Welcome to the Xerox Holdings Corporation Third Quarter 2021 earnings release conference call. After the [Indiscernible] there will be a question-and-answer session. [Operator Instructions] At this time, I'd like to turn the meeting over to Mr. David Beckel, Vice President and Head of Investor Relations.

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 2021, Earnings Release Conference Call hosted by John Visentin, Vice Chairman and Chief Executive Officer. He is joined by Xavier Heiss Chief Financial Officer. At the request of Xerox Holdings Corporation, today's conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the express permission of Xerox. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor, and will make comments that contain Forward-looking statements, which by their nature address matters that are in the future and are uncertain. Actual future financial results may be materially different than those expressed herein. At this time, I would like to turn the meeting over to Mr. Visentin. Mr. Visentin, you may begin.

Good morning, and thank you for joining our Q3 2021 earnings call. I hope everyone is safe and healthy. Revenue this quarter of 1.76 billion was essentially flat with the prior year's third quarter, despite a challenging operating environment. Adjusted EPS of $0.48 was flat year-over-year and we generated free cash flow of 81 million, down slightly from 88 million in the prior year. Adjusted operating margin of 4.2% was lower year-over-year by 320 basis points. This quarter's results were negatively affected by two significant secular challenges: a deterioration of Global Supply Chain conditions and the Delta variant. As the third quarter progressed, the challenging supply chain conditions we highlighted on our Q2 earnings call deteriorated further. Specifically, raw material and component shortages limited the availability of certain of our products and supplies, particularly our A3 devices. Transportation constraints extended delivery times by weeks, and drove unit shipping costs multiples higher than normal levels. And when our products arrive, labor shortages further delayed delivery times. These challenges accounted for two-thirds of the year-over-year decline in this quarter's gross margin and caused equipment revenue to fall short of our expectations. Demand for our products remained strong, resulting in further growth of our backlog of equipment and third-party hardware to 265 million, which is approximately 90% higher year-over-year and more than 20% higher than the prior quarter. Our backlog also has a larger proportion of high-margin A3 devices relative to the previous periods. Post-sale revenue grew 1.7% year-over-year, but fell below our expectations as the Delta variant disrupted many companies' plans to return workers to the office. We expect vaccination rates will improve as governments encouraged companies to implement vaccination mandates. And we continue to see a strong correlation between vaccination rates, a return of employees to the workplace, page volumes, and…

Thank you John and good morning, everyone. As John noted, significant disruption to global supply chains and delays in the returns of worker to the workplace negatively affected our financial results in Q3. Despite these challenges, our revenue were essentially flat year-over-year as gradual improvements in page volumes on IT services, growth in [inaudible 00:16:26] revenue on offset lower equipment sales, which were negatively affected by component shortages on logistic constraints that affected [Indiscernible] cost on capacity. However, underlying demand for our equipment remained strong as evidenced by our growing backlog, which is almost two times higher than normal level. Higher supply chain costs are less profitable mix of equipment sales on lower margins, on post-sales revenue drove our profitability lower year-over-year. Gross margin declined from that on 40 basis point. Around 219 basis point of the decline is attributable to supply chain costs on capacity of restrictions, including significantly higher freight on shipping costs on constrained availability of higher margin equipment. 60 basis points of the declines relate to investment to support future growth. The remainder of the decline reflects lower government subsidies, net of Project Own It settings on lower royalty from FUJIFILM business innovation. We expect supply generated pressure on gross margin to dissipate over time as supply chain normalize. But this pressure will likely continue to weight on gross margin in Q4 into the first half of 2022. Adjusted operating margin of 4.2% decrease 320 basis points year-over-year, reflecting lower gross profit, lower government subsidies on higher R&D investment to support our targeted growth area. Indeed, we maintain this investment despite the unfavorable operating environment. These headwinds were partially offset by lower bad debt expense on savings from Project Own It. SAG expense of 413 million decreased 31 million year-over-year, primarily driven by savings from Project…

Thank you Xavier. Operator, can you please open the lines for questions?

Certainly. [Operator Instructions] Our first question comes from the line of Katy Huberty from Morgan Stanley. Your question, please.

Yes, thanks. Good morning. How much of the 200 million lower revenue guide at constant currency is a function of the backlog build versus the slower recovery in page volumes and just connected to that, how much do you expect backlog to build in the fourth quarter? Then I have a follow-up.

Hi, Katy. Good morning. This is Xavier here. Regarding backlog going into the year 200 million revised guidance there, the vast majority of this is relative to equipment. The equipment backlog that we face here. As we put it here, we ended with 265 million of backlog, which is close to 60%, 59% of the total revenue of quarter 3. We expect these backlog to grow base d on the supplies outlooks that we have for quarter 4 at this date.

Okay. So backlog grew about 50 million sequentially in the September quarter, if most of that 200 million guide down is related to backlog build, that would imply that you would expect even more backlog build in the 4th quarter. Is that the way to think about it?

This is correct, Katy.

Okay. Okay. And then -- I know it's really early, but do you have any initial thoughts as to how you -- how you're contemplating Fiscal '22 as it relates to the increased supply chain costs and revenue impact that carry into the first half of the year? Does that setup for potentially flattish or even pressure on EPS and free cash flow relative to 2021 or is it too early to tell?

Katy, as we indicated during the call here, we expect the supply chain in part to carry on, and the had some impact during the first-half. During the quarter 3, we have been surprised by the size of the supply chain. As we commented here, it is mainly related to some material shortages. But also the fact that the chips on the -- you know, profits are becoming well positively well-facing [inaudible 00:32:40] this year. We put in place a lot affection, including redesigning some of the -- [inaudible 00:32:47] some boards are currently implemented on our product, but it will take time to recover. So what I want to point out that's what this is not only the scarcity of certain component here, it's also the overall supply chain. You have heard -- it should not be new news here, over the year, challenges that a lot of Company are currently facing with [Indiscernible] shipment, but also up to the delivery to the end customer. So we expect some of it to stay into the first half of 2022, and hopefully our backlog is strong evidence that our customers are still renewing their equipment. Also, as we mentioned during our comment, we grew market share. So we're still growing market share. We did it in quarter one, we did it in quarter two as well, And clearly, the orders that we are reaching from our customer have the evidence that there is still a strong demand here. So we will manage this. It's a little bit early to provide [Indiscernible] guidance. And as we mentioned it, we will hold down the -- manage, we hope, face-to-face Investor Day in February, where we will be able to provide you more information.

Thank you.

Thank you. Our next question comes from the line of Ananda Baruah from Loop Capital. Your question, please.

Hey, thanks guys for taking the question. I apologize if this has been addressed, I have a couple of calls and an event going on this morning, but just to the -- to what you guys are seeing, sort of demand-wise, revenue-wise, and any sort of incremental feedback you've gotten from your enterprise customers as you move through the quarter that might be different from what you have been communicating to us over the last couple of quarters or so. Thanks.

Ananda, what we've been seeing is demand is strong, and the other thing that we've noticed is return to the office has slowed down from what we anticipated. So we're anticipating more early next year, being full back to the office. Because of Delta variant, a lot of the corporations we've spoken to have delayed their openings or slowed them down. But demand for our product is strong. And again, with the supply chain constraints, that's become an issue for us.

I appreciate the context, John, and then let me just ask a follow-up in that regard. Any -- because you guys are pretty deep in the weeds with your conversations with your enterprise customers. Strategically from their perspective, have you seen anything change in terms of long-terms intention for sort of how they're thinking about back to the office or the use of your products in the context of those strategies?

No, we haven't seen a change from what we've expressed in the past. They're focused on bringing their employees back to the office in a safe matter and they're using our products more for products -- both for productivity and for security. And in some cases with our software to utilize a hybrid environment in which when their employees do work from home, but not really much of a change there. I think what slowed that down was the Delta variant and everybody is being careful in getting their employees back safely to the office.

Very good [inaudible 00:36:25] I appreciate it.

[inaudible 00:36:25] We have seen as well on our global document solution businesses some good traction on offerings enabling to work from home and work in the office here. As an example in capture on content services here, we've seen significant double-digit growth of signings, which show that the enterprise are supporting these type of offerings, but also willing to enable this on the [Indiscernible].

That's helpful. Thank you, guys. I appreciate it.

Thank you. Next question comes from the line of Samik Chatterjee from JPMorgan. Your question, please.

Hi. Good morning. This is Angela Zhang on for Samik Chatterjee. Thanks for taking my question. The first question I have was -- so HP at their Investor Day said that they expect a low to mid-single-digit decline in supplies next year, which we thought was interesting. Are you seeing similar trends there given that you're also forecasting greater return to office in '22? And then I have a follow-up.

Yes. Good morning. So as you know, our business model is slightly different from the one that HP had. We are less dependent on what we call [inaudible 00:37:43] or consumable out model. Our model is based on subscription and we do not see this trend. Our trend is mainly related to page volume, on how customers are using our equipment. But not only to print but also to drive the workflows that our equipment are much more than a device. On support, what [Indiscernible] that the customers are using here. So we -- if you want data point, a proof point of what we're faced, we saw some increase in quarter three of what we call the sole supplies from [inaudible 00:38:20] on the -- we are positive of seeing a gradual recovery of page volume over the time.

Great. Thank you. And then for my follow-up. Just thinking about your product mix on A3 versus A4 printers, it seems like for the industry view, is that A4 will become more popular over time as offices migrate towards smaller printers spread out more evenly, are you seeing a shift in strategy towards A4 printers? And if so, will that result in a structural margin decline?

If we look at our third quarter, our backlog for A3 went up from Q2. We're gaining market share and then, we're seeing a strong demand in the A3. And we've also gained market share in the A4 market.

Great. Thank you so much.

Thank you. [Operator Instructions] Our next question comes from the line of Shannon Cross from Cross Research.

Thank you very much. I was wondering about the pricing environment, both on the short and long-term for hardware as well as pages. Obviously, given all the supply chain challenges, certain other industries have been able to raise prices. I know inkjet printers for instance, there's less promotion, so I'm curious what you're doing there. And then we talked to Cannon and they're thinking long term. They're going to see some price pressure on pages. So I'm just kind of curious how you think this plays out both in the next few quarters and then maybe long term? And then I have a follow-up.

Thank you, Shannon. Good morning, Shannon, too. You asked a good question here. What we see on the pricing on Vermont mainly related to the supply-demand dynamic here, is the ability of raising prices. This is something's that we started executing. We started executing already in quarter 2 on [Indiscernible] plan in order to reflect some of the cost that we are facing here specifically on supply chain, on some of the raw material costs that we have here. Regarding page volume on those or price per page here, this is our [inaudible 00:40:34] usual business as usual negotiation, we have not seen an increased competitive on Vermont on this on -- as you know it, we are quite stringent in managing the pricing and also protecting with minimums our annuity volumes.

Okay. And then SG&A is at the lowest level that I have in my model, even after incorporating the 14 million, it's going back split and then I'm assuming pre -split, Xerox is a bigger Company back then. How much further can you cut SG&A, what did you take down, how much of SG&A is onetime versus recurring in nature? Just trying to understand given that the gross margin pressure you're facing, how much flex you have in some of your other expense lines? Thank you.

Yes, Shannon. So on SG&A, we quoted the only, I would say, one of [inaudible 00:41:29] I highlighted here is related to there but debt [Indiscernible] that we have, which is by the way good news, which shows that the business is recovering in light of last year or two years ago, starting the impact of COVID -19 here. For the rest, you know that we have Project Own It in place. And Project Own It is much more than a pure cost-cutting type of activity. It's also ingrained in the DNA of the Company on how we adjust our cost base, based on, I will say the environment here. So flexibility exist within the cost base and will ensure that we can reflect some of the gross profit decline and gross margin declines that we have in our fixed cost base as well.

Do you think you can get down below 300 million? Or I'm sorry, 400 million?

It's a little bit early here, Shannon, because we're growing source of planning cycle here. But clearly, Own It, as I mentioned it, Own It is not only SG&A, Own It is the entire cost base as a Company. On the -- we look at any opportunity we can have here. You know that we have had the benefit of last year. We call it the amount on this year as well. So we have the benefit of Government subsidies. These Government subsidies are instigation, you can see that in our cost base, specifically in G&A, we are able to offset this via cost actions that we're taking to flexibilize the cost base.

Okay. Thank you.

Thank you, Shannon.

Thank you. Our next question comes from the line of Jim Suva from Citi. Your question please.

Thank you. Thank you for being so open and transparent about the taking the outlook down a little bit. And can you help us understand, do you fully believe or can you know is this supply chain issue driven or I know, of course, going back to the office has been delayed or is it actually structurally people are printing less? And how should we think about that if it's the case or not the case, or how do we actually know? Thank you.

Jim, we've seen a strong demand for our products, and in fact, you saw in third quarter that our backlog increased again to record levels. So we are seeing the demand. We're increasing market share, even in September there's a direct correlation with vaccination and going back to the office and volumes. And we saw an uptick in September. So our belief is that going back to the office is a question of when, not if. And the delays have happened for again, safety of employees. And -- but that's how we're seeing it right now.

Great. Thank you so much for the details.

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

Okay. Thank you. Look, we cannot predict with precision when supply chains will return to normal. But we expect they will normalize overtime. We also believe a broader return of employees to the workplace as a matter of when not if, and in-office work will be different, but we are prepared to meet workers involving print and document management needs. Be safe and be well.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Good day.