Xerox Third Quarter Results — Revenue Declines But Improved Operating Profit and Cash Flow

Xerox announced its third-quarter earnings Oct. 23. In the release and earnings call, Xerox CEO John Visentin said, “We are progressing on our priorities, which include optimizing our operations for greater simplicity, reenergizing our innovation engine and focusing on cash flow to drive increasing shareholder returns.”

Revenue growth remained elusive and EPS was off by 4 cents year over year (adjusted for a non-cash charge of $95 million due to the 2017 U.S. Tax Act enactment). Operating margin increased 13.1 percent YTD, a 1 percent improvement, and free cash flow improved $157 million year over year.

Revenue trends

Total revenue for the third quarter was down 5.8 percent year over year (4.7 percent in constant currency). North America contributed 61 percent of the total revenue and was down 4.2 percent while International, 35 percent of Xerox’s total revenue, experienced a 2 percent decline. Equipment revenue was down by 2 percent compared to second quarter results. Post sale revenue, which includes services, equipment maintenance, supplies and financing, and makes up 78 percent of total revenue, declined 5.2 percent due to weaker supply sales and some slowdown in MPS, according to Bill Osbourn, executive VP and CFO. “(We) have not seen the contracted post-sale revenue trend improve (which is dependent on growing our machines in field and page volumes),” he said. “The supplies declines were driven by lower indirect channel sales, which were impacted by lower demand, including large customer order timing and economic uncertainty in certain developing market countries.”

While equipment revenue declined in total, the segment performance results were mixed. The entry-level A4 segment, making up 11 percent of total equipment revenue, grew 9.1 percent. That growth was driven by A4 black and white, which grew at a 21 percent rate. Color A4 revenue was down 8 percent, while midrange A3 grew 1 percent. “Midrange A3 is a key leadership segment for Xerox, and overall, it is midrange that has driven our equipment revenue share gains over the past three quarters,” said Osbourn.

High-end revenue made up 18 percent of total equipment revenue, and, while better than the second-quarter results, still showed a decline of 5.1 percent. Strong demand for the newly released Iridesse production press exceeded expectations but was not able to offset iGEN and Versant decreases.

Managed Document Services, which comprises 36 percent of total revenue, did see an increase of 0.9 percent but this was well below the 2.3 percent growth of the second quarter.

Visentin acknowledged the disappointment in revenue performance and noted that while there is work to do on all fronts, “clearly, our priority to drive revenue requires the most effort.” He discussed Xerox’s new project, “Own It,” which is “focused on simplifying the business to drive end-to-end transformation of our systems and processes to create greater focus, speed accountability and effectiveness. This will deliver superior customer experience while setting the company up for growth. In Q3, we identified the actions and work streams while also capturing some early wins.”

Vistentin pointed to several actions Xerox is taking to build a simpler, more agile organization. These include better aligning sales compensation to metrics, expanding the dealer channel presence including independent dealer coverage to penetrate the SMB market, enhancing e-commerce capabilities, leveraging digital demand generation and improving deal pricing and contracting.

Profit and loss

Total gross profit remained flat at 40.1 percent with equipment gross margin improving 5.1 points from 2017 to 34.6 percent. However, post-sale gross margin decreased 1.2 points to 41.7 percent compared to 42.9 percent a year ago. Selling, administration and general expenses were slightly lower at 24.8 percent (compared to 25.2 percent in 2017). Pretax income margin came in at 8.2 percent, up by 1.5 points from 2017. Using non-GAAP adjustments Xerox shows an adjusted operating margin of 13.1 percent versus 12.1 percent in 2017.

Other information

Highlighting some of the successes of the third quarter, Visentin listed:

  • Xerox is first and only MPS vendor to receive security authorization from the U.S. government for cloud-based MPS.
  • The launch of an e-commerce apps platform to make it easier to purchase and deploy ConnectKey apps.
  • Ninth consecutive year of a leadership position in Quocirca Managed Print Services Market Landscape Report.
  • A strong showing and winning 11 awards at PRINT 18.

Our take

Xerox continues to feel the financial pressures from the dynamics shaping the print and imaging industry, including competition for a decreasing universal MIF and the decline in printed page volumes. Post-sale revenue fuels the profit engine in this industry’s business model, and that is certainly true for Xerox, with post sales amounting to almost 80 percent of their revenue — virtually four times larger than equipment revenue, with a gross margin of seven points better than equipment. Given those numbers, Xerox must increase its MIF if overall revenue growth is to be achieved. Visentin and his team appear to fully understand this and that it will be hard work to get there. “We have not yet gotten back the MIF lost prior to the ConnectKey launch, so growth needs to continue to get higher MIF and drive post-sale improvement,” said Osborn

The ConnectKey products and Xerox’s openness toward working with developers and dealers to create apps on that platform certainly positions them as innovative and focused on being a solution provider rather than simply “the copier company.” But good innovative product alone most likely is not the full answer to the challenges Xerox facesExpanding dealer channel presence to increase SMB market penetration may be a good strategy. Some of the largest and most successful dealers in the country have become Xerox dealers, and Xerox must also make sure that, for dealers, doing business with them is easy and profitable. The “Own It” project, with its stated objective of “optimize operations for simplicity to better serve clients and partners” seems to be a good start. Changing Xerox from a direct sales culture to a dealer channel support culture is not easy, and Visentin will have to work hard to break through and make the necessary changes.

Driving growth in software and services, MDS, and other new printing technologies such as 3D printing will position Xerox for a stronger future. Through the “Own It” project it appears Xerox is reviewing its R&D strategies and considering business incubators, M&A and other investments. Careful selection and development of commercially relevant and quick to monetize technologies will be important to the company during this process.

The new team at Xerox has clearly focused on improving returns to shareholders through their commitment to distribute 50 percent or more of the free cash flow to shareholders in the form of dividends and share repurchases. In the first three quarters of the year the company has returned 75 percent of its free cash flow to shareholders in this way — and yet it still retains $1.2 billion in a cash balance. To keep that cash flow moving will take focused attention on revenue growth, innovation development, and disciplined cost and expense management.