Xerox Earnings – Stock Cruising As Cash Flow Up, Margins Holding and Revenue Falls

Xerox Releases Third-Quarter Results, Raises 2019 Guidance

  • $356 million of operating cash flow, up $82 million year-over-year, and $339 million of free cash flow, up $88 million year-over-year
  • GAAP earnings per share (EPS) of $0.96, up $0.62 year-over-year, and adjusted EPS of $1.08, up $0.23 year-over-year (YOY)
  • Adjusted operating margin of 12.1 percent, up 120 basis points year-over-year
  • $2.2 billion of revenue in the quarter, a decrease of 6.5 percent in actual currency, or 5.3 percent in constant currency, year-over-year
  • Increasing 2019 guidance for GAAP EPS to $3.10 – $3.20, adjusted EPS to $4.00 – $4.10, operating cash flow to $1.2 – $1.3 billion and free cash flow to $1.1 – $1.2 billion
  • Completed $368 million of share repurchases through the third quarter, expecting at least $600 million in total for the year

NORWALK, Conn.–(BUSINESS WIRE)–Today Xerox Holdings Corporation (NYSE: XRX) announced its third-quarter 2019 financial results and said it would raise 2019 guidance for EPS and cash flow.

“Our strategy and execution delivered a strong third quarter despite industry headwinds. We increased cash flow, earnings per share and adjusted operating margin while we improved the revenue trend. These results give us confidence to raise our earnings and cash flow guidance for the year as we position Xerox for long-term growth,” said Xerox Vice Chairman and CEO John Visentin.

Key Financial Results:

(in millions, except per share data)   Q3 2019   Q3 2018   B/(W)

YOY

  % Change

YOY

Revenue   $2,200   $2,352   $(152)   (6.5)% AC
(5.3)% CC
1
Gross Margin   40.0%   40.1%   (10) bps    
RD&E %   4.5%   4.3%   (20) bps    
SAG %   23.3%   24.8%   150 bps    
Pre-Tax Income   $230   $192   $38   19.8%
Pre-Tax Income Margin   10.5%   8.2%   230 bps    
Operating Income – Adjusted1   $267   $257   $10   3.9%
Operating Margin – Adjusted1   12.1%   10.9%   120 bps    
GAAP EPS   $0.96   $0.34   $0.62   nm
EPS – Adjusted1   $1.08   $0.85   $0.23   27.1%
  1. Refer to the “Non-GAAP Financial Measures” section of this release for a discussion of these non-GAAP measures and their reconciliation to the reported GAAP measures.

Key Business Highlights:

  • On track to drive 2019 gross savings of at least $640 million under Project Own It, Xerox’s enterprise-wide initiative to simplify operations, drive continuous improvement and free up capital to reinvest in the business
  • Added and renewed several contracts with Fortune 500 and public sector clients such as AstraZeneca, Leonardo S.p.A., Cardiff Council, and Prince George’s County Public Schools
  • Launched new products and enhancements such as the Xerox PrimeLink™ C9065/C9070and the iGen®5 XLSto capture incremental production volume

Xerox also announced today that it has completed its evaluation of its customer financing business and will not pursue a sale of the business at this time. The company received and reviewed bids from multiple potential counterparties that were interested in purchasing the business at an attractive premium but ultimately determined that retaining and optimizing the business through Project Own It will generate the greatest return for shareholders.

About Xerox

In the era of intelligent work, we’re not just thinking about the future, we’re making it. Xerox Holdings Corporation is a technology leader focused on the intersection of digital and physical. We use automation and next-generation personalization to redefine productivity, drive growth and make the world more secure. Every day, our innovative technologies and intelligent work solutions-Powered by Xerox®-help people communicate and work better. Discover more at www.xerox.com and follow us on Twitter at @Xerox.

Non-GAAP Measures

This release refers to the following non-GAAP financial measures for the third quarter 2019 and 2018 and full-year 2019 guidance:

  • Adjusted EPS, which excludes restructuring and related costs (including our share of Fuji Xerox restructuring), the amortization of intangible assets, non-service retirement-related costs, transaction and related costs, net and other discrete adjustments.
  • Adjusted operating margin and income, which exclude the EPS adjustments noted above as well as the remainder of other expenses, net.
  • Constant currency (CC) revenue growth, which excludes the effects of currency translation.
  • Free cash flow, which is cash flow from operations less capital expenditures.

Refer to the “Non-GAAP Financial Measures” section of this release for a discussion of these non-GAAP measures and their reconciliation to the reported GAAP measures.

Forward-Looking Statements

This release, and other written or oral statements made from time to time by management contain “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “will”, “should”, “targeting”, “projecting”, “driving” and similar expressions, as they relate to us, our performance and/or our technology, are intended to identify forward-looking statements. These statements reflect management’s current beliefs, assumptions and expectations and are subject to a number of factors that may cause actual results to differ materially. Such factors include but are not limited to: our ability to address our business challenges in order to reverse revenue declines, reduce costs and increase productivity so that we can invest in and grow our business; our ability to attract and retain key personnel; changes in economic and political conditions, trade protection measures, licensing requirements and tax laws in the United States and in the foreign countries in which we do business; the imposition of new or incremental trade protection measures such as tariffs and import or export restrictions; changes in foreign currency exchange rates; our ability to successfully develop new products, technologies and service offerings and to protect our intellectual property rights; the risk that multi-year contracts with governmental entities could be terminated prior to the end of the contract term and that civil or criminal penalties and administrative sanctions could be imposed on us if we fail to comply with the terms of such contracts and applicable law; the risk that partners, subcontractors and software vendors will not perform in a timely, quality manner; actions of competitors and our ability to promptly and effectively react to changing technologies and customer expectations; our ability to obtain adequate pricing for our products and services and to maintain and improve cost efficiency of operations, including savings from restructuring actions; the risk that confidential and/or individually identifiable information of ours, our customers, clients and employees could be inadvertently disclosed or disclosed as a result of a breach of our security systems due to cyber attacks or other intentional acts; reliance on third parties, including subcontractors, for manufacturing of products and provision of services; the exit of the United Kingdom from the European Union; our ability to manage changes in the printing environment and expand equipment placements; interest rates, cost of borrowing and access to credit markets; funding requirements associated with our employee pension and retiree health benefit plans; the risk that our operations and products may not comply with applicable worldwide regulatory requirements, particularly environmental regulations and directives and anti-corruption laws; the outcome of litigation and regulatory proceedings to which we may be a party; any potential termination or restructuring of our relationship with Fujifilm Holdings Corporation; the shared services arrangements entered into by us as part of Project Own It; and other factors that are set forth in the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of Xerox Corporation’s 2018 Annual Report on Form 10-K, as well as in Xerox Corporation’s and Xerox Holdings Corporation’s Quarterly Reports on Form 10-Q and Current Reports on Form 8-K filed with the SEC. These forward-looking statements speak only as of the date of this release or as of the date to which they refer, and Xerox assumes no obligation to update any forward-looking statements as a result of new information or future events or developments, except as required by law.

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Xerox®, iGen®, PrimeLink™ and Powered by Xerox® are trademarks of Xerox in the United States and/or other countries.

XEROX HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

    Three Months Ended
September 30,
  Nine Months Ended
September 30,
(in millions, except per-share data)   2019   2018   2019   2018
Revenues                
Sales(1)   $ 804     $ 856     $ 2,379     $ 2,628  
Services, maintenance and rentals(1)   1,336     1,431     4,132     4,465  
Financing   60     65     184     204  
Total Revenues   2,200     2,352     6,695     7,297  
Costs and Expenses                
Cost of sales(1)   515     539     1,531     1,664  
Cost of services, maintenance and rentals(1)   772     838     2,400     2,620  
Cost of financing   33     33     98     100  
Research, development and engineering expenses   100     102     280     303  
Selling, administrative and general expenses   513     583     1,580     1,835  
Restructuring and related costs   27     29     176     91  
Amortization of intangible assets   9     12     35     36  
Transaction and related costs, net   4     (33 )   8     63  
Other expenses, net   (3 )   57     74     126  
Total Costs and Expenses   1,970     2,160     6,182     6,838  
Income before Income Taxes & Equity Income(2)   230     192     513     459  
Income tax expense   66     142     108     220  
Equity in net income (loss) of unconsolidated affiliates   58     43     137     (6 )
Net Income   222     93     542     233  
Less: Net income attributable to noncontrolling interests   1     4     7     9  
Net Income Attributable to Xerox Holdings   $ 221     $ 89     $ 535     $ 224  
                 
Basic Earnings per Share   $ 0.99     $ 0.34     $ 2.34     $ 0.84  
Diluted Earnings per Share   $ 0.96     $ 0.34     $ 2.27     $ 0.83  

____________________________

  1. Certain prior year amounts have been conformed to the current year presentation. See Appendix III for this change in presentation.
  2. Referred to as “Pre-Tax Income” throughout the remainder of this document.

XEROX HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

    Three Months Ended
September 30,
  Nine Months Ended
September 30,
(in millions)   2019   2018   2019   2018
Net income   $ 222     $ 93     $ 542     $ 233  
Less: Net income attributable to noncontrolling interests   1     4     7     9  
Net Income Attributable to Xerox Holdings   221     89     535     224  
                 
Other Comprehensive (Loss) Income, Net                
Translation adjustments, net   (155 )   (13 )   (122 )   (159 )
Unrealized gains (losses), net   1     (9 )   3     5  
Changes in defined benefit plans, net   (48 )   83     (38 )   191  
Other Comprehensive (Loss) Income, Net   (202 )   61     (157 )   37  
Less: Other comprehensive income, net attributable to noncontrolling interests   1         1      
Other Comprehensive (Loss) Income, Net Attributable to Xerox Holdings   (203 )   61     (158 )   37  
                 
Comprehensive Income, Net   20     154     385     270  
Less: Comprehensive income, net attributable to noncontrolling interests   2     4     8     9  
Comprehensive Income, Net Attributable to Xerox Holdings   $ 18     $ 150     $ 377     $ 261  

XEROX HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in millions, except share data in thousands)   September 30, 2019   December 31, 2018
Assets        
Cash and cash equivalents   $ 922     $ 1,084  
Accounts receivable, net   1,188     1,276  
Billed portion of finance receivables, net   106     105  
Finance receivables, net   1,145     1,218  
Inventories   758     818  
Other current assets   221     194  
Total current assets   4,340     4,695  
Finance receivables due after one year, net   2,037     2,149  
Equipment on operating leases, net   374     442  
Land, buildings and equipment, net   442     499  
Investments in affiliates, at equity   1,517     1,403  
Intangible assets, net   203     220  
Goodwill   3,853     3,867  
Deferred tax assets   688     740  
Other long-term assets   1,206     859  
Total Assets   $ 14,660     $ 14,874  
Liabilities and Equity        
Short-term debt and current portion of long-term debt   $ 1,602     $ 961  
Accounts payable   1,070     1,091  
Accrued compensation and benefits costs   321     349  
Accrued expenses and other current liabilities   930     850  
Total current liabilities   3,923     3,251  
Long-term debt   3,230     4,269  
Pension and other benefit liabilities   1,599     1,482  
Post-retirement medical benefits   335     350  
Other long-term liabilities   473     269  
Total Liabilities   9,560     9,621  
         
Convertible Preferred Stock   214     214  
         
Common stock   221     232  
Additional paid-in capital   3,000     3,321  
Treasury stock, at cost   (68 )   (55 )
Retained earnings   5,552     5,072  
Accumulated other comprehensive loss   (3,850 )   (3,565 )
Xerox Holdings shareholders’ equity   4,855     5,005  
Noncontrolling interests   31     34  
Total Equity   4,886     5,039  
Total Liabilities and Equity   $ 14,660     $ 14,874  
         
Shares of common stock issued   221,292     231,690  
Treasury stock   (2,329 )   (2,067 )
Shares of Common Stock Outstanding   218,963     229,623  

XEROX HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

    Three Months Ended
September 30,
  Nine Months Ended
September 30,
(in millions)   2019   2018   2019   2018
Cash Flows from Operating Activities                
Net Income   $ 222     $ 93     $ 542     $ 233  
Adjustments required to reconcile Net income to Cash flows from operating activities                
Depreciation and amortization   104     122     332     398  
Provisions   16     16     58     56  
Net gain on sales of businesses and assets   (19 )   (3 )   (20 )   (35 )
Undistributed equity in net income of unconsolidated affiliates   (59 )   (43 )   (102 )   9  
Stock-based compensation   11     15     41     44  
Restructuring and asset impairment charges   8     29     80     91  
Payments for restructurings   (17 )   (39 )   (71 )   (130 )
Defined benefit pension cost   21     36     89     89  
Contributions to defined benefit pension plans   (37 )   (36 )   (107 )   (111 )
Decrease in accounts receivable and billed portion of finance receivables   51     1     62     37  
Decrease (increase) in inventories   16     (20 )   33     (91 )
Increase in equipment on operating leases   (41 )   (63 )   (113 )   (182 )
Decrease in finance receivables   5     39     124     181  
(Increase) decrease in other current and long-term assets   (14 )   (4 )   1     17  
Increase (decrease) in accounts payable   21     (31 )   (34 )   12  
(Decrease) increase in accrued compensation   (15 )   4     (99 )   (97 )
Increase in other current and long-term liabilities   27     15     19     11  
Net change in income tax assets and liabilities   40     124     27     165  
Net change in derivative assets and liabilities   5     21     15     (2 )
Other operating, net   11     (2 )   18     30  
Net cash provided by operating activities   356     274     895     725  
Cash Flows from Investing Activities                
Cost of additions to land, buildings, equipment and software   (17 )   (23 )   (48 )   (73 )
Proceeds from sales of businesses and assets   20         21     32  
Acquisitions, net of cash acquired           (42 )    
Other investing, net   1         1     1  
Net cash provided by (used in) investing activities   4     (23 )   (68 )   (40 )
Cash Flows from Financing Activities                
Net proceeds (payments) on debt   2         (399 )   (306 )
Dividends   (61 )   (69 )   (183 )   (204 )
Payments to acquire treasury stock, including fees   (68 )   (284 )   (368 )   (284 )
Other financing, net   (10 )   (6 )   (33 )   (21 )
Net cash used in financing activities   (137 )   (359 )   (983 )   (815 )
Effect of exchange rate changes on cash, cash equivalents and restricted cash   (20 )   (1 )   (13 )   (20 )
Increase (decrease) in cash, cash equivalents and restricted cash   203     (109 )   (169 )   (150 )
Cash, cash equivalents and restricted cash at beginning of period   776     1,327     1,148     1,368  
Cash, Cash Equivalents and Restricted Cash at End of Period   $ 979 $ 1,218   $ 979   $ 1,218  

Revenues

    Three Months Ended
September 30,
          % of Total Revenue
(in millions)   2019   2018   %
Change
  CC %
Change
  2019   2018
Equipment sales   $ 494     $ 511     (3.3)%   (2.2)%   22%   22%
Post sale revenue   1,706     1,841     (7.3)%   (6.2)%   78%   78%
Total Revenue   $ 2,200     $ 2,352     (6.5)%   (5.3)%   100%   100%
                         
Reconciliation to Condensed Consolidated Statements of Income:                        
Sales(1)   $ 804     $ 856     (6.1)%   (5.0)%        
Less: Supplies, paper and other sales(1)   (310 )   (345 )   (10.1)%   (9.2)%        
Equipment Sales   $ 494     $ 511     (3.3)%   (2.2)%        
                         
Services, maintenance and rentals(1)   $ 1,336     $ 1,431     (6.6)%   (5.6)%        
Add: Supplies, paper and other sales(1)   310     345     (10.1)%   (9.2)%        
Add: Financing   60     65     (7.7)%   (7.0)%        
Post Sale Revenue   $ 1,706     $ 1,841     (7.3)%   (6.2)%        
                         
Americas   $ 1,487     $ 1,544     (3.7)%   (3.6)%   68%   66%
EMEA   641     713     (10.1)%   (6.8)%   29%   30%
Other   72     95     (24.2)%   (24.2)%   3%   4%
Total Revenue(2)   $ 2,200     $ 2,352     (6.5)%   (5.3)%   100%   100%
                         
Memo:                        
Xerox Services(3)   $ 830     $ 883     (6.0)%   (4.6)%   38%   38%

____________________________

CC – Constant Currency (see “Non-GAAP Financial Measures” section).

  1. Certain prior year amounts have been conformed to the current year presentation. See Appendix III for this change in presentation.
  2. Refer to Appendix II for our Geographic Sales Channels and Products and Offerings Definitions.
  3. Excluding equipment revenue, Xerox Services was $719 million and $760 million in the third quarter 2019 and 2018, respectively, representing a decrease of 5.4% including a 1.6-percentage point unfavorable impact from currency.

Third quarter 2019 total revenue decreased 6.5% as compared to third quarter 2018, including a 1.2-percentage point unfavorable impact from currency, and an approximate 0.7-percentage point unfavorable impact from lower OEM sales. Third quarter 2019 total revenue reflected the following:

  • Post sale revenueprimarily reflects contracted services, equipment maintenance, supplies and financing. These revenues are associated not only with the population of devices in the field, which is affected by installs and removals, but also by the page volumes generated from the usage of such devices, and the revenue per printed page. Post sale revenue also includes transactional IT hardware sales and implementation services from our XBS organization. Post sale revenue decreased 7.3% as compared to third quarter 2018, including a 1.1-percentage point unfavorable impact from currency, and reflected the following:
    • Services, maintenance and rentals revenueincludes rental and maintenance revenue (including bundled supplies) as well as the post sale component of the document services revenue from our Xerox Services offerings. These revenues decreased 6.6% as compared to third quarter 2018, including a 1.0-percentage point unfavorable impact from currency. The decline at constant currencyreflected the continuing trend of lower page volumes (including a higher mix of lower usage products), an ongoing competitive price environment, and a lower population of devices, which are partially associated with continued lower Enterprise signings and lower installs in prior periods.
    • Supplies, paper and other salesincludes unbundled supplies and other sales. These revenues decreased 10.1% as compared to third quarter 2018, including a 0.9-percentage point unfavorable impact from currency and a 3.9-percentage point unfavorable impact from lower OEM sales. Excluding OEM sales, the decline at constant currencyreflected lower paper sales from developing markets (primarily from the Latin America region), as well as the impact of lower supplies revenues primarily associated with lower page volume trends. These declines were partially offset by the implementation of a large transactional IT sales arrangement from our XBS organization.
    • Financing revenue is generated from financed equipment sale transactions. The 7.7% decline in these revenues reflected a continued decline in the finance receivables balance due to lower equipment sales in prior periods and included a 0.7-percentage point unfavorable impact from currency.
    Three Months Ended
September 30,
          % of Equipment Sales
(in millions)   2019   2018   %
Change
  CC %
Change
  2019   2018
Entry   $ 49     $ 56     (12.5)%   (10.9)%   10%   11%
Mid-range   344     351     (2.0)%   (1.2)%   70%   69%
High-end   96     94     2.1%   3.4%   19%   18%
Other   5     10     (50.0)%   (50.0)%   1%   2%
Equipment Sales   $ 494     $ 511     (3.3)%   (2.2)%   100%   100%

____________________________

CC – Constant Currency (see “Non-GAAP Financial Measures” section).

  • Equipment sales revenuedecreased 3.3% as compared to third quarter 2018, including a 1.1-percentage point unfavorable impact from currency as well as the impact of price declines of approximately 5%. The decline at constant currency1 was primarily driven by lower sales of our office-centric devices (entry and mid-range products) partially offset by higher sales of our production-centric systems (high-end). The decline at constant currency1 reflected the following:
    • Entry – The decreasereflected lower sales of devices primarily from developing market regions in EMEA reflecting in part continued weakness and delayed decisions as a result of uncertainty in the economic environment. Revenues from entry products through our indirect channels in the U.S. also declined as they were further impacted by price investments, and lower sales of devices from the lower end of the portfolio.
    • Mid-range –The decrease reflected lower sales from EMEA, primarily from developing market regions reflecting in part continued weakness and delayed decisions as a result of uncertainty in the economic environment. Revenues from our Americas region were flat as compared to the prior year, reflecting the favorable impact of a large account order (part of a refresh cycle), some of which occurred earlier than anticipated, offsetting lower sales from our US indirect channels and from our XBS sales organization, which continued to gradually stabilize from the impact of organizational changes that were part of our Project Own It transformation actions (including the transitioning of accounts to implement coverage changes, consolidation of real estate locations and the reduction of management layers).
    • High-end The increase reflected higher sales of color systems associated with continued demand for our Iridesse production press and installs of our Versant production systems, as well as higher sales of our iGen press in the U.S., partially offset by lower sales of black-and-white systems.

Total Installs

Installs reflect new placement of devices only. Revenue associated with equipment installations may be reflected up-front in Equipment sales or over time either through rental income or as part of our Xerox Services revenues (which are both reported within our post sale revenues), depending on the terms and conditions of our agreements with customers. Installs include activity from Xerox Services and Xerox-branded products shipped to our XBS sales unit. Detail by product group (see Appendix II) is shown below:

Entry2

  • 10% increase in color multifunction devices reflecting higher installs of ConnectKey devices primarily from our indirect channels in the U.S. partially offset by lower installs from EMEA.
  • 6% decrease in black-and-white multifunction devices driven by lower activity primarily from our indirect channels in the U.S. and from EMEA.

Mid-Range3

  • 2% increase in mid-range color installs primarily reflecting installs associated with a large account’s refresh cycle order.
  • 20% decrease in mid-range black-and-white reflecting lower installs of ConnectKey devices primarily from developing market regions and from our indirect channels in the U.S. The decline also reflected global market trends.

High-End3

  • 12% increase in high-end color installs reflecting continued demand for our Iridesse production press and higher installs of our lower-end Versant production systems as well as higher activity from iGen in North America.
  • 22% decrease in high-end black-and-white systems.

___________________________

  1. See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure.
  2. When combined with OEM sales, Entry color multifunction devices increased 10%, while Entry black-and-white multifunction devices decreased 7%.
  3. Mid-range and High-end color installations exclude Fuji Xerox digital front-end sales; including Fuji Xerox digital front-end sales, Mid-range color devices increased 2%, and High-end color systems increased 12%.

 

Costs, Expenses and Other Income

Summary of Key Financial Ratios

The following is a summary of key financial ratios used to assess our performance:

    Three Months Ended September 30,
(in millions)   2019   2018   B/(W)
Gross Profit   $ 880     $ 942     $ (62 )
RD&E   100     102     2  
SAG   513     583     70  
             
Equipment Gross Margin   34.4 %   34.6 %   (0.2) pts.
Post sale Gross Margin   41.6 %   41.6 %   0.0 pts.
Total Gross Margin   40.0 %   40.1 %   (0.1) pts.
RD&E as a % of Revenue   4.5 %   4.3 %   (0.2) pts.
SAG as a % of Revenue   23.3 %   24.8 %   1.5 pts.
             
Pre-tax Income   $ 230     $ 192     $ 38  
Pre-tax Income Margin   10.5 %   8.2 %   2.3 pts.
             
Adjusted(1) Operating Profit   $ 267     $ 257     $ 10  
Adjusted(1) Operating Margin   12.1 %   10.9 %   1.2 pts.

____________________________

  1. See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure.

Pre-tax Income Margin

Third quarter 2019 pre-tax income margin of 10.5% increased 2.3-percentage points as compared to third quarter 2018. The increase was primarily driven by lower operating expenses, mainly reflecting the net benefit from our Project Own It transformation actions, which more than offset the adverse impact of lower revenues. The increase also reflected lower Other Expenses, net, partially offset by higher Transaction and related costs, net, due to a prior year credit associated with recoveries from insurance and other vendors.

Adjusted1 Operating Margin

Third quarter 2019 adjustedoperating margin of 12.1% increased by 1.2-percentage points as compared to third quarter 2018 primarily reflecting the impact of SAG reductions and cost productivity associated with our Project Own It transformation actions, which more than offset the pace of revenue decline and an approximate 0.2-percentage point unfavorable impact from transaction currency. The increase also reflected a $5 million favorable impact from higher costs in the prior year related to the termination of certain IT projects.

____________________________

  1. Refer to the Operating Income and Margin reconciliation table in the “Non-GAAP Financial Measures” section.

Gross Margin

Third quarter 2019 gross margin of 40.0% decreased by 0.1-percentage points compared to third quarter 2018, and reflected an approximate 0.2-percentage point unfavorable impact from transaction currency, and the impact of lower equipment and supplies sales revenues as well as lower page volumes offset by cost productivity and restructuring savings associated with our Project Own It transformation actions.

Third quarter 2019 equipment gross margin of 34.4% decreased by 0.2-percentage points as compared to third quarter 2018, reflecting cost productivity and the favorable mix impact of higher sales of high-end production systems offset by an approximate 0.6-percentage point unfavorable impact from transaction currency and selective price investments.

Third quarter 2019 post sale gross margin of 41.6% was flat as compared to third quarter 2018 as a result of productivity and restructuring savings associated with our Project Own It transformation actions, which entirely offset the impact of lower revenues, including lower pricing on contract renewals.

Gross margins are expected to be negatively impacted in future periods as a result of an increase in the cost of our imported products from higher import tariffs. We are taking actions to mitigate the impact of these tariffs, such as raising prices on certain products, however, we currently estimate approximately $24 million cost impact from these higher tariffs in 2019, with a significant portion impacting the fourth quarter 2019.

Research, Development and Engineering Expenses (RD&E)

Third quarter 2019 RD&E as a percentage of revenue of 4.5% increased by 0.2-percentage points as compared to third quarter 2018, primarily due to lower revenues as expenses were essentially flat year-over-year.

RD&E of $100 million decreased $2 million as compared to third quarter 2018 and reflected cost productivity and restructuring savings from our Project Own It transformation actions partially offset by the timing of investments that started to ramp during the quarter.

Selling, Administrative and General Expenses (SAG)

SAG as a percentage of revenue of 23.3% decreased by 1.5-percentage points as compared to third quarter 2018, primarily reflecting the benefit from productivity and restructuring associated with our Project Own It transformation actions.

SAG of $513 million decreased by $70 million as compared to third quarter 2018, reflecting productivity and restructuring savings associated with our Project Own It transformation actions as well as lower compensation and incentives (consistent with lower revenues); the decrease also includes the favorable impacts of approximately $6 million from translation currency and $5 million from higher costs in the prior year associated with the termination of certain IT projects. Bad debt expense of $13 million was $3 million higher compared to third quarter 2018 and on a trailing twelve-month basis (TTM) remained at less than one percent of total receivables.

Restructuring and Related Costs

During the second half of 2018, we started our Project Own It transformation initiative. The primary goal of this initiative is to improve productivity by driving end-to-end transformation of our processes and systems to create greater focus, speed, accountability and effectiveness and to reduce costs. We incurred restructuring and related costs of $27 million for the third quarter 2019 primarily related to costs to implement initiatives under our business transformation projects including Project Own It.

The following is a breakdown of those costs:

(in millions)   Three Months Ended
September 30, 2019
Restructuring Severance (1)   $ 12  
Asset Impairments (2)   2  
Other contractual termination costs (3)   1  
Net reversals (4)   (7 )
Restructuring and asset impairment costs   8  
Retention related severance/bonuses (5)   11  
Contractual severance costs (6)   3  
Consulting and other costs (7)   5  
Total   $ 27  

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  1. Reflects headcount reductions of approximately 150 employees worldwide.
  2. Primarily related to the exit and abandonment of leased and owned facilities. The charge includes the accelerated write-off of $2 million for leased right-of-use asset balances net of any potential sublease income and other recoveries.
  3. Primarily include additional costs incurred upon the exit from our facilities including decommissioning costs and associated contractual termination costs.
  4. Reflects net reversals for changes in estimated reserves from prior period initiatives as well as $4 million in favorable adjustments from the early termination of prior period impaired leases.
  5. Includes retention related severance and bonuses for employees expected to continue working beyond their minimum notification period before termination.
  6. Reflects severance and other related costs we are contractually required to pay on employees transferred (approximately 2,200 employees) as part of the shared service arrangement entered into with HCL Technologies.
  7. Represents professional support services associated with our business transformation initiatives.

Third quarter 2019 actions impacted several functional areas, with approximately 50% focused on gross margin improvements, approximately 45% focused on SAG reductions, and the remainder focused on RD&E optimization.

The implementation of our Project Own It initiatives as well as other business transformation initiatives is expected to result in significant cost savings in 2019 and future years. However, expected savings associated with these initiatives may be offset to some extent by business disruption during the implementation phase and until the initiatives are fully implemented and stabilized.

Third quarter 2018 restructuring and related costs of $29 million included $40 million of severance costs related to headcount reductions of approximately 900 employees worldwide and $1 million of lease cancellation costs. These costs were partially offset by $12 million of net reversals for changes in estimated reserves from prior period initiatives. Third quarter 2018 actions impacted several functional areas, with approximately 30% focused on gross margin improvements, approximately 65% on SAG reductions, and the remainder focused on RD&E optimization.

The restructuring reserve balance as of September 30, 2019 for all programs was $57 million, which is expected to be paid over the next twelve months.

Transaction and Related Costs, Net

There were $4 million of Transaction and related costs, net recognized during third quarter 2019 as compared to a $33 million credit in third quarter 2018 which was primarily associated with recoveries from insurance and other vendors. These expenses primarily relate to on-going costs for litigation associated with the terminated Fuji transaction, which are expected to continue. We also continue to pursue recoveries from insurance carriers and other parties for costs and expenses related to the terminated Fuji transaction and related shareholder litigation and therefore additional recoveries and adjustments may be recorded in future periods, when finalized.

Amortization of Intangible Assets

Third quarter 2019 Amortization of intangible assets of $9 million decreased by $3 million compared to third quarter 2018 as a result of the write-off of trade names in prior periods associated with our realignment and consolidation of certain XBS sales units as part of Project Own It transformation actions.

Worldwide Employment

Worldwide employment was approximately 27,600 as of September 30, 2019 and decreased by approximately 4,800 from December 31, 2018. The reduction resulted from net attrition (attrition net of gross hires), of which a large portion is not expected to be backfilled, as well as the impact of organizational changes including employees transferred as part of the shared services arrangement entered into with HCL Technologies earlier this year.

Other Expenses, Net

    Three Months Ended
September 30,
(in millions)   2019   2018
Non-financing interest expense   $ 27     $ 28  
Non-service retirement-related costs   (2 )   33  
Interest income   (2 )   (5 )
Gains on sales of businesses and assets   (19 )   (3 )
Litigation matters   (8 )   1  
Contract termination costs – IT services   (8 )    
Currency losses, net   4     3  
Loss on sales of accounts receivable   1     1  
All other expenses, net   4     (1 )
Other expenses, net   $ (3 )   $ 57  

Non-financing interest expense

Third quarter 2019 non-financing interest expense of $27 million was $1 million lower than third quarter 2018. When combined with financing interest expense (Cost of financing), total interest expense decreased by $1 million from third quarter 2018 primarily due to a lower debt balance.

Non-service retirement-related costs

Third quarter 2019 non-service retirement-related costs were $35 million lower than third quarter 2018, primarily driven by the favorable impact of a 2018 amendment to our U.S. Retiree Health Plan and lower losses from pension settlements in the U.S.

Gains on sales of businesses and assets

Third quarter 2019 gains on sales of businesses and assets were $16 million higher than third quarter 2018, reflecting the sale of non-core business assets.

Litigation matters

Third quarter 2019 litigation matters were $9 million lower than third quarter 2018, reflecting the favorable resolution of certain litigation matters in third quarter 2019.

Contract termination costs – IT services

Contract termination costs – IT services was an $8 million credit in third quarter 2019 reflecting an adjustment to a $43 million penalty recorded in fourth quarter 2018, associated with the termination of an IT services arrangement.

Income Taxes

Third quarter 2019 effective tax rate was 28.7%. On an adjusted1 basis, third quarter 2019 effective tax rate was 26.5%. These rates were higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits. The adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section.

Third quarter 2018 effective tax rate was 74.0% and included an additional charge of $95 million related to a change in the provisional estimated impact from the 2017 Tax Cuts Jobs Act (the “Tax Act”). On an adjustedbasis, third quarter 2018 effective tax rate was 24.5%. This rate was higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits. In addition to excluding the impact of the Tax Act, the adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net, and non-service retirement-related costs.

Our effective tax rate is based on nonrecurring events as well as recurring factors, including the taxation of foreign income. In addition, our effective tax rate will change based on discrete or other nonrecurring events that may not be predictable.

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  1. Refer to the Effective Tax Rate reconciliation table in the “Non-GAAP Financial Measures” section.

Equity in Net Income of Unconsolidated Affiliates

Equity in net income of unconsolidated affiliates primarily reflects our 25% share of Fuji Xerox net income. Third quarter 2019 equity income of $58 million increased $15 million compared to third quarter 2018, primarily reflecting savings from Fuji Xerox restructuring and the benefit of $7 million of lower year-over-year charges related to our share of Fuji Xerox after-tax restructuring and other charges in the prior year.

Net Income

Third quarter 2019 net income attributable to Xerox Holdings was $221 million, or $0.96 per diluted share. On an adjusted1 basis, net income attributable to Xerox Holdings was $248 million, or $1.08 per diluted share. Third quarter 2019 adjustments to net income included Restructuring and related costs, Amortization of intangible assets, Transaction and related cost, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section.

Third quarter 2018 net income attributable to Xerox Holdings was $89 million, or $0.34 per diluted share, which included an estimated non-cash charge of $95 million or $0.37 per diluted share associated with the Tax Act. On an adjusted1 basis, net income attributable to Xerox Holdings was $222 million, or $0.85 per diluted share. Third quarter 2018 adjustments to net income included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section.


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SOURCE Xerox

Chester Carlson and Xerography