XEROX HOLDINGS CORPORATION Throughout this Management's Discussion and Analysis (MD&A), references to "Xerox Holdings " refer toXerox Holdings Corporation and its consolidated subsidiaries while references to "Xerox" refer toXerox Corporation and its consolidated subsidiaries. References herein to "we," "us," "our," and the "Company" refer collectively to bothXerox Holdings and Xerox unless the context suggests otherwise. References to "Xerox Holdings Corporation " refer to the stand-alone parent company and do not include its subsidiaries. References to "Xerox Corporation " refer to the stand-alone company and do not include its subsidiaries. Currently,Xerox Holdings' primary direct operating subsidiary is Xerox and Xerox reflects nearly all ofXerox Holdings' operations. Accordingly, the following MD&A primarily focuses on the operations of Xerox and is intended to help the reader understand Xerox's business and its results of operations and financial condition. The MD&A is provided as a supplement to, and should be read in conjunction with, the Condensed Consolidated Financial Statements and the accompanying notes. Throughout this MD&A, references are made to various notes in the Condensed Consolidated Financial Statements which appear in Item 1 of this combined Quarterly Report on Form 10-Q (this Form 10-Q), and the information contained in such notes is incorporated by reference into the MD&A in the places where such references are made.Xerox Holdings' other direct subsidiary isXerox Ventures LLC , which was established in 2021 solely to invest in startups and early/mid-stage growth companies aligned with the Company's innovation focus areas and targeted adjacencies.Xerox Ventures LLC had investments of approximately$21 million atSeptember 30, 2022 . Due to its immaterial nature, and for ease of discussion,Xerox Ventures LLC's results are included within the following discussion.
Currency Impact
To understand the trends in the business, we believe that it is helpful to analyze the impact of changes in the translation of foreign currencies intoU.S. Dollars on revenue and expenses. We refer to this analysis as "constant currency," "currency impact" or "the impact from currency." This impact is calculated by translating current period activity in local currency using the comparable prior year period's currency translation rate. This impact is calculated for all countries where the functional currency is the local country currency. We do not hedge the translation effect of revenues or expenses denominated in currencies where the local currency is the functional currency. Management believes the constant currency measure provides investors an additional perspective on revenue trends. Currency impact can be determined as the difference between actual growth rates and constant currency growth rates.
Overview
Revenue growth during the third quarter 2022 accelerated in constant currency, reflecting the benefit from recent acquisitions as well as resilient demand for our products and services amid an increasingly challenging macroeconomic environment. Equipment revenue increased 0.8% in actual currency and included a 5.9-percentage point adverse impact from currency. The 6.7% increase in constant currency1, reflects the first quarter of equipment revenue growth since the supply chain constraints began last year. As expected, backlog2 slightly declined sequentially, reflecting sustained order flow, offset by gradual easing of supply constraints. Although we were encouraged by supply chain improvements, the pace of improvement was slower than expected. The increase in Post sale revenue was driven by another strong quarter for paper and supplies. Growth in these consumables reflects the early benefits of recent pricing actions, and for supplies, an ongoing, gradual recovery of print-related activity. Post sale revenue also benefited from growth in IT and Digital Services, including contributions from recent acquisitions. Consistent with prior quarters, we continue to see a strong correlation between return-to-office trends and page volumes. We did see an improvement in page volume relative to 2019 levels; however, page volumes are recovering slower than we expected, as employers' efforts to bring employees back to offices have been slow to gain momentum. Adjusted1 operating income margin declined 0.5-percentage points year-over-year but improved sequentially, reflecting the benefits of price and cost actions we have taken year-to-date. Improvement was slower than expected due to persistently high rates of inflation across our cost base, an unfavorable geographic mix in equipment sales, and a slower-than-expected easing of supply chain constraints.
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(1)See the "Non-GAAP Financial Measures" section for an explanation of the non-GAAP financial measure. (2)Order backlog is measured as the value of unfulfilled sales orders, shipped and non-shipped, received from our customers waiting to be installed, including orders with future installation dates. It includes printing devices as well as IT hardware associated with our IT services offerings. Third quarter 2022 backlog of$429 million excludes sales orders fromRussia andPowerland Computers Ltd. , which was acquired in the first quarter of 2022. Prior quarter backlog was revised to conform to current reporting methodology. Xerox 2022 Form 10-Q 45 --------------------------------------------------------------------------------
Russia-Ukraine Conflict
With respect to the war inUkraine , in the first quarter 2022, we halted shipments toRussia andBelorussia when sanctions were imposed and the resulting financial impact has thus far been minimal. The Eurasian region in total comprised a low single digit percentage of our revenue and operating profits in 2021. As ofSeptember 30, 2022 the net assets of our Eurasian operations were approximately$18 million (approximately$30 million of total assets) and comprised approximately 0.5% of consolidated net assets. At all times from the imposition of sanctions through the date of the filing of this Form 10-Q, we have been compliant with sanctions and government restrictions.
Reportable Segment Change
During the first quarter of 2022, the Company made a change to its reportable segments from one reportable segment to two reportable segments - Print and Other, and Financing (FITTLE) - to align with a change in how the Chief Operating Decision Maker (CODM), our Chief Executive Officer (CEO), allocates resources and assesses performance against the Company's key growth strategies. As such, prior period reportable segment results and related disclosures have been conformed to reflect the Company's current reportable segments.
Third Quarter 2022 Review
Total revenue of$1.75 billion for third quarter 2022 decreased 0.4% from third quarter 2021, which included a 5.1-percentage point adverse impact from currency partially offset by a 3.4-percentage point benefit from acquisitions. Total revenue reflected a decrease of 0.7% in Post sale revenue, which included a 4.8-percentage point adverse impact from currency, and reflected increased IT services revenues, which benefited from recent acquisitions, as well as higher consumables revenues including from paper and supplies, partially offset by lower service and rental revenue. Equipment sales revenue increased 0.8%, which included a 5.9-percentage point adverse impact from currency and reflected higher demand for our products and a modest improvement in product availability, primarily in EMEA. Total revenue of$5.17 billion for the nine months endedSeptember 30, 2022 decreased 1.8% as compared to the prior year period, including a 3.5-percentage point adverse impact from currency partially offset by a 2.4-percentage point benefit from acquisitions. Total revenue reflected an increase of 0.8% in Post sale revenue, including a 3.4-percentage point adverse impact from currency, and a decrease of 10.6% in Equipment sales revenue, including a 3.6-percentage point adverse impact from currency.
Net (loss) income attributable to
Three Months Ended September 30, Nine Months Ended September 30,
(in millions) 2022 2021 B/(W) 2022 2021 B/(W)
Net (loss) income attributable to
Xerox Holdings $ (383) $ 90
33 90 (57) 43 231 (188)
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(1)See the "Non-GAAP Financial Measures" section for an explanation of the non-GAAP financial measure.
Third quarter 2022 Net (loss) attributable toXerox Holdings of($383) million was a decrease of$473 million as compared to third quarter 2021 Net income attributable toXerox Holdings of$90 million . The decrease primarily reflects an after-tax non-cashGoodwill impairment charge of$395 million ($412 million pre-tax), as well as lower gross margin, reflecting unfavorable product and services mix associated with product supply constraints, and higher Restructuring and related costs, net, Other expenses, net, and Income tax expense. These negative impacts were partially offset by lower Research, development and engineering expenses. Third quarter 2022 Adjusted1 Net income attributable toXerox Holdings of$33 million decreased$57 million as compared to the prior year period, primarily due to lower gross margin, reflecting unfavorable product and services mix associated with product supply constraints, as well as higher Income tax expense and Other expenses, net. Net (loss) attributable toXerox Holdings for the nine months endedSeptember 30, 2022 of$(443) million was a decrease of$663 million as compared to the prior year period Net income attributable toXerox Holdings of$220 million . The decrease primarily reflects an after-tax non-cashGoodwill impairment charge of$395 million ($412 million pre-tax), as well as lower gross margin, reflecting unfavorable product and services mix as well as higher freight costs associated with product supply constraints, and higher Selling, administrative and general expenses due to higher stock compensation expense associated with the accelerated vesting of all outstanding equity awards, in the second quarter 2022 according to the terms of the award agreement, in connection with the passing ofXerox Holding's former CEO. Other expenses, net, were$94 million higher primarily due to a$33 million charge in the first quarter 2022 associated with the termination of a product supply agreement (which was net of an$8 million Xerox 2022 Form 10-Q 46 -------------------------------------------------------------------------------- previously recorded accrual), lower gains on sales of businesses and assets, and a lower benefit from non-service retirement costs. These negative impacts were partially offset by lower Income tax expense. Adjusted1 Net income attributable toXerox Holdings for the nine months endedSeptember 30, 2022 of$43 million decreased$188 million as compared to the prior year period, primarily reflecting lower gross margin, as a result of unfavorable product and services mix as well as higher freight costs associated with product supply constraints, and higher Selling, administrative and general expenses and Other expense, net. These negative impacts were partially offset by lower Income tax expense.
A summary of our segment information is as follows:
Three Months Ended September 30, Nine Months Ended September 30, % of Total
(in millions) 2022 2021 % Change 2022 2021 % Change 2022 2021
Revenue
Print and Other $ 1,641 $ 1,636 0.3 % $ 4,824 $ 4,889 (1.3) % 93 % 93 %
Financing (FITTLE) 150 171 (12.3) % 459 528 (13.1) % 9 % 10 %
Intersegment
Elimination(1) (40) (49) (18.4) % (117) (156) (25.0) % (2) % (3) %
Total Revenue $ 1,751 $ 1,758 (0.4) % $ 5,166 $ 5,261 (1.8) % 100 % 100 %
Profit
Print and Other $ 57 $ 50 14.0 % $ 55 $ 232 (76.3) % 57 % 80 %
Financing (FITTLE) 8 24 (66.7) % 42 57 (26.3) % 43 % 20 %
Total Profit $ 65 $ 74 (12.2) % $ 97 $ 289 (66.4) % 100 % 100 %
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(1)Reflects net revenue, primarily commissions and other payments, made by the
Financing (FITTLE) segment to the Print and Other segment for the lease of Xerox
equipment placements.
Cash flows from operating activities during the nine months ended September 30,
2022 was a use of $27 million and decreased $458 million as compared to the
prior year period, primarily related to lower net income as well as lower
royalty payments, higher finance receivable originations, a $41 million one-time
payment in second quarter 2022 associated with the termination of a product
supply agreement, and higher working capital2. Cash used in investing activities
during the nine months ended September 30, 2022 was $95 million reflecting
capital expenditures of $39 million , acquisitions of $93 million and $13 million
of noncontrolling investments as part of our corporate venture capital fund,
partially offset by $49 million related to the sale of surplus assets including
buildings and land in the U.S. Cash used in financing activities during the nine
months ended September 30, 2022 was $755 million reflecting payments of $600
million on existing secured financing arrangements, $300 million on Senior Notes
that matured in 2022 and $353 million for the early redemption of 2023 Senior
Notes, partially offset by proceeds of $753 million on new secured financing
arrangements, as well as dividend payments of $131 million and $113 million for
repurchases of our Common Stock.
2022 Outlook
The global macroeconomic outlook has become more volatile in the past three months, but we are not yet seeing a meaningful effect of a global slowdown on our revenues. We continue to see resiliency in demand for our office products, particularly our A3 devices. However, consistent with the uncertain macro environment, we are beginning to see longer project deployment times, and in some cases, lower page volume commitments. Due to the recent weakening of the Euro and British Pound, and an uncertain outlook for global foreign exchange rates, we are adjusting our full-year revenue guidance from at least$7.1 billion to a range of$7.0 billion to$7.1 billion in actual currency. Additionally, we are lowering our cash flow guidance due to slower-than-expected supply chain improvements and persistently high rates of inflation, which negatively affected operating profit, as well as a greater-than-expected use of working capital to fund originations growth at FITTLE and inventories. Accordingly, we are adjusting our full-year 2022 Operating cash flows guidance from at least$475 million to at least$180 million (excluding the$41 million one-time payment associated with the termination of a product supply agreement), and expect capital expenditures of$55 million (previously$75 million ) for full-year 2022.
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(1)See the "Non-GAAP Financial Measures" section for an explanation of the non-GAAP financial measure. (2)Working capital, net reflects Accounts receivable, net, Inventories and Accounts payable.
Xerox 2022 Form 10-Q 47
--------------------------------------------------------------------------------Critical Accounting Policies and Estimates - Update
Except as noted below, there have been no significant changes for the three and nine months endedSeptember 30, 2022 to the items that we disclosed as our critical accounting estimates and policies in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our combined Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 (the 2021 Form 10-K).
We assessGoodwill for impairment at least annually during the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. During 2022, we had events and conditions in the first quarter and third quarter that required an interim assessment ofGoodwill .
First Quarter 2022 - Change in Segments
During the first quarter 2022, the Company made a change to its operating and reportable segments from one operating/reportable segment - Printing - to two operating/reportable segments - Print and Other, and Financing (FITTLE). As a result of the new operating and reportable segments, we also reassessed our reporting units for the evaluation ofGoodwill . Prior to this change, consistent with the determination that we had one operating/reportable segment, we determined that we had one reporting unit forGoodwill assessment purposes. Our reassessment during the first quarter of 2022 determined that consistent with the determination that we had two operating/reportable segments, we now have two reporting units forGoodwill assessment purposes - Print and Other, and Financing (FITTLE). As a result of the change in reporting units, effectiveJanuary 1, 2022 , we estimated the fair value of our new reporting units and, based on an assessment of the relative fair values of our new reporting units after the change, we determined that noGoodwill was allocable to the Financing (FITTLE) segment. This determination was largely based on the fact that at this stage in the stand-up of the Financing (FITTLE) business, its separate valuation is constrained and limited because the operation is significantly integrated with the Print and Other segment and is primarily an extension or enabler to facilitate the sale of the Company's products. The change in reporting units was also considered a triggering event indicating a test forGoodwill impairment was required as ofJanuary 1, 2022 before and after the change in reporting units. The Company performed those impairment tests, which did not result in the identification of an impairment loss as ofJanuary 1, 2022 . We perform an assessment ofGoodwill , utilizing either a qualitative or quantitative impairment test. As a result of our impairment charge in the fourth quarter 2021, we elected to bypass the qualitative impairment test and proceed to the quantitative test for the assessment of the recoverability of ourGoodwill balance effectiveJanuary 1, 2022 before and after the change in segments. In estimating the fair value of our single reporting unit before the change in segments, our analysis reflected a 75/25 allocation between the income and market approach and the application of a discount rate applied to our projected cash flows of approximately 7.50%. The weighting between the income and market approach was consistent with our assessment in the fourth quarter 2021. The applied discount rate was 25 basis points lower than the rate applied in the fourth quarter 2021 assessment largely due to changes in market inputs with respect to the Cost of Equity as well as a slightly higher Cost of Debt weighting, which carries a lower cost. We believe that the discount rate applied was reasonable based on the estimated capital costs of applicable market participants and an appropriate company-specific risk premium that reflected current market and industry conditions. In estimating the fair value of our reporting unit withGoodwill after the change in segments (Print and Other), our analysis likewise reflected a 75/25 allocation between the income and market approach, respectively, but the discount rate applied to our projected cash flows was increased to approximately 8.75%. The increase in the discount rate was largely due to an increase in the Company Specific Risk Premium to balance the overall Company valuation and to reflect an increased risk to Print and Other as a result of the removal of a portion of the steadier annuity financing revenues to the Financing (FITTLE) reporting unit. As with the assessment before the segment change, we continue to believe that the discount rate applied was reasonable based on the estimated capital costs of applicable market participants and an appropriate company-specific risk premium that reflected current market and industry conditions. Based on our forecast model, which we believe reflects the inherent uncertainty of the future, we estimated that the excess of fair value over carrying value for the reporting unit withGoodwill ranged between 15% and 20%. Xerox 2022 Form 10-Q 48 --------------------------------------------------------------------------------
Third Quarter 2022
In the first nine months of 2022, the Company continued to encounter operational challenges due to unfavorable product and services mix associated with supply chain constraints as well the impacts of unfavorable macroeconomic conditions including inflationary pressure on product and labor costs, geopolitical uncertainty inEurope and the continued impacts from the COVID-19 recovery. Additionally, higher interest rates continue to put downward pressure on the Company's valuation. Although operating results are expected to improve in the fourth quarter 2022, and in 2023 as the Company works down its backlog; operating results are expected to be below previous forecasts and will continue to be pressured as result of these unfavorable macroeconomic conditions. As a result of these negative financial impacts as well as a sustained market capitalization below our book value, in the third quarter 2022 we determined there was a triggering event requiring an interim quantitative assessment ofGoodwill . After completing our interim impairment test, we concluded that the estimated fair value of the Print and Other reporting unit (the only reporting unit withGoodwill ) had declined below its carrying value and we recognized an after-tax non-cash impairment charge of$395 million ($412 million pre-tax) related to ourGoodwill in the third quarter 2022. In estimating the fair value of the Print and Other reporting unit, our analysis reflected a 75/25 allocation between the income and market approach, respectively, and the application of a discount rate applied to our projected cash flows of approximately 10.75%. The weighting between the income and market approach was consistent with our assessment in the fourth quarter 2021 as well as the first quarter 2022. The applied discount rate was 200 basis points higher than the rate applied in the first quarter 2022 assessment primarily due to higher market interest rates. We believe that the discount rate applied was reasonable based on the estimated capital costs of applicable market participants and an appropriate company-specific risk premium that reflected current market and industry conditions. As a result of recent macroeconomic volatility and continued supply chain constraints, our current results and internal forecasts indicate that the Company could have a slower-than-expected recovery from the impacts of the COVID pandemic and supply chain issues experienced over the past few years. Although operating results and related cash flows are expected to improve in the fourth quarter 2022, and in full-year 2023, we expect an increased risk to our previous outlooks and estimates, at least in the near term. This impact combined with higher market interest rates and the resulting effect on valuation discount rates, continues to negatively impact the Company's valuation resulting in theGoodwill impairment charge for the third quarter 2022. In performing its assessment, the Company believes it has made reasonable estimates based on the facts and circumstances that were available as of the reporting date. However, the determination of fair value includes assumptions that are subject to risk and uncertainty. The discounted cash flow calculations are dependent on subjective factors including the timing and amount of future cash flows and the discount rate. If the Company's future performance varies from current expectations, assumptions, or estimates, including those assumptions relating to the supply chain constraints, interest rates, inflationary pressure on product and labor costs, geopolitical uncertainty inEurope , or the continued impacts from the COVID-19 recovery, this may impact the impairment analysis and could reduce the underlying cash flows used to estimate fair values and result in a decline in fair value that may trigger future impairment charges. We will continue to monitor developments throughout the remainder of 2022, including updates to our forecasts as well as our market capitalization, and an update of our assessment and related estimates may be required in the future. Xerox 2022 Form 10-Q 49 -------------------------------------------------------------------------------- Financial Review Revenues Three Months Ended Nine Months EndedSeptember 30 ,September 30 , % of Total Revenue (in millions) 2022 2021 % Change CC % Change 2022 2021 % Change CC % Change 2022 2021 Equipment sales$ 390 $ 387 0.8 % 6.7 %$ 1,070 $ 1,197 (10.6) % (7.0) % 21 % 23 % Post sale revenue 1,361 1,371 (0.7) % 4.1 % 4,096 4,064 0.8 % 4.2 % 79 % 77 % Total Revenue$ 1,751 $ 1,758 (0.4) % 4.7 %$ 5,166 $ 5,261 (1.8) % 1.7 % 100 % 100 %
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