Xerox announced its first quarter 2019 financial performance on April 25, with Vice Chairman and CEO John Visentin saying, “Our transformation initiatives are yielding results, which give us confidence to raise our full-year earnings guidance despite revenue declines. We are investing in our core business as well as new technologies that create value for our stakeholders and position us for long-term growth.”

Highlighting an $0.08 rise in GAAP earnings per share (EPS) to $0.55 from $0.47, Xerox also pointed out that adjusted EPS was $0.91, a $0.23 increase year over year. In addition, Xerox underscored increases in operating and free cash flow. Operating cash flow increased to $226 million, a $10 million increase over the same time last year, and free cash flow was up $13 million to $211 million.

With these results and expected savings of at least another $640 million in 2019 through the Xerox Project Own It initiative (a company-wide program to simplify its business and improve operational efficiency — see this article for more) , Xerox raised 2019 guidance for GAAP EPS to a range of $2.90 to $3.05 (from $2.60 to @2.70). Adjusted EPS was raised to a range of $3.80 to $3.95 (from $3.70 to $3.80).

Recent news about Xerox adopting a holding company structure and a potential sale of the Xerox leasing business were addressed in a FAQ slide in the publicly available financial slide deck.

Frequent question Xerox answer
Why adopt a holding company structure? The holding company structure provides more flexibility to develop and realize a range of strategic growth opportunities, whether incubated or acquired, as well as optionality to have these exist within or separate from our current Xerox business.
What is the status of the potential sale of the leasing business? We are evaluating strategic alternatives for our leasing business. It is possible that there may be no transaction. We are committed to

maintaining a strong balance sheet while ensuring our clients continue to have

seamless access to high-quality product offerings.

 

Visentin also reviewed the strategic initiatives introduced in 2018 to guide the transformation of Xerox:

  • Optimize operations for simplicity
  • Drive Revenue
  • Re-energize innovation
  • Focus on cash flow and increasing capital returns

Revenue trends

Even as EPS was up, Xerox equipment and post-sales revenue (services, maintenance, rentals, supplies, and finance) continued to decline. Overall Xerox revenue dipped to $2.20 billion in 1Q 2019, down 9.4% (7% in constant currency) from 2018 first-quarter revenue of $2.43 billion.

Equipment revenue decreased 10.2% year over year, with a $51 million drop from 1Q 2018. Xerox cited price declines and an “unfavorable impact from the absence of OEM equipment sales in the first quarter of 2019″ as reasons for the poorer revenue performance of 1Q 2019.

Entry level equipment (A4 devices and desktop printers) saw revenue of $53 million in actual currency (AC) the same as 2018. In constant currency (CC), Xerox showed an increase of 3.2% in this segment. Xerox said this segment reflected higher installs of ConnectKey devices through the American sales organization and improvement of these sales through the Xerox U.S. indirect channel.

Mid-range equipment (A3 office and light production devices) declined to $302 million, a 9.6% drop in AC from 2018 (7.2% in CC). Xerox attributed these results to lower sales from the Americas, including the XBS sales unit, that were partially offset by higher sales in Europe.

High-end production printing and publishing systems experienced a 3.3% decrease in AC from 1Q 2018 (.3% in CC). Again, Xerox attributed this performance to lower sales from the Americas offset by growth in Europe. In addition, Xerox noted there was a favorable mix toward higher-end models such as Iridesse.

In new device installs, Xerox reported a 10% increase in color MFPs in the entry segment and a 2% decrease in black-and-white MFPs. The increase was attributed to higher installs of ConnectKey devices through the indirect channels in the U.S., which also offset some of the decreases in the black-and-white entry installs.

Mid-range color installs decreased 7% with lower installs of ConnectKey devices through the indirect channel and the XBS sales unit. As the market continues to shift to color models Xerox noted a 19% decrease in mid-range black-and-white devices. Lower black-and-white installs were attributed to lower ConnectKey installs from the indirect channel and the XBS sales unit with some offset through higher installs in Europe.

Xerox showed a 14% decline in high-end color installs. This was the result of lower iGen installs and other lower end production systems such as Versant. While high-configuration Iridesse models and inkjet production systems increased, they were unable to offset the overall decline. Black-and-white high-end systems experienced a 12% decrease from 2018 with Xerox noting the effect of market trends.

Xerox post-sale revenue declined 9.2% (6.8% in CC) to $1.75 billion. Post-sale revenue includes service, maintenance and rentals; supplies, paper, and other sales; and financing revenue. Xerox showed that each of these decreased during 1Q 2019 compared to 1Q 2018.

(in millions $) 2019 2018 % Change CC % Change
Services, maintenance and rentals  $        1,393  $        1,519 -8.3% -5.8%
Supplies, paper and other sales  $            302  $            346 -12.7% -10.7%
Financing  $              63  $              71 -11.3% -9.0%
Post-Sale Revenue  $        1,758  $        1,936 -9.2% -6.8%

Xerox cited lower page volume trends, lower machine-in-field (MIF) populations due to lower installs in prior periods, a competitive price environment and continuing lower Enterprise signings as reasons for the decline in services, maintenance and rentals revenue. Xerox noted that the declines were larger in the Americas where organizational changes have occurred due to Project Own It actions. Xerox said supplies, paper, and other sales were impacted by lower sales in developing markets and “lower transactional IT network integration solutions sales” from XBS. Xerox explained that financing revenues were impacted by a declining financing receivables balance due to low equipment sales in prior periods.

Regionally, Xerox reported that all regions declined in sales revenue. Americas region declined 8.1% to $1.4 billion (75% CC), EMEA had a 10.4% decline to $712 million (4.3% CC), and Other (Rest of World) decreased by 20% in both AC and CC to $84 million. The Americas region contributed 64% of 1Q 2019 sales (up from 63% in 1Q 2018), EMEA stayed at 33% of total Xerox sales and Other stayed at 4%.

Profit and loss

Xerox reported a gross profit of $889 million, down $81 million (8.4%) from 1Q 2018. Gross margin, however, was up by 0.5 points to 40.3% supported by equipment gross margin increasing by 3.1% over 1Q 2018 results. Xerox said this higher equipment margin reflected a mix benefit from lower OEM sales and effects of Project Own It cost reduction initiatives. Post sales gross margin, however, showed a decline of 0.2 points to 41.5%. Xerox noted a 0.6-point unfavorable impact “related to a prior year benefit from a change in estimate for consumables usage by customers.” When this was excluded, Xerox said post sales margin would have increased.

Xerox’s 1Q 2019 consolidated statements of income show $806 million in expenses after cost of goods (COGS). These include traditional R&D, SG&A expenses, as well as restructuring costs, amortization, transactional and other costs. R&D investment was down $8 million from 1Q 2018 representing 4.1% of sales (the same percentage as 1Q 2018). SG&A (Xerox uses SAG terminology) decreased by 1.0 percentage point as a percent of sales to $548 million. Xerox said this was primarily due to the benefits from the Project Own It program. Xerox explained that restructuring costs are associated with the Project Own It initiative, transaction costs are due to expenses to insurance carriers and other parties relating to the Fuji transaction termination and amortization expenses are related to accelerated write-offs of trade names due to the reorganization of XBS sales units as part of Project Own it.

With these sales results and expense reductions, Xerox reported income before taxes of $83 million, a 39% drop from 1Q 2018 results. However, when including a tax benefit of $8 million and $45 million of equity income due to their 25% share of Fuji Xerox, and adjustments for net income attributable to non-controlling interest, net income attributable to Xerox rose to $133 million from $23 million in 1Q 2018, a 3.7x increase.

Other information

Summarizing the presentation for 1Q 2019 Xerox stressed it is “Executing on our strategic initiatives to transform Xerox for the long term.” The report emphasized the adjusted EPS increase of 34% year over year, the expansion of operating margin, and the $10 million improvement in operating cash flow. An improved outlook for EPS was announced, as well as the expectation of share repurchase increases from $300 million to $600 million for 2019.

Our take

The team that Carl Icahn put in place, particularly through John Visentin and his additions, is continuing to achieve what Icahn’s stated goal has been — increase returns to shareholders. Through tough cost-cutting initiatives and reorganizations from the Project Own It program, Xerox reports that, even with dropping revenues, the new Xerox team has improved profit margins and cash flow. With this “cut the fat” approach, share buyback strategies, and more Project Own It cost reductions and share buybacks expected in 2019, Xerox has set expectations for EPS to grow this year. This seems to be having a positive impact as Xerox’s stock price has risen almost 15% over the last year.

Yet, a few questions remain. What is Xerox doing to deal with the declining revenues? In 4Q FY2018, Xerox revenue was off 6.1% year-over-year with total FY2018 revenues down 4.9% (see our recap). Starting FY2019 with first-quarter revenue down 9.4% is a concern. Additionally, Visentin provided guidance that revenue is expected to decline a total of 5% in 2019. All these decreases are deeper than overall market trends and, in this first quarter, all areas of the business (equipment and post sales) witnessed double-digit or close to double-digit revenue declines.

Particularly troublesome is that unit installs are in decline. Xerox explained that the lower services, maintenance and rentals revenues were due in part by “a lower population of devices” and said the reduced finance revenue was due to “lower equipment sales in prior periods.” This has an exponentially negative impact on future financial performance since the sales of these high margin annuity streams are dependent upon the number of Xerox devices installed and used. Couple this device population reduction with ongoing declining page volume trends and the expected 5% revenue decline in 2019 communicated by Xerox may be optimistic.

A final question is how much additional “fat” can Project Own It find to take out of the corporation? Outsourcing administrative and support functions to HCL will take up to 18 months before full benefits from that move can be expected. Final costs in the reorganization of XBS will most likely continue in 2019 and reducing R&D costs would seem to go against the “re-energize the innovation engine” pillar in the Xerox transformation strategy. In reality, at least in 1Q 2019, operating profit (income before taxes and equity income) dollars were down by 38% from 1Q 2018. Examining the non-GAAP reporting, at best it could be said operating profit was up 3% year-over-year. First quarter net income was supported heavily by income from the continuing interest in Fuji Xerox.

As we have stated previously, while Xerox is delivering better shareholder returns, sustaining those results will require managing the top line to stability and, preferably, to growth. Cost reductions and productivity gains have a finite limitation. Margin improvements on lowering revenues are not as valuable as margin improvements on flat revenue and clearly not a home run as when coupled with increasing revenue. Profit from Xerox operations will come under increasing pressure, as will shareholder returns, if top line revenue continues to fall. It will be an interesting year watching Xerox, as they grapple with the challenges presented by their current business model.