Good day, and thank you for standing by. Welcome to the Xerox Holdings Corporation Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question and answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today to Mr. David Beckel, Vice President of Investor Relations at Xerox Holdings Corporation. Please go ahead.

Good morning, everyone. I'm David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation second quarter 2022 earnings release conference call hosted by Steve Bandrowczak, Interim Chief Executive Officer. He is joined by Xavier Heiss, Executive Vice President and Chief Financial Officer. At the request of Xerox Holdings Corporation, today's conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the expressed permission of Xerox. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/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. Bandrowczak.

Good morning, and thank you for joining our Q2 2022 earnings call. I'd like to begin today's call by acknowledging the passing of our dear friend and colleague, John Visentin. As we mourn his loss, I am inspired and deeply humbled by how the Xerox family has come together and become stronger. We will honor John by continuing to execute across the four strategic initiatives he articulated for returning Xerox to long-term sustainable growth, and by operating as one cohesive team to help propel us forward. John instilled in all of us one boat, one team mentality. And these words will serve as inspiration as we work to fulfill his legacy. I am honored to have received the confidence of the Board to lead this great company. Summarizing results for the quarter. Revenue of $1.75 billion declined 2.6% in actual currency and grew 1.1% in constant currency. Adjusted EPS was $0.13, $0.34 lower year-over-year. Free cash flow was a use of $98 million, which includes the onetime contract termination charge of $41 million we disclosed in last quarter's earnings compared to a source of $198 million in the prior year. And adjusted operating margin of 2% was lower year-over-year by 500 basis points. Revenue was slightly ahead of our expectation and reflects momentum in demand for our products and services, notwithstanding a challenging operating environment. Equipment revenue declined 14.7% or 11.4% on a constant currency basis. Supply chain constraints continue to limit our ability to fulfill demand, which remains strong as evidenced by further growth in our equipment order backlog. Post sale revenue grew 1.2% or 5% in constant currency. This represents a sequential improvement, mirroring a recovery in print-related activities as employees gradually return to the office. Page volumes once again grew modestly this quarter. And importantly, we are…

Thank you, Steve, and good morning, everyone. As Steve mentioned, strong demand for our product and services this quarter drove revenue growth in constant currency despite ongoing supply constraint. Equipment revenue declined as expected, but order continued to outpace supplies as evidenced by another quarter of backlog growth. Backlog in Q2 was $440 million, which is more than double last year level and exceeds a full quarter of revenue. Backlog remains elevated but is healthy and its rate of growth declined quarter-over-quarter. We expect to convert substantially all of our backlog into revenue and believe backlog is now at peak levels. Post sales revenue grew in actual currency and constant currency due to growth in IT services and print activity-driven revenue, such as consumables and services. Consistent with prior quarter, we see a strong correlation between return to office trends on page volumes. In the second quarter, we were encouraged to see service revenue growth outpace page volume growth as contractual price increases began to materialize. We expect that trend to continue through the remainder of the year. Turning to profitability. As with prior quarter results, profits were lower year-over-year due to lower equipment sales, lower margin on equipment on post sales revenue, broad-based inflationary pressure on incremental investment associated with our new businesses. However, early benefit of price increases and lower spending resulted in a sequential improvement in both profit and profit margin. Gross margin declined 370 basis points in the second quarter. 340 basis points of this decline is applicable to supply chain costs on capacity restriction, including higher freight and shipping costs, constrain availability of higher-margin A3 devices and higher product and service cost. Approximately 80 basis points of the decline relate to investment to support future growth, lower royalty from Fujifilm business innovation and lower government…

I show our first question comes from the line of Ananda Baruah from Loop Capital. Please go ahead.

Really appreciate you taking the questions. Yes, and just want to say our thoughts remain with you guys and John's family at this time as well. Business-wise, yes, I think listen, congrats on the solid actions and the ongoing sort of solid outlook for second half of the year, which also speaks to your execution. I guess just sort of starting there, any context, guides, you can provide with regard to a customers are actually communicating to you, get it sounds like the sort of order patterns -- all forget. Any context that they're giving you around under what conditions may cause them to sort of get more cautious, rethink their order patterns, rethink their projects, anything like that? And then I have a couple of quick follow-ups after that.

What we see currently is that as you see from near start point of view, our backlog remains strong, and we still see demand that outpaced the supplies here. And clearly, customers are still planning return -- gradual return to the office. And if I move now on to the post sales element here. You saw that our strong post sale revenue with a growth at constant currency of 5% -- broad on across the, I would say, the Board. It's not only related to page volume on print-related activity, but IT services as well grew significantly during the quarter. So what the customers are indicating to us is that they are still relying on our technology and services, and the demand that we see currently for this remained strong and keep us positive for the remaining of the year.

And just -- so just to that, Xavier, can you tell -- give us any sense of how big the backlog is?

How big are we, Ananda?

Yes. How large is the backlog? How big...

Backlog. So the backup is $440 million. So backlog grew. It grew less than what we had from quarter one to quarter four. So it grew roughly 5%. And we see, I would say, good sign of supply chain easing, but $440 million, as you know, it is more than a full quarter of equipment revenue sales here. So still strong, but I should add as well a good quality backlog. One question we have seen, or one of the concerns you can see on the industry is with this backlog last -- I mean, with customers stopped ordering. We see very, very minor cancellation and we are able to manage the aging of the backlog. So customer order can be fulfilled, I will say, on time. And with the support of FITTLE, our leading financing business, we're able to extend some of the leads. So customers are not suffering from backlog here. So good, confident in the strength of the backlog. And also, we see line of sight during the second half of an ability to realize some of these backlog during the second half of the year.

And I show our next question comes from the line of Erik Woodring from Morgan Stanley.

This is Maya on for Erik. So where are we along that path to reach 80% of pre-COVID page volume averages? Some of your peers have talked about returning close to that level. Are we at the point where page volumes have stabilized given the variability in working environments? Or are we still a little bit away?

So it's a great question. So we are monitoring that very closely. So -- and if you remember, we observe and we carry on observing, a straight correlation between vaccination rate, which is now raised all across the world, presence and return to the office and print volume. And what we have observed during quarter two is what we call a gradual recovery. So we are on the trajectory to increase and to get closer to this 80%. So geographies have different type of dynamic. So between EMEA and Americas, we see different type of dynamic within this segment there. But currently, what we observe is that we are getting closer to the 80%. And we are also expecting during the second half of the year, a gradual recovery of the print volumes.

And I show our next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

I had a couple. I guess, firstly, if I'm looking at your revenue guide for the year, which you reiterated, there's a $300 million improvement, second half to the first half, I think, in terms of revenues that you're guiding to. Was wondering if you can give me a breakdown of how much that has supply improvement led sort of equipment revenue relative to some of the price increases on services that you talked about? If you can just give me a bit more of details around sort of the improvement that you're expecting in the second half. And then I have a follow-up.

So the three components that are the foundation of second half revenue improvement is number one, equipment sales improvement and -- in equipment sales improvement, this is mainly related to supply chain capacities and component availability. We have line of sight based on the recent number from our OEM of improvement coming into the second half of the year. If you combine that as well with the price increase that we have elected on equipment sales there, you have a double effect, more product on products that could be sold at a higher price. I will add as well, and this is mainly related to margin, it will be done with a better mix. And one of the challenge that we have had since the beginning of the year is a lack of A3 equipment with a better line of sight now of A3 product availability, driving profitability and margin improvement. So that's the first pillar. The second pillar is around the print volume and page volume improvement, and we are expecting here a double effect as well here with a gradual recovery of page volume, but also combined with price increase that we have been able to apply across the range of the contractual agreement with our customer. And lastly, IT services, and you certainly heard this year, in quarter two was an organic growth of more than 30%, and we have also, the benefit of inorganic growth there. IT services, both demand and availability, I would say, with some improved product availability will also drive the revenue improvement in the second half of the year. So the $300 million difference that you can see are based on these three pillars here.

And the second question is more of a follow-up on -- to the comments that you have on Slide 6 about how the business fares in a recession. I'm just trying to understand those comments a bit better here, where you say two-thirds of your business is contracted for multiple years and you go on to say there's a contractual revenue risk in the near-term downturn. So maybe just if you can give more details there to help me understand that a bit better. Do you expect some of the contracts to be passed by your customers in a near-term downturn or sort of downsize how you're thinking about sort of the contractual revenue risk for what you mentioned is two-thirds of your business and is contracted for multiple years?

Yes. So as you know, our business model is made on the, I would say, two type of revenues simply. A transactional type of revenue and a contractual type of review. On the transactional, or the -- let's start with the contractual. So contractual is around two-thirds of the business. So when we enter into a period where customer have a question around the future, for Xerox, the benefit of our business model is that two-thirds of the revenue is revenue that is booked and this book on contract with an average length of the contract, which is between four to five years. So this gives us as well here confidence on top of the demand that we see currently because when you look at what customers are asking us to deliver today, this is mainly related to -- the demand that they have is mainly related to not only being able to support the processes with print and services here, but we have also IT on the digital services where usually, this type of businesses have a countercyclical aspect. When a company goes through, I'd say, a recession or try to generate savings, they will invest in this technology in order to improve their own productivity, reduce the cost base and deliver their own cash flow here.

And I show our next question comes from the line of Jim Suva from Citi. Please go ahead.

Thank you so much for and -- all the details, of course, our heart thoughts with Mr. Visentin and his family and loved ones and team members of Xerox. As we look ahead, the inflationary environment, both on labor costs and other things like that, I'm just kind of curious about how should we be thinking about your operating costs and your margins going forward? I know there's puts and takes about shipping costs, material costs or maybe operating margin is a better focus item. Can you give us any clarity? And also, I don't remember, are there like typical merit increases that fold into the Xerox employee base that we should kind of be mindful of as we look ahead for kind of either 2023 or believe it or not, we're starting to model and look into 2023? Just on the inflationary environment overall?

Yes, thanks, Jim. So yes, we see as in lack of businesses, see a pressure of inflation. However, as we mentioned it, some of the erosion that we are seeing currently on our business is mainly related to supply chain. The supply chain, if you look at the gross margins that we printed for this quarter, we have a gross margin, which is down 370 basis points this quarter versus last quarter. Otherwise, the number were roughly the same in quarter one with a sequential improvement, but 340 basis points out of the 370 basis points come from supply chain. Then we also, as you know, make investment in our future businesses and to support the future growth, business growth outside of the print services businesses here. And then, we have put on stake from last year number with lower royalty government subsidies and things like that. But when you look at the way we are addressing the inflation challenges, it's quite simple. The first thing is to ensure that via Project Own It, we optimize and drive the cost base of the company to the level that we can afford. The second point after this is also to enact on the increased prices all across the board. And when I say all across the board, it has been done at Xerox since quarter three of last year where we increased prices on equipment, but also on post-sales contractual agreement that we have with customers. So that's the way to look at it. Employees on the specific, I will say, pressure on labor costs there are included within this. At the end of the day, what you try to drive is improve the productivity that you have on your labor cost, on doing technology as well in order to, I will say, lean or simplify some of the processes and the offerings that we offer to customers. But at least the key message, Jim here is that we believe with this action here that we will drive margin improvement during the second half of the year, by the way, at the level that the company has been able to achieve during the second half of the year. You know that traditionally, specifically in quarter four, we have a strong finish depending on supply chain and macroeconomic condition being as what we know today, we are confident that we will be able to drive this gradual improvement in gross margin and operating margin.

I'm showing no further questions in the queue at this time. I would like to turn the call back over to Mr. Steve Bandrowczak for closing remarks.

Thank you for listening to our earnings conference call this morning. We are seeing encouraging in the second half of 2022 forward to a stronger second half of the year. I am honored to lead this great company and team who collectively are resolved in prime to grow revenue on profitability in the second half of 2022 and beyond. Thank you for attending, and have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.