Xerox Holdings Corporation Common Stock 2026 Q3 Earnings Call

I am Greg Stein, Senior Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation third quarter 2026 earnings release conference call hosted by Louis Pastor, Chief Executive Officer. He is joined by Chuck Butler, 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 express 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 would like to turn the meeting over to Mr. Pastor.

Good morning, and thank you for joining our Q3 2026 earnings call. I will start with the most important news. Today, we are lowering our full year adjusted operating income and free cash flow guidance, and our board has suspended our common and preferred dividends. These decisions reflect a quarter of two realities. The parts of the business we have rebuilt are performing. Print revenue trends are better, equipment revenue grew, and we expect industry data to show we gained share. But the parts exposed to the market and to input costs got worse, faster than we can offset this year. Let me begin with the progress. We advanced each of our three priorities, stabilize revenue, increase profitability, and reduce leverage in the quarter. Revenue of $1.87 billion, declined less than 5%, a 180 basis point pro forma sequential improvement.

Adjusted operating margin was 6.6%, up 330 basis points from a year ago. And we again improved our gross and net leverage ratios. Print is where the progress is most visible. Print and other revenue declined 3% compared with a 10% pro forma decline a year ago. The stronger pipeline we discussed in recent quarters is beginning to convert as equipment revenue grew 3% in Q3, led by double-digit growth in both entry and production, more than offsetting double-digit declines in mid-range. This was our first quarter of year-over-year organic equipment growth in more than three years. And for the first time since we began reporting them separately, entry equipment revenue exceeded mid-range, reflecting the market shift toward entry and the strength of the portfolio we gained with the Lexmark acquisition.

Production remains a bright spot and grew in the quarter, with installs up 13% and equipment revenue up 14%, even before the three new platforms we announced last month at PRINTING United enter the market next year. Together with our Xeikon partnership, which takes us into packaging and labels, we believe we are well-positioned to gain share and production. This is a roughly $9 billion growing market, and we are now entering its fastest-growing segments. Why are we lowering our outlook after a quarter of progress? Four factors are working against us. Rising input costs, the shift in our equipment mix, a weaker print market outlook, and underperformance in IT Solutions. Together, they are more than we can offset in Q4 alone. Let me take each of them in turn. First, input costs. Last quarter, Chuck noted that if memory and oil prices continued to rise, they could put our profit guidance at risk.

They have. We now expect a combined impact of approximately $60 million on this year's adjusted operating income from memory and oil, most of it in Q4, as higher cost inventory flows through cost of goods. To put this in perspective, coming into 2026, memory was about 2% of the cost of a machine. Today, it is 10%, and we expect it to reach 15% in 2027. We are also now seeing knock-on inflation in other electrical components that go into our machines. On the post-sale side, parts, freight, and tariff-affected costs are also rising faster than planned, pressuring service margins. At the same time, service labor doesn't come down as fast as service revenue because we need a certain density of technicians to cover a territory.

When service revenue falls, most of that decline comes straight out of gross profit. That pressures post-sale margins, and it is why the service model, I will come back to later, is actually central to our long-term plan for workplace print. Second, mix. Entry is performing well, with installs up 16% and equipment revenue up 21%. Mid-range, by contrast, is declining faster than we expected, with installs down 20% and equipment revenue down 15%. This is consistent with an industry-wide shift from mid-range to entry. That matters because the economics of entry and mid-range are very different. Entry devices are unprofitable at the hardware level, and the margin gap between an entry device and a mid-range device can exceed 30 points. We make up that profit difference after the sale through supplies and service, where entry margins are higher.

Over the life of the device, entry and mid-range profitability is about the same. But in the near term, the shift weighs meaningfully on profit. With Q4 our largest equipment quarter, that impact is magnified. Third, the market outlook. Based on IDC data, we held share in the first half of 2026, and with equipment revenue up 3% and installs up 9% in Q3, we are confident we gained share during the quarter. But the market itself has weakened. The second half typically brings a meaningful seasonal lift. IDC shows second half unit growth over the first half of about 11% in 2024 and 7% in 2025. For 2026, IDC now forecasts just over 1%, as higher costs, geopolitical uncertainty, and competing IT priorities weigh on demand.

While we are holding revenue guidance at approximately $7.6 billion and are positioning ourselves to grow share, we will be doing so in a softer market with lower volumes weighing on profit. Fourth, IT Solutions. After strong performance following the November 2024 acquisition of ITsavvy, with pro forma billings up 12% in 2025 and 21% in Q1, growth slowed. Last quarter, I attributed this partly to rebuilding our sales force. The benefits of that rebuild are taking longer than expected. The funnel is there, but conversion has not improved yet. Tighter supplier and distributor terms specific to IT Solutions have also added friction. With backlog up 24% and a larger Q4 pipeline, we expect a better year-over-year comparison in Q4 than in Q3, but we have work to do. What has not changed is the quality of the platform.

A full lifecycle offering from procurement through managed services, a deep bench of engineers, strong partnerships with Microsoft and leading OEMs, and a scalable, highly automated delivery model. The demand is there, and we are focused on converting it. Here is what we are doing about all of this. Let me separate our actions for the fourth quarter from the reset of our cost and margin structure for 2027 and beyond. In the fourth quarter, we have already moved quickly to a weekly deal-by-deal review of the business. Our late-stage pipeline is still up meaningfully, so our focus is conversion and install timing. Every late-stage opportunity now carries a committed install date, with sales, supply chain, and service delivery all working from the same list. We have also frozen discretionary spending, including non-essential travel and hiring outside revenue-generating roles. These actions are about delivering the guidance we are giving you today.

For 2027, we are acting on three fronts. First, price. Beginning in the first quarter, we are implementing pricing actions across our portfolio, segmented by product and market, and tightening placement discipline so that entry placements meet higher payback thresholds on their lifetime economics. Because part of our post-sale revenue is under multi-year contracts that reprice only at renewal, pricing will only offset some of next year's cost increase, not all of it, and the benefit builds through the year. Second, cost. The Lexmark Synergy program remains on track. On top of it, we are taking further actions that began this month and run through next year, including further simplifying our organization and management structure, expanding the use of our global capability centers, which now represent about 15% of our workforce, up from 11% at the start of the year, consolidating distribution centers and real estate, and renegotiating key vendor contracts.

We will size the full program when we provide our 2027 outlook next quarter. Third, IT Solutions. We are aligning the cost base with the current run rate, including through our ITaaS and INOC autonomous delivery platforms and expanding agentic solutions across the business. That builds scale and operating leverage into the platform. We are also implementing additional measures to improve our competitiveness on larger deals. We are also acting on the balance sheet, because reducing debt remains our top capital allocation priority. Our board has suspended our common and preferred dividends effective immediately, preserving approximately $28 million a year of cash to strengthen our liquidity and support deleveraging.

Today, we announced an exchange of approximately $174 million of our 2028 senior notes for 2030 first-lien notes and equity at the equivalent of 75 cents on the dollar, reducing our overall debt by $53 million and extending nearly a third of our 2028 maturities by 2 years. Together with the debt we have already retired this year at a discount, these actions keep us on a path to lower leverage over time. Beyond these near-term actions, our biggest long-term profit opportunity is service, which is our largest cost base. It was a central theme at our partner summit in Nashville earlier this month, our biggest to date, with more than 500 partners from 70 countries. In workplace print, every page has three costs: equipment, supplies, and service. The first two are physical products, so there will always be a cost. Service is different. Every service call starts with a machine breaking down, and that is something we can engineer out.

Our goal is to drive the cost of service disruption towards zero, and we believe we are best positioned in the industry to do so. That is because we now own the full technology stack. The 9-Series, for example, has about 500 fewer parts than the externally sourced generation it replaces, with a single access door and one paper path, so there is less to fail. Because we design the devices, we decide where the sensors in the device actually go and what data they capture, something you cannot bolt on later. Across our connected fleet, AI can now flag failures before they happen, and we have made remote resolution our default, both in our contracts and in how we hold every region accountable.