due to strong growth in consumable, such as paper on supplies, on IT and digital services, including benefit from written acquisitions. Consistent with prior quarter, we continue to see a strong correlation between return to office trends on paid volumes. We are encouraged to see another quarter of page volume improvement relative to 2019 levels. However, page volumes are recovering slower than we expected, as employers' efforts to bring employees back to offices have been slow to gain momentum. Turning to profitability. Profit 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 condition, which negatively impacted product geography mix. This 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 benefit associated with pricing on cost reduction action. We expect operating margin to improve sequentially in Q4, but at a slower pace than previously communicated, as I will discuss later. Growth margin declined 60 basis points in the third quarter. Constraint on the availability of equipment on product cost inflation, net of lower logistic costs, contributed the majority of the decline. Favorable currency, pricing, and restructuring benefits were offset by lower benefits of government subsidies in the prior year and other non-products related operating costs. More specifically, supply chain constraints adversely affected the geographic mix of equipment installed in Q3. We expect gross margin to improve significantly in Q4 as geographic and product mix improve, a higher portion of contractual price increase are realized, and we see further benefit from improvement in supply chain costs. Adjusted operating margin of 3.7% decreased 50 basis points year over year, reflecting lower gross profit, higher bad debt expense, on inflation-related operating cost increases, partially offset by lower R&D spending on project-owned savings. Specifically, supply chain disruption on higher product costs accounted for 60 basis points of the decline in operating margin. Higher bad debt expense on government subsidies benefits in the prior year accounted for another 110 basis points of the decline. Offsetting this impact were benefits from pricing, currency, and the recent cost reduction action noted above. SAG expenses of $418 million increased $5 million year-over-year. The year-over-year increase was largely driven by an increase in bad debt expense of $11 million, reflecting a release of bad debt expenses reserved in the prior year, as well as labor inflation, the effect of acquisition on benefit from temporary government subsidies in the prior year. These increases were partially offset by currency benefit on savings from projects on it. Size expense declined sequentially by $20 million, excluding the one-time accelerated share-based compensation expense recognized in Q2 due to project-owned savings offset by the effect of acquisition on investment in new businesses. RD&E was $73 million in the quarter, or 4.2% of revenue, which was a decrease of 50 basis points as a percentage of revenue year over year. The reduction was driven by lower spending for print on the suspension or deferral of innovation projects. Other expenses net were 34 million higher year-over-year. The increase was mainly driven by lower sales of non-core business assets and increase in non-service retirement-related interest costs due to higher discount rate and higher litigation expenses. Third quarter adjusted tax rate was 42.1% compared to minus 3.5% last year. The increase was largely due to changes in election made to certain tax positions for recently filed returns as well as prior year non-recurring tax benefits from tax return filing positions on the remeasurement of deferred tax assets. Adjusted EPS of 19 cents in the third quarter was 29 cents lower than in the prior year. This decline was driven by a year-over-year reduction in adjusted operating income, lower sales on non-core business assets on a higher tax rate, offset by a lower share count. Gap loss per share of $2.48 was $2.96 lower year-over-year due to an after-tax non-cash goodwill impairment charge of $395 million or $2.54 on an increase in adjusted items, including higher non-service retirement-related and restructuring costs. So goodwill impairment charges reflect a re-evaluation associated with macroeconomic uncertainty, as well as higher discount rate being applied to our forecast. Turning to revenue, demand for our product and services was strong in Q3, but total revenue fell slightly below our expectation due to significant euro and British pound weakness. Despite adverse currency movement, equipment revenue was at its highest level since supply chain constraints began last year. Postales revenue grew mid-single digit on a constant currency basis for the second straight quarter, inclusive of the benefit of acquisitions. While we are observing increased caution from some of our customers, the underlying driver of demand on revenue growth for our business remains healthy. Equipment orders continue to benefit from years of underinvestment in print hardware. Growth in supplies revenue reflects improvement in print activity, managed print, IT, and digital services revenue is growing. And we are realizing the early benefit of recent price increase. Equipment sales of 390 million in Q3 grew 6.7% year over year in constant currency, or 0.8% in actual currency. Constant currency growth was driven by strength in EMEA. The geographic disparity of revenue growth between regions this quarter reflects the availability of units more than demand trend, which remains resilient in both regions, particularly for A3 equipment. We received more equipment specific to European markets than expected, which negatively affected growth margin as the achieved selling prices are lower in EMEA. Installation went down year over year across all categories of black and white machines, but higher year over year for all categories of color machines. This reflects our prioritization of installation to higher value color equipment. Margin benefits associated with an improvement in the mix of color devices were offset by geographical mix on the installation of equipment from our backlog that does not yet reflect recent price increases. We expect a more favorable geographic channel on product mix in Q4. Post sales revenue of 1.36 billion grew 4.1% in constant currency year over year and fell 0.7% in actual currency. Post sales growth in constant currency was driven by IT services, which includes revenue associated with the recent acquisition of Powerland in Canada on growth in sole supplies on paper. Maintenance on outsourcing services revenue growth accelerated this quarter in constant currency due to recent pricing action and the acquisition of Go Inspire. These improvements were partially offset by lower financing revenue, which was impacted by Xerox product availability. Let's now review cash flow. Free cash flow was a use of 18 million in Q3 and was lower year over year by 99 million, driven by a 60 million increase in the use of working capital and an incremental 46 million of capital used to finance origination on operating lease growth at FITO. Operating cash flow was a use of cash of 8 million in Q3 compared to a source of cash of 100 million in the prior year. Working capital was a use of cash of $14 million this quarter, $60 million higher than the prior year, driven by the late receipt of product in the quarter on an increase in inventory in anticipation of higher Q4 revenues. Additionally, cash used to fund an increase in finance receivable on operating leads was $54 million in the quarter compared to a use of fund of $8 million in the prior year quarter. reflecting fetal portfolio growth strategy. Investing activity where use of cash of 33 million compared to a source of cash of 18 million in the prior year, due in large part to 41 million of cash used to acquire businesses on lower proceeds from the sales of non-core business asset, partially offset by lower capex. Capex of 10 million was 9 million lower year over year. CapEx mainly supports our investment in IT infrastructure. Financing activity consumed $168 million of cash this quarter, driven by a net reduction in securitized debt. During the quarter, we paid dividends totaling $43 million and did not repurchase any shares. We remain committed to returning at least 50% of our free cash flow back to shareholders. We expect to exceed this amount based on a year-to-date share repurchase on our annualized dividend. Turning back to profitability. Adjusted operating income margin improved sequentially this quarter, but at a slower pace than expected due to the effect of supply constraint, geographic mix, and the impact of higher than expected inflation across our cost structure. We remain on target to deliver $450 million of gross cost savings this year through Project ONIT, but high levels of inflation have caused a rise in operating costs above the level expected when we increase our savings target to $450 million in Q1. Further, supply chain conditions are improving, but not at the pace we anticipated as recently as last quarter. We expect adjusting operating margins to improve again in Q4, As product supply constraints ease further and we realize the benefit of incremental pricing benefit, a more profitable geographic mix on cost action. However, we no longer expect our full-year operating income margin to exceed prior year level. We are not providing an update to our 2023 margin outlook today, but I will provide some perspectives. Profitability improvement is the most important mid-term prerogative for our management team. We expect adjusted operating margin to improve in Q4 and continue into 2023. Specifically, price increases and cost action taken this year have trailing on compounding benefit for 2023 and incrementally if revenue continues to grow as we expect it will. Further aiding our profitability next year are the actions we have taken to reduce our spend on innovation projects with longer periods of realized benefit. We will provide more detail on expected 2023 savings from adjusting spending on new businesses when we provide 2023 guidance next quarter. Finally, we remain diligent in our approach to managing our overall cost structure. Project ONIT will have delivered more than $2.2 billion of savings since 2018 by the end of this year. As we have noted in prior calls, ONIT is as much about generating operating efficiencies as it is cost-cutting. We have additional capacity to do both in the coming year. As Steve noted, we are currently undergoing a detailed strategic review of our business structure, the result of which is expected to yield significant savings and enable greater sales. We expect the combination of margin improvement from better supply chain conditions on price and cost action already executed, along with future profit enhancing actions, will drive operating margin in 2023 closer to the level indicated at our February 2022 investor day. Turning to segments, Feet of revenue declined 12.3% in Q3, mainly due to a reduction in operating lease revenue, reflecting lower Xerox equipment in store due to product constraints. Segment profit fell 16 million or 67% due to lower profit from operating lease on higher bad debt expense, including a reserve release of approximately 14 million in 2021. which were only partially offset by lower inter-segment commissions due to lower originations. Segment margin was 5.4% compared to 14.3% a year ago. Year-to-date, fetal margin of 9.3% remained above our full-year estimate of 8 to 9%. We continue to expect fetal margin to fall in that range for the full year as Xerox leaves volume pickup driving increase in inter-segment commission. In Q3, Fetal's finance assets were stable at constant currency quarter over quarter. Fetal origination volume grew 6% year over year. Non-captive channel originations, which include third-party dealers and non-Xerox vendors, grew 33% year over year due to growth in new dealer relationship and third-party equipment origination volumes. This growth was partially offset by a decline in captive product origination of 11%, which were negatively affected by Xerox product availability. Print-on-other revenue grew slightly in Q3 in actual currency. Print-on-other segment profit grew 14% year-over-year, with a 50 basis point expansion in segment profit margin, despite being negatively impacted by the ongoing effect of supply chain constraints on inflation. Turning to capital structure, we ended Q3 with a neutral net core cash position. $2.7 billion of the $3.7 billion of our outstanding debt is allocated to unsuperficial lease portfolio. The remaining debt of around $1 billion is attributable to the core business. Debt consists of senior unsecured bond on finance asset securitization. We have a balanced bond maturity ladder on no unsecured maturity for the remainder of the year. As a reminder, we plan to refinance the entirety of our 2023 obligation with additional securitized receivable financing. The vast majority of our debt carries a fixed rate. As a result, we do not expect material near-term profitability or free cash flow headwind associated with rising interest rates. Finally, I will address guidance. We lower our revenue guidance from at least 7.1 billion to a range of 7 to 7.1 billion at actual currency, largely due to adverse currency movement and to a lesser extent, slower than expected easing of supply chain constraint. Since we last gave guidance, currency fluctuation has caused a 70 million headwind to our revenue outlook in actual currency. Our constant currency outlook for full-year revenue growth is largely unchanged as we maintain a sizable backlog and have good visibility to Q4 product shipment. We lower our free cash flow guidance for the year from at least $400 million to at least $125 million. As noted on previous call, our guidance was predicated on an easing of supply chain conditions on an expected level of paid volume improvement. When you have experienced improvement on both fronts and continue to expect further improvement going forward, the improvements realized to date are lower than our initial expectations. More than 150 million of the decrease in free cash flow guidance reflect a greater than expected use of working capital to fund origination growth of FITL on inventory, which was a larger than expected use of cash in Q3 due to late delivery of equipment. Neither of these have any impact on profitability. On our investment in FITL portfolio are expected to produce double digit margins on return on investment over time. The remainder of the reduction in free cash flow guidance reflect a lower operating profit outlook for the second half of the year due to slower than expected improvement in supply constraint, paid volume trends on stronger than expected inflation across our cost base, the effect of which we'll expect will normalize in 2023. Similar to my comment on margin, I want to be clear that we are in no way satisfied with this year's expected free cash flow result. Our team is working tirelessly to improve margin on working capital efficiency, and we expect significantly stronger free cash flow results in the years ahead, due in part to improvement in supply chain constraints and an easing of inflationary pressure on our cost base, in combination with additional strategic action. Our expectation is that free cash flow will more than amply cover our dividend of $1 a share which we have every intention of maintaining. We now open the line for Q&A.

Certainly, ladies and gentlemen. Once again, as a reminder, if you have a question at this time, please press star 11 on your telephone. And our first question comes from the line of Anel Abruja from Loop Capital. Your question, please.

Hey, good morning, guys. Thanks for taking the question and a lot of really, really useful details, so appreciate that. I guess the big one for me is really on demand and on revenue, which has held up really well. Any customer context that you can share that would be useful? 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, you know, 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, You know, 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? Appreciate that. Thanks.

Thanks, Amanda. So as we noticed it, so our demand for product on services remain very, I would say, resilient. You know, you understand the macro environment is challenging. At the same time, what we have seen is the demand for product remains strong. Our backlog moderately reduced. It was only 8%. As we mentioned it in quarter two, we're expecting the backlog, you know, 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 on specifically on A3. And what we see from the macro environment is that we are not perceiving a reduction in IT investment related to our product. And our products support the resolution or how our customer are currently looking at addressing some of the challenges that they have, 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 a demand decrease, and the backlog is steady. We're expecting to absorb some of the backlog as well in Q4. On what we are facing currently is mainly related to the challenges we face during the quarter, was mainly related to supply chain and nutrition pressure.

And I would say the other thing is, 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 Zavi, I believe You may have mentioned you got to expect to grow in 2023. Is that accurate? And I guess what underpins that? Is it really just sort of the stuff you talked to just a moment ago, or is there anything incremental to that? Thanks.

Yeah, so we'll I will give you two data points. First data point is on equipment revenue. Equipment revenue, 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 one quarter of the full year revenue. So still a strong backlog here. And 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 orders from customers. So this is healthy. Other customers are clearly waiting for the supply chain challenges to be fixed here. Regarding post sales, as you have noticed in quarter two, by the way, both on equipment on post sales since quarter two 2021. So this was the first time where we started to face some of the supply chain challenges there. But equipment revenue and 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, other revenue stream in post sales taking, you know, shape. on the 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 there, 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 these components and you project this for next year, we're expecting, you know, revenue to grow. ESA will be a key driver, but IT services as well on other revenue stream in process will drive the growth.

That's a lot of good detail. I appreciate it, guys. Thanks a lot.

Thank you, Ananda.

Thank you. One moment for our next question. And our next question comes from the line of Eric Woodring from Morgan Stanley. Your question, please.

Hi. Good morning, guys. This is Maya Newman on for Eric Woodring. Thank you for taking my questions. 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?

Yeah, so these two indications is to address one question we often receive around how do you see the post sales for the new stream going there. So as I mentioned it, post sales was a growth in the quarter. It was at constant currency, a growth of 4.1%. So still, I would say a healthy stream here. However, we have noticed in some occasion, you know, customer taking longer to deploy certain project. It could be a relative 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 on the way I'm not losing revenue because often this customer are currently using our solution. So this is an expansion of the current contract up to a next contract. Commenting on the page volume, we have seen in quarter three over quarter two a sequential growth increase of page volume. We are not yet at 80%. Some of our geography are at 80% of what we were in 2019, but it's a gradual recovery. I would say a transparent here. In our expectation, we were expecting a higher recovery during this quarter, but it 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 a pendulum going down. This is still a growth quarter over quarter on the sequential improvement here. and still the correlation 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... Yep. Yeah, I'll let you go. Thank you.

Okay, it's very simple and 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 assumptions that you have when you build a case. So discount rate on how you calculate the WACC. And I would say the vast majority or 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 and how we just adjust it. And it's, you know, one of the components that help us to assess, you know, how the goodwill should be sustained in the future. This is – I want to reiterate this point there. This is a known cash item on the – you have noticed this is treated below the line. So this is something that we're doing every year, and I'm certain that this is challenges that other companies are facing as well.

Great. Thank you so much.

Thank you.

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

Hi, good morning, and thanks for taking my question. I guess I wanted to go back to the comment about page volumes again, and I know, 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 your understanding that that's driven by less return to the office, or is 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 you would expect sort of your customers to take certain budget decisions or priorities based on the page volumes that you're seeing? Why wouldn't their sort of priorities and their budgets change around print? Why shouldn't we think of that in 2023? And have a follow-up, please.

Yes, thank you, Samick. So the main point that we observe here is that return to the office has been slower than companies were 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, you know, 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 page volume. We are getting our trajectory to go to 60%. We are getting closer to this number, and I mentioned some geography are already above 80%, but we are not yet there in every place is there. So getting closer, gradual improvement, but we do not observe, you know, like a significant shift or changes in the printing pattern of our employees. Another point is we still have a strong demand around our MPS management solution around, you know, working from home or when an employee wants, you know, a company wants to support working from home. And the A4 business, so 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 spread volume is one indicator, but another indicator is how the devices have been used by our customer. 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 customers, 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.

For my follow-up, if I can ask on the cash flow, the change in guidance here from 400 to 125 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 part, I believe, You had updated us that you spent looking at a cash flow or cash investment about 250 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.

Yeah, so the way to look at it and to simplify it, so the reduction between 400 and 125, more than 150 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 a late arrival of products in Q3, which is good news because it will help us as well to deliver a strong quarter flow from an ESR 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 fetal growth. And you know, Fitol is a business where you borrow money and then you sell this money back to customer as part of our financing arrangement with customer here. And the fact that FITOL is growing, it's a good thing, because what does that mean? You have heard it, the portfolio of FITOL now at constant currency is flattish on the start, you know, has a trajectory to reverse the trend that was a trend down. But does that mean that FITOL 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 FITOL. So that's the working capital. It's more than $150 million of decline, free cash flow decline or difference versus guidance. The remainder, which is around $125 million, is mainly related to profitability and behind profitability. This is the supply chain challenges that we face and the fact that the mix of products that we are receiving on 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. 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, good install in quarter four. And we have also taken action on, we mentioned it during our call there, reducing some of the AR&D on the innovation project. Some of these projects have a longer realization period. So we are focusing on a better return on investment on some of these projects there. And as always, Project ONIT is one of the drivers of our cost-based adjustments. So, again, I want to repeat and reinforce this message here. Improvement in margin sequentially on free cash flow in Q4 on 2023. Thank you. Thanks for taking my questions. Thank you.

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.

Thank you very much. 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 and that. And how should we think about the value or how to track the minority ownership that you retained in those businesses? And I have a follow-up. Thank you.

Hey, Shannon. Steve, thank you for the question. So, you know, when you think about macroeconomic conditions, the cost of capital and valuations of high-growth businesses, you know, they've evolved since Invest Today, right? Current opportunities in favor, investments out of 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 LRQ as we think about the amount of investment that it would take in the long lead time for return. We've scaled back 3D. But importantly, you know, we've made sure that two businesses, specifically Noviti and our HVAC business, Mojave, have been spun out, and they will get cash investments and see that grow. 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.

But, 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 yet.

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 know, 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. You know, are you looking at massively shrinking your technicians or going more to inside sales or, you know, how should we think about how you're going to, you know, morph this given sort of the end market dynamics as well as the macro challenges?

Yeah, 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. We're talking about carry-offs. 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, in 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 on it. And, you know, obviously as we get to end of Q4, we'll give you more callers 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, you know, how you can maintain the dividend that you're at And 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. Thank you.

So Shannon, we have no issue with paying the dividend on the 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 will be paid on December, will be entirely funded by securitization, and this is in flight. So we have no concern on this point here. Regarding our 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 little growth. It is a good thing to have. On the other side inventory, I clearly expect the inventory situation to reverse. As you know, Q4 is always the strongest quarter, and we are still sitting with a backlog of $120 million. So we should have a strong quarter from an ESR point of view that will deplete the ESR inventory and reduce this inventory down.

Okay. Thank you very much.

Thank you, Shannon.

Thank you. One moment for our final question. And our final question for today comes from the line of Jim Zula from Citi. Your question, please.

Thank you so much for fitting me in. Can you help me better understand how to bridge with more investment into Fiddle 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 Fiddle because if sales are being challenged and you have a more cautionary outlook on macro concerns, building FIDL just seems kind of interesting. If you can help me bridge that, that'd be great.

Yeah, so, Jim, I will step back a little bit on the described FIDL strategy. So FITEL has been for a long time a captive operation, and this other captive was behaving as what you described, which was completely linked, connected, correlated with Xerox equipment review. When Xerox equipment review was up, you know, 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, since we reinitiated, reinvigorated Fittal, due to the fact that Fittal has a strong credit assessment capability, a good platform, and the ability to expand beyond Xerox, the Fittal team, management team, has expanded well beyond the pure Xerox product. on what we have noticed in quarter three on 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 quarter three. As I described it, I call that a good cholesterol 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 customers here. So back to your question, precise question. It was mainly related to non-Xerox equipment or solution growth, not correlated to the pure Xerox equipment.

That makes sense. Thank you so much.

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Steve VanRosick 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 honored 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's 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.