Welcome to the Xerox Holdings Corporation's Fourth Quarter 2023 Earnings Release Conference Call. After the presentation, there will be a question-and-answer session. [Operator Instructions] At this time, I would like to turn the meeting over to Mr. David Beckel, Vice President 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 Fourth Quarter 2023 Earnings Release Conference Call, hosted by Steve Bandrowczak, Chief Executive Officer. He is joined by John Bruno, President and Chief Operating Officer; and 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/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'd like to turn the meeting over to Mr. Bandrowczak.

Good morning, and thank you for joining our Q4 2023 earnings call. I'd like to start by commending the Xerox team for delivering strong growth in full-year adjusted operating income, EPS and free cash flow, amid a challenging and uneven macroeconomic environment. We achieved 2023 adjusted operating income margin and free cash flow guidance, despite slightly weaker than expected macro conditions in the second-half of the year. Our ability to overcome top line headwinds and meet full-year profit and cash flow targets is a testament to this company's culture of operating discipline, which has been forged and strengthen in recent years through operational and macroeconomic challenges. Summarizing the results for the year. Revenue of $6.89 billion declined 3.1% in actual currency and 3.3% in constant currency. Our corporate, digital, and IT service businesses perform much better than this top line result would suggest, however. As Xavier will describe later in the call, revenue declined less than 1% in 2023 after adjusting for the effects of backlog reductions in the current and prior year, structural simplification efforts and the intentional de-emphasis of certain non-strategic businesses. Adjusted EPS was $1.82, $0.70 higher year-over-year. Free cash flow was $649 million, an increase of $547 million over 2022. And, adjusted operating margin of 5.6% was higher year-over-year by 170 basis points within our guidance range. 2023 was a pivotal year for Xerox and marked the first full-year of a multi-year strategy to reposition our businesses for long-term sustainable growth in revenue and profits, which we call our reinvention. We took structural and foundational actions to improve our core business and simplify operations, resulting in greater operational focus and a clear path for more transformative reinvention actions this year and beyond. All the while, we delivered key accomplishments towards the strategic priorities set out at…

Thank you, Steve, and good morning everyone. I appreciate the opportunity to speak to you today and provide more context around our multi-year reinvention journey. At its core, reinvention is about operationalizing a balanced strategy to improve our legacy business and build a foundation to address adjacent opportunities with existing and new clients. These adjacent market opportunities are available to Xerox today, but they require enhancements to our client coverage model and our service offerings. By the market, I'm predominantly referring to the mid-market, where digital IT services remain underutilized by our clients. There is opportunity for Xerox to improve client penetration of digital and IT services within this market, and assertion be validated through primary and secondary research as part of our reinvention planning. Critical to more fully addressing these market opportunities is a core business that is stable, fit for purpose, in today's market environment, and capable of meeting the evolved needs of our clients. We understand the dynamics of the markets we're in. And to win in a separately challenged market like print, we must be more competitive, easier to do business with and relevant to our clients as their needs evolve. As such, our reinvention is aimed at addressing the complexity of our business that was built over time, and for a different time. In its place, we are designing a simpler, more operationally efficient organization to address our clients most important hybrid workplace challenges now and into the future. I have been part of similar transformation efforts with other large companies which like Xerox have strong heritage. Pattern recognition tells me Xerox has what we need to successfully modernize and transform this business. In my first year I've experienced very little resistance or lack of desire to change. Our people are eager to embrace and…

Thank you, John. And good morning, everyone. As Steve mentioned, important steps were taken in 2023 to simplify our business and improve Xerox balance sheet on profit profile. For the year, we deliver strong growth in earnings per share and free cash flow, despite a modest decline in revenue, reflecting the successful implementation of a more flexible cost structure and rigorous operating discipline. Additional structural efficiencies enabled by our reorganization are expected to drive further profit improvement in 2024, our second full-year of reinvention. In Q4, revenue, margin and profit decline year-over-year due mainly to a significant reduction of equipment backlog in the prior year quarter. Revenue growth was further affected by the intentional reduction of certain non-strategic revenue. Excluding this factor, revenue would have increased low-single-digit year-over-year. Turning to profitability. Gross margin declined 130 basis points over the prior year quarter, due mainly to lower activity, higher product cost, and the termination of Fuji Royalty partially offset by strategic pricing action, lower freight cost, and the benefit of structural cost reductions. Adjusted operating margin of 5.4% declined 380 basis points year-over-year, due to lower revenue on gross profit on higher compensation expense, partially offset by the benefit of pricing on structural simplification effort. Adjusted other expenses net were $45 million higher year-over-year, due to lower sales of non-core business asset and an increase in non-financing interest expense. Adjusted tax rate was 15.2%, compared to 21.9% last year. The decrease was largely due to the benefit associated with change to deferred tax asset valuation allowances on redetermination of certain unrecognized tax position. Adjusted EPS of $0.43 in the fourth quarter was $0.46 lower than the prior year, driven by lower operating income on higher other expenses net, partially offset by the benefit of lower shares. GAAP loss per share of…

Certainly. One moment for our first question. And our first question comes from the line of Ananda Baruah from Loop Capital. Your question please.

Hey. Thanks guys for taking the questions. I guess a couple, if I could, the headwinds to revenue that you guys pointed out on the call and you, sort of, quantified in the deck as well. And I think they impacted last quarter as well. What's a good way to think about how those roll off, as we move through the year? And I guess at what point in time do you expect them to be fully rolled off and for the reported revenue to kind of be sort of apples-to-apples? And then I have a quick follow-up.

Hi, Ananda. Xavier Speaking here. So, phasing of the headwinds that we have, they are different by nature here. But the main one, as you mentioned it. So if you look at next year, our forecast here is minus 3% to minus 5%. And we said we have around 400 basis point that are, I would say, are normal by nature. They do not impact the core business here. So, the first one is a backlog. The backlog is 200 basis point out of the 400 basis point impact. The backlog, we expect at the end of the compare of backlog to end at the end of quarter two, 2024. So quarter three and quarter four should be normal compare, because last year in 2023, we still have the impact of flushing the backlog. The other items, 200 basis point items that we have there, with phase out during the year. There are some items related to, we mentioned paper sales, IT endpoint, they will stay within the year there. But the Fuji royalty, for example, is an item that will end at the end of Q1, but they are less important in nature. The largest one is the backlog, and the backlog is end of quarter two.

That's super helpful. And then just sort of like a sanity check here. It looks like this is easy math to do, but it looks like you're forecasting our profit to be up year-over-year and maybe nicely up. I'm getting like $90 million, $80 million to $100 million or something like that, depending on what revenue you use. Is that an accurate assessment?

Yes, annualized it is even higher. So the operating margin this year is 5.6%. After last year it was 3.9%. So quite a nice progression that we have done in operating profit. And for next year, we are forecasting, guiding at least 7.5%. So this is 190 basis point progress here that we are doing in operating margin in absolute value, we are speaking about more than $100 million, after this year which has also been in operating income, adjusted operating income of more than $100 million as well. So, a nice momentum that we are building. And the other point I want to flag that is the dependency of delivering this operating profit or operating margin improvement is not entirely driven by revenue, we have given our revenue guidance, you understand the one-off impact there. But a lot of the actions that are supporting the operating profit, operating margin improvement are already actions that we have in play. One of these being the actions that we have announced at the beginning of January, which is a large restructuring action that we have started now.

That's super helpful, because let me dovetail that into one last one. Can you remind us of the $300 million that you have for the 2026 goal, incremental OP income. How much of that is revenue driven versus things that are completely under the company's control? And that's it from me. Thanks.

So, one of the things -- it's Steve. One of the things we did, as you remember, we announced the very, very strategic structural changes and the launch of the Reinvention and the combination of which drives an end-to-end simplification drives cost out and has a very strategic strengthening of our core business and make sure that we have the flexibility to adjust whether revenue goes up or revenue goes down. So two pieces of it. One Reinvention will drive simplification. We talked about GBS and what we're doing there to drive our overall margins and drive improvements of our business. Second, we're going to take strategic actions in our geographies and our products. So the whole $300 million of operating profit, independent of what happened with the revenue, so that we can adjust up and adjust down based on whatever decisions we make on non-strategic revenue.

I got it. And so -- Steve, so any incremental revenue driven would be in addition to the $300 million. Is that accurate…

It should. We are very strategically targeting higher revenue that has higher profitability and by default, you're absolutely right. We increased our revenue we should increase our profitability.

Okay, great. Thanks guys, I appreciate it.

Thank you. One moment for our next question. And our next question comes from the line of Samik Chatterjee from J.P. Morgan. Your question please.

Yes. Hi. Thanks for taking my questions. I guess if I can start with a clarification on your revenue guide for 2024, you're guiding to flat when we ex-out the backlog and exit from certain non-strategic businesses. How do I keep that in context of what you're referring to here for 4Q, which is a mild softening in demand in the European markets? How are you sort of thinking about or baking in the macro impact you've seen in 4Q into your 2024 outlook? And have a follow-up. Thank you.

Yes, let me take the start of that, and then turn over for Xavier for numbers. We took a look at Q4 and we saw a strong signings in our services business and grow that, and that backlog looked extremely strong. We also see strengthening in our core business in the areas that we played today. So a combination of increase in orders, backlog and our service. And the other piece that Xavier mentioned was in our signings, we're signing now at over 100% on revenue renewal in our core contracts and our services business. So those gives us good foundation for growth and stability as we go forward. Xavier?

Yes. Steve, I will add as well. So those are the macro conditions that we were observing, specifically in Europe quarter three, a little bit smoother in the quarter four. We see a little bit of easing specifically around the interest rate on both sides of what we found here. So this gives us a little bit of confidence on this revenue side. But the important thing, Samik, is when you look at the revenue, normalized revenue, as you mentioned it here, this is flat to minus 1% this is what the industry is seeing here. When we look also at the trend of return to office page volume and cut, we have also indicated that is telling us that the numbers that we put on paper here can be sustained.

Got it. Got it. Okay, and for my second one on cash flow, you did $649 million in 2023, there's an operating income improvement of $100 million or so. And then you have the HPS transaction continue to sort of accrued some cash. So, maybe help us with the walk there and particularly what's the restructuring piece in there as well. And why isn't the cash flow guidance a bit more -- a bit higher? Thank you, for 2024, I mean.

Yes, Samik, that's a good question. So free cash flow, we said at least $600 million at this stage of the year. The improvement in operating cash flow, which is directly related to the improvement of the operating income. We are still expecting our conversion rate from operating income or adjusted operating income to free cash flow being 70%, 80% range, which is what we are used to produce there. But for this year, as you mentioned it, we have a restructuring provision. Restructuring provision from a cash point of view has an impact of around $140 million. Then we have also an additional contribution in pension that you do in the U.S. and due to the profitability as well, additional cash tax is there. So when you net all of this, it gives us this number of around $600 million over time. We will provide more visibility quarter-by-quarter on how this trend is going.

Okay, great. Thank you. Thanks for taking my questions.

Thank you, Samik.

Thank you. One moment for our next question. Our next question comes from the line of Erik Woodring from Morgan Stanley, your question please.

Hey guys. Thank you for taking my questions. I have a few as well. Steve, maybe if we just start, the helpful color on the renewal rates for large customers, can you maybe just help us understand what percentage of -- I don't know how you'd frame it, services, contracts those large customers represent, and then how to think about the rest of those cohorts, the same metric for smaller customers. I believe you have a fairly long tail of SMB customers. So how do renewal rates look for that cohort? And how do I think about the importance of the large enterprise versus kind of SMB customer set? And then I have a follow-up, please. Thank you.

Yes, thanks Erik, I appreciate it. So it's roughly about one third of our overall revenue. And so what we're seeing there, is the opportunity to really embed IT and digital services on top of our core services contracts, as we start to see, and we're seeing renewals come up year-over-year, we put a big focus on client centricity. And what that means is how do we help our clients drive productivity, how do we help them solve some of the biggest challenges they have. So if you think about headwinds, whether it's around use of capital, whether it's around labor pressure, whether it's around pressure on profitability. We continue to bring products and solutions that helps them to offset that and that's why we've been successful in our renewal rates up. Same thing applies in our SMB businesses, right? When we look at our SMB, it's probably even more of an opportunity. We see significant SMB has the same enterprise challenges with profitability due to increase of, whether it's labor costs, whether it's pressure on capital, whether it's pressure on overall increase in costs, they're looking to us to help to offset. So we continually bring solutions. We talked about some of these last quarter on some of the vertical solutions that we're really focusing on. How do we help inside of healthcare? How do we help inside of universities, law firms, et cetera. And so as we look at those renewal rates, we continue to bring solutions on top of it and we've been very successful. And I've made the statement a couple of times now that we have a great opportunity to expand in existing accounts with products and services that we already have. Better stated, the TAM for us is beyond just the core that everybody sees as our core business. We need to execute and grow inside of our client accounts with products and services that we already have. And we’re seeing evidence of that with new signings.

Okay, super. Thank you. Very helpful, Steve. Xavier, if I maybe turn to you, can you maybe help us all better understand maybe the trajectory of gross margins relative to OpEx in 2022 to kind of land at that 7.5% operating margin target? And I just asked because, you know, depending on how we think about gross margins, you know, we are looking at a -- as a percentage of revenue, fairly significant reduction in OpEx. I understand you announced the RIF on January 2, but it would imply revenue as a percentage of OpEx that is quite low? And so, really just want to better understand how to think through some of those dynamics and how much you might be reinvesting on the other end? So just all of that collectively, if you could help us understand that for next year or this year 2024, please?

Yes, Erik, you got the big picture here. So what we are expecting is a slight expansion of gross margin. This is just to -- I would say via all the actions that we have put in place, that we have supported or enabled a lot of pricing actions that have driven some margin expansion this year, but next year as well, we will have some expansion of gross margin. And also, as we mentioned it, we are exiting or reducing some low profitability revenue. We mentioned paper, I mentioned also IT endpoint solution with lower margin and we are offsetting this margin or this revenue reduction by other type of revenue stream with a higher profitability. OpEx is clearly the area with improvement and you have already been able to measure it this year. If you look at SRI specifically with the PARC donations that we have done, it's a significant improvement year-over-year and it reduces RD&E amount that we had related to PARC by more than 100 basis point here. When you look at the trajectory we will have on SAG with the restructuring here, then this will be the main driver of the operating margin -- adjusted operating margin improvement year-over-year. So 190 basis point are based on action that we have already either announced on actioning or actions that were taken last year on the back end of last year where we would see the benefit on the flow through. So, the key point. The key point behind my message here is that the dependency on the revenue trajectory, it is less than on us executing the cost actions.

Yes, Erik. the other thing I'd like to add, because we always get the question, you did the big actions with Own-It, now you're doing reinvention. And so in the beginning of the year, we really looked at all of our end to end cost structures, whether it was it finance, whether it's SG&A, what we did with sales coverage, et cetera. And when you look at that against industry benchmarking, look at that against opportunity to where we can drive this company, that's where we're confident. We still got a lot of work to do to simplify this business. Whether it's around the number of systems we have, number of processes we have, the variations in different ways in which we do business. So when we look at it, just from a pure benchmark standpoint against other companies and industries, we've got a lot of opportunity ahead of us. Obviously, we got to execute. We'll execute that through the next 24 to 36 months, but there's still a lot of room for us. And that's really where we put GBS in place. GBS is really focused, our global business services is really focused on looking at each and every one of those end to end processes, looking at the cost that we're using and that we're expending in each one of those processes. How do we simplify it? And then think about how do we automate and how do we drive technology. We see AI, we see chat-GPT, RPA, robotics process automation, and the simplification of our business as a significant opportunity to grow those margins in the future, independent of their revenue line staying flat or a slight decline. So we're very, very optimistic that we can execute and we can drive and we've got a lot of room in our cost basis to make this company a lot more efficient.

Super. Thank you for that incremental color, and Xavier at the beginning for that. Maybe one last quick question, and that was on capital allocation. Obviously, we didn't really hear about buybacks, and so just want to make sure I kind of understood those priorities right and that we should not be thinking about any buybacks being done in 2024? And then that's it from me. Thank you.

You are correct.

Okay. 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 Bandrowczak for any further remarks.

Thank you for listening to our earnings conference call this morning. We are firmly on our path of Reinvention. Our focus in this second year of our Reinvention is to strengthen our core businesses, further reduce structural cost through reorganizations and allocate the more than $600 million of free cash flow we expect to generate in 2024 in a way that optimizes total shareholder returns. We have clear line of sight to targeted profit improvements in 2024 and are laser focused on ensuring we exceed our three year goal of at least $300 million of adjusted operating income profit improvement above the 2023, 2024 levels by 2026. Thank you for listening 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.