Xerox Holdings Corp. (XRX) Q2 2021 Earnings Call Transcript

Xerox Holdings Corp. (NYSE: XRX) Q2 2021 earnings call dated Jul. 27, 2021

Corporate Participants:

David Beckel — Vice President and Head of Investor Relations

John Visentin — Vice Chairman and Chief Executive Officer

Xavier Heiss — Executive Vice President and Chief Financial Officer

Analysts:

Ananda Baruah — Loop Capital — Analyst

Matt Cabral — Credit Suisse — Analyst

Angela Jen — JPMorgan — Analyst

Katy Huberty — Morgan Stanley — Analyst

Shannon Cross — Cross Research — Analyst

Presentation:

David Beckel — Vice President and Head of Investor Relations

Good morning, everyone. I am David Beckel, Vice President and Head of Investor Relations at Xerox Holdings Corporation. Welcome to the Xerox Holdings Corporation Second Quarter 2021 Earnings Release Conference Call, hosted by John Visentin, Vice Chairman and Chief Executive Officer. He is joined by Xavier Heiss, Chief Financial Officer.

During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor. 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. [Operator Instructions] During this conference call, Xerox executives 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. Visentin.

John Visentin — Vice Chairman and Chief Executive Officer

Good morning, and thank you for joining our Q2 2021 earnings call. I hope everyone is safe and healthy. We saw growing demand for our products and services in the second quarter. Revenue totaled $1.79 billion, up 22.4% year-over-year or 18.1% in constant currency. Free cash flow was $198 million, up $183 million year-over-year. Adjusted earnings per share totaled $0.47, up $0.32 year-over-year. And adjusted operating margin was 7%, up 280 basis points year-over-year.

Increased equipment sales and print volumes are consistent with the continuing gradual return to the office and give us confidence to reaffirm our revenue and free cash flow guidance for the year. In the second quarter, we increased investments in our operations and targeted growth areas while generating greater free cash flow. Our reaffirmed full year cash flow guidance reflects our commitment to fund initiatives that will return Xerox to long-term growth.

Our four strategic initiatives: optimize operations, drive revenue, reenergize the innovation engine, and focus on cash flow and increasing capital returns continue to guide us and serve us as the foundation of our transformation. The operating discipline and still through Project Own It has enabled our team to navigate through an unprecedented level of uncertainty, including a pandemic and the resulting disruption of the global supply chain, while continuing to deliver value to our clients.

Increased demand in material shortages impacted the supply chain of certain products to our customers this quarter, creating a backlog of equipment, including IT products, that is nearly double that of last year’s. Despite these constraints, we delivered strong equipment sales result in the second quarter. We expected supply chain challenges to persist through at least the third quarter and possibly through the year. We are working with our global suppliers and transportation partners to mitigate the impact to both Xerox and to our clients.

The team remains committed to further optimizing operations to make it easier for customers and partners to work with Xerox while reducing costs. Project Own It is on-track to deliver $375 million of gross cost savings this year. At the same time, Project Own It has freed up cash, allowing us to reinvest in targeted growth areas and digital transformation technologies.

Robotic process automation and analytics were our initial areas of focus for digital transformation. Bots are now managing increasingly more complex transactions across the enterprise in every business and function, completing 4 million transactions per quarter, up 300% year-over-year. We have expanded our investment focus to include augmented reality and artificial intelligence. Utilizing these technologies internally will improve the service experience for customers, make us more efficient and create additional opportunities for Project Own It related savings in the future.

The gradual return of workers to the office, combined with strong demand for our products and services, positions Xerox to return to growth this year. The correlation between greater levels of in-office work and increased page volumes continued in the second quarter as page volumes increased slightly compared to the first quarter. Based on what we know today, more customers are planning to bring employees back on site beginning in the third quarter, building to a more fulsome return by the end of the year. With this, we expect page volumes and post-sale revenue to improve, driving higher margins in the second half of the year.

In preparation for bringing more employees back on site, customers are investing in more office technology. This is demonstrated by our year-over-year growth in equipment sales revenue for office-centric devices. ESR in every category grew compared to Q2 2020.

In print, taking market share as an important part of our strategy to return to growth. Enhancements to our print portfolio, coupled with investments in security, cloud and automation, are enabling us to capture share. According to the latest data available from research firm, IDC, our market share performance for the first quarter was our best in the past three years, having taken share in all product segments in the regions Xerox serves.

Managed Print Services also benefited from these investments. According to the most recent IDC MPS 2020 market share report, Xerox continues to be the global and U.S. leader and we expanded our lead in the U.S., where we grew our share to 21%. In fact, we were the only provider to grow market share in 2020. MPS remains an attractive market for Xerox. MPS spend in both the enterprise and SMB market is projected to grow over the next three years.

The SMB market continues to play a key role in our strategy to return Xerox to growth. To accelerate our expansion in this market, we acquired two document solution providers in the second quarter, one in the U.S. and one in Canada. Each acquired company is well established in a growing local market, giving us an opportunity to knock out competitors and provide MPS and adjacent offerings such as IT services.

In the second quarter, IT services sales and signed deals continue to be strong. Our managed IT services includes high-growth offerings, such as advanced security services and RPA. RPA launched in February and is already seeing early success with SMBs in various industries, including legal, health care and financial services. Earlier in the year, Xerox Financial Services expanded its leasing platform to provide customers and OEMs with a total solution for financing equipment, software, IT services and other office needs. In the quarter, we used $60 million of cash to fund originations growth. XFS grew originations compared to last year and the first quarter, up 54% year-over-year and 7% compared to last quarter. We expect XFS to carry this momentum throughout the remainder of the year.

In software, we are revolutionizing the way service technicians and customers solve technical challenges. At the same time, we are helping businesses solve three of their biggest challenges: the skills gap, talent shortages and greenhouse gas emissions. Companies are looking to technology to overcome these challenges, which is why the total addressable market for next-generation service delivery software is expected to reach $80 billion by 2027.

Our software solution makes expertise instantly accessible for customers, employees and field workers through live visual interactions, instructions and insights as part of a seamless digital workflow experience. To deliver this experience, we integrated augmented reality from CareAR, DocuShare’s content management system, personalization software from XMPie and artificial intelligence from PARC to create the industry’s first service experience management platform.

Making any user an expert capable of solving technical issues means companies can service their customers with fewer dispatches of highly experienced technicians. This is why blue-chip companies such as Verizon, are starting to use our service experience management platform.

PARC continues to execute on its commitment to monetize innovation. Part of our strategy includes working with strategic partners to accelerate the commercialization of new technologies in our focus areas: 3D printing, industrial IoT and cleantech. Collaborating with partners provides several benefits, from speeding up product development to expanding our reach.

One example of this is our partnership with VicTrack, a state-owned enterprise in Victoria, Australia. Together, we announced Eloque, a joint venture to commercialize PARC developed industrial IoT technology that will remotely monitor the structural health of critical infrastructure assets such as roads and railway bridges. This solution tackles a global secular challenge, the world’s crumbling infrastructure. In the U.S. alone, 42% of bridges are at least 50 years old and nearly 231,000 bridges are in immediate need of repair and preservation work. The recent closure of the I-40 Bridge over the Mississippi River demonstrates the fragility of the world’s aging bridges, the safety issues and the economic impact that results when they fail or need to be closed. The bridge has now been closed on an emergency basis for more than 75 days since the cracked steel beam was first discovered, and there’s no reopening date yet set.

The U.S. trucking industry loses $2 million every day the bridge is closed, and this ongoing closure further strains the country’s already fragile supply chain. Our Eloque solution uses tiny fiber optic sensors that attach to a bridge to accurately measure structural health. Advanced analytics are then used to evaluate the sensors data and deliver insights directly to the bridge owners and operators in real time, revealing if the bridge has structural problems or damage that needs repair. As a result, infrastructure operators can rely on technology and data to prioritize repairs rather than waiting until a physical inspection reveals a major problem.

The Victorian government has already committed AUD50 million to deploy Eloque’s technology on bridges across the state, including several of its high priority bridges by year-end. The team is now engaging public officials and infrastructure managers in the U.S. and other countries about deploying this new technology elsewhere.

For the quarter, free cash flow was $198 million, up $183 million year-over-year. We delivered strong improvement in free cash flow, while investing in our operations and our targeted growth areas, such as XFS, software, PARC innovation. In the quarter, we also repurchased $251 million of outstanding shares, demonstrating our continued commitment to shareholder returns. In the second half, we expect free cash flow to grow as revenue and margins improve. This gives us confidence in our ability to generate at least $500 million of free cash flow for 2021, while we continue to make investments that position the company for long-term sustainable growth.

Before turning it over to Xavier, let me recap a few key points. We expect the return to the workplace around the world and increasing demand will enable Xerox to return to growth in 2021. Along the way, there will be challenges we can predict, such as supply constraints and challenges we cannot predict, such as the impact of the Delta variant. But the Xerox team has demonstrated it can navigate through difficult periods full of unanticipated challenges. Long-term sustainable growth will be driven by taking share in print and growing our adjacent offerings as well as XFS, software and PARC innovation. We plan to provide more details on our strategy at our November Investor Day.

Now I would like to hand it over to Xavier to cover our financial results in detail.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Thank you, John, and good morning, everyone. We are pleased with our Q2 results. We experienced significant year-over-year growth in all key financial metrics on sequential improvement in revenue, free cash flow and earnings. Revenue growth reflected strong demand for both equipment and supplies. On page volume, which grew sequentially from Q1 to Q2, continued to demonstrate a high degree of correlation with a gradual reopening of workplaces.

Strong demand, along with ongoing supply chain disruption resulted in an order backlog for equipment, including IT product that is significantly higher than last quarter. Higher revenue and operating leverage drove significant growth in our profitability in Q2. Gross margin declined 219 basis points year-over-year due to higher mix of equipment sales, lower government subsidies, net of Project Own It savings, lower FUJIFILM Business Innovation royalty revenue and higher freight and delivery costs.

Adjusted operating margin of 7% increased 280 basis points year-over-year, reflecting the flow-through of higher revenue, lower bad debt expense on savings from Project Own It, which were partially offset by the impact of lower government subsidies, increased R&D investments supporting our targeted growth areas and higher compensation accruals.

SAG expense of $434 million increased $8 million year-over-year, including a $15 million negative impact from translation currency. This increase was partially offset by lower bad debt expense of around $10 million, which included a $6 million reserve reduction.

RD&E grew year-over-year, yet improved 80 basis points as a percentage of revenue. We remain committed to investing in PARC, innovation towers, PSA [Phonetic] next-generation service experience management platform, and enhanced product and solution for our print and IT services clients.

Other expenses net of $1 million was $6 million lower year-over-year, primarily driven by a reduction in non-service retirement-related costs, partially offset by higher net interest expense. Second quarter adjusted tax rate was 9.7% compared to 23.4% last year. The 13.7% year-over-year decrease primarily reflects a 16 percentage point benefit from a change in tax law, resulting in the remeasurement of deferred tax asset as well as a geographical mix of earnings.

Adjusted EPS of $0.47 in the second quarter increased $0.32 year-over-year. This increase reflects higher profit from operations, lower taxes, reduced share count on lower bad debt expense, partially offset by higher net interest expense. GAAP EPS of $0.46 was $0.35 higher year-over-year due to a decrease in adjusted items, including lower year-over-year nonservice retirement-related costs, partially offset by higher restructuring charges.

Turning to revenue. We continue to see improving trends across geographies and customer segments and solid demand drove increased sales in the quarter. Sales were particularly strong through indirect channel partners, which have begun rebuilding inventory level in anticipation of a recovery. EMEA as a larger indirect channel compared to the U.S. grew 33.2% in constant currency year-over-year compared to 12.7% in the America. Both geographies had strong growth in equipment and supply sales.

Despite growth in revenue, we, like many other businesses, have experienced supply chain challenges. As a result, our backlog for equipment, including IT products in the June quarter was almost double that of the prior year and our equipment backlog is well ahead of pre-COVID levels. We expect supply chain disruption to continue in the third quarter, but we are actively working with current and alternative suppliers to mitigate any potential disruption to our customers. Equipment sales of $429 million in Q2 increased 38.4% year-over-year or 34% in constant currency.

Similar to Q1, sales increased across entry, mid-range and high-end product in both North America and EMEA. This quarter, office-centric devices led the increase, indicating a trend to what businesses planning for return to work. Post-sales revenue of $1.4 billion increased 18.1% year-over-year or 13.8% in constant currency. Page volume modestly increased sequentially in quarter two with economies such as U.K., France and Germany, beginning to come out of partial lockdown in the quarter.

While we are seeing a correlation between return to office trend and print volume, the pace of employees returning to office has been gradual. We expect continued improvement in page volume throughout the remainder of the year, consistent with the pace of workplace on school reopenings.

Post sales also include unbundled supplies, which grew significantly, reflecting increased demand, particularly through resellers. IT services, which is included in Other sales was impacted by global supply constraints that affected hardware technology installed. Demand for our IT services offerings, including our RPA solutions for the small and medium-sized business is growing across industry verticals and signings continue to be strong. Last, our services signings grew in the quarter as did our renewal win rate. Our services pipeline is strong.

Next, turning to cash flow. We are pleased with our free cash flow result. Free cash flow grew significantly in the quarter from $15 million in the prior year to $198 million this year. Importantly, we generated the solid growth in free cash flow, while continuing to invest in our operations on targeted growth area. We generated $214 million of operating cash flow in the quarter, which was an increase of $118 million compared to prior year. Working capital was a use of cash of $35 million, but was $12 million better than prior year. This reflects year-over-year improvement in inventory and accounts payable, which was partially offset by an increased use of cash from accounts receivable, driven by revenue growth. However, DSO was significantly better than Q2’20.

Other notable cash-related items in the quarter include $100 million onetime payment from FUJIFILM Business Innovation related to the two-year expansion of a license for the continued use of our brand in Asia Pacific. This increase was partially offset by a $60 million use of cash to grow the lease portfolio of our XFS business. I will talk more about XFS shortly.

Cash from investing was a $55 million use and includes the acquisition of Digitex in Canada and the U.S. to support our SMB growth strategy. Capex was $16 million in the quarter. Capex primarily support our strategic growth program and investment in IT infrastructure. Within financing cash flow, $115 million of securitization debt was repaid. This debt amortized monthly, and we expect to issue additional securitizations in support of XFS growth in 2021.

Finally, in the quarter, we repurchased $251 million of shares and paid $54 million in dividend, resulting in a return of cash to shareholders of $305 million, well in excess of free cash flow of $198 million.

Looking at profitability, the second quarter improvement in adjusted operating margin reflects the flow-through of higher revenue, disciplined expense management and cost savings generated by Project Own It, which is on-track to deliver $375 million of gross cost savings this year. Further, we are managing supply chain disruptions impacting our business, including increased delivery on freight costs. We are confident in our ability to mitigate this impact from both price and cost perspective. We expect continuing improvement in operating margin in 2021, driven by improvement in revenue as more people return to the office, and we execute on our strategy to gain share in print and grow our XFS, IT services and software businesses.

Turning to XFS. We are progressing on our growth plan and look forward to providing more financial and operating details about this business at our Investor Day in November. XFS lease origination increased in the quarter, both sequentially and year-over-year, mainly driven by XBS. We expect the portfolio will continue to grow throughout the year, and we execute on our strategy to expand XFS presence beyond Xerox equipment and services. Cash-wise, XFS portfolio growth created a $60 million use of operating cash compared to a source of cash of $74 million in the prior year’s quarter. Continued growth of XFS portfolio is included in our cash flow guidance for 2021.

Next, looking at capital structure. We ended June with a net core cash position of $1 billion. $3 billion of the $4.2 billion of debt outstanding is allocated to and support the XFS lease portfolio. The remaining debt of around $1.2 billion is attributable to the core business. Debt primarily consists of senior unsecured bonds and asset securitization. We have a balanced bond maturity ladder with no bonds maturing in 2021 and $300 million maturing in 2022. We also had $2.2 billion of cash, cash equivalents and restricted cash at the end of the quarter. We have spent $413 million on share repurchase since the beginning of the year, which contributed to the $300 million decrease in net core cash since the end of 2020.

Finally, we will move to guidance. Growth in install activity, our backlog on print volume indicate our customers are planning for a broader return of employee to offices in the back half of the year. Accordingly, we expect to see an increasing level of in-office work more weighted to the end of Q3 and Q4 and a gradual recovery in our business. We remain focused on executing our strategy to grow revenue and cash flow. We are maintaining our full year guidance of at least $7.2 billion of revenue. And despite ongoing supply chain disruption, we remain confident in our ability to generate at least $500 million of free cash flow in 2021.

Thank you. And now back to John.

John Visentin — Vice Chairman and Chief Executive Officer

Thank you, Xavier. Now let’s open the line questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Ananda Baruah from Loop Capital. Your question, please.

Ananda Baruah — Loop Capital — Analyst

Hi. Good morning, guys. Thanks for taking the question. Just two quick ones, if I could. I guess the first is on the free cash flow. You guys are tracking, I think, $300 million year-to-date. And typically, second half of the year, particularly December quarter is stronger than the first half of the year. So is it just a healthy dose of conservatism? I know the guidance is at least $500 million. But it would seem like you guys are set up to do probably more than $600 million, unless there’s some puts and takes. And then I have a quick follow-up. Thanks.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Yes. Thanks, Ananda. So yes, so we are pleased with the results we delivered in quarter two, both from a revenue, but specifically as well from a free cash flow point of view. As you know it, we have a plan to invest in the business in our different levers here, including XFS. That’s the reason why we keep this guidance to $500 million. So it’s important for us to leverage this strategy, including the investment, not only cash, but also in a P&L that we’ll have for the rest of the year.

Ananda Baruah — Loop Capital — Analyst

Got it. And then just with regards, John, to your remarks around the business environment. Now that we’re halfway through the year, how would you characterize sort of the tracking of the business environment to what you guys are anticipating. Is it relatively in line? Or are there any meaningful differences positive or negative at this point?

John Visentin — Vice Chairman and Chief Executive Officer

Yes. Good morning, Ananda. I would say that, look, June had an uptick on — in Q2 in terms of employees going back to the office. And as we look at the rest of the year, you’re hearing a lot of CEOs saying that in the third quarter, everyone is going back to the office, the vaccination going on. And the way we see it is that — the way we’re projecting it is probably near the end of the Q3. And then we’ll start seeing more and more folks coming to the office in Q4. What gives us confidence is our ESR and our pipeline and our backlog in that area. So you can see that a lot of companies are setting up for this. In fact, that we’re gaining market share in that area gives us confidence. But yes, that’s how we see it, Ananda.

Ananda Baruah — Loop Capital — Analyst

All right. That’s helpful. I appreciate it. Thanks, guys.

John Visentin — Vice Chairman and Chief Executive Officer

Thank you.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Thanks, Ananda.

Operator

Thank you. Our next question comes from the line of Matt Cabral from Credit Suisse. Your question, please.

Matt Cabral — Credit Suisse — Analyst

Thank you. I wanted to actually follow-up on that last question. I guess, as we think about the correlation you guys called out between usage and the return to the office, just wonder if you could be a little bit more explicit on what you’re seeing in terms of usage relative to the pre-COVID baseline, both overall within the base and then within areas that have been a little bit quicker to return back to the office? And as we start thinking out longer-term, just curious for your impact on what COVID has done to the steady state for office print?

Xavier Heiss — Executive Vice President and Chief Financial Officer

Okay. Hi, Matt. So as you know, we are monitoring it. And there is — and we observe a strong correlation between vaccination, people returning back to the office and print volumes. We track it day by day, month by month, we have a data point showing how this data correlates here. So as you observe it, we don’t have yet full population being vaccinated here, but we are encouraged by the progress that we have seen. And we are seeing sequentially, progress in print volume and directly related to the presence in the office, not the only one reporting this type of indicator, but this give us confidence that for back end of quarter three, specifically September, on quarter four, we will return to a better print volumes that we have here.

Regarding your second point on trend on how people are working, what we observe today is that there is a mix of different approach company by company around bringing employees back to the office, a certain number of days. But what we see is that when employees are back to the office, they print on some of the volumes that they bring up, some of the volumes they either do not print at home or volumes that could be printed on, I would say, lower type or lower different type of decentralized solution, I won’t call it the hybrid work, but what we see currently is that overall, the print volume on the presence to office remains correlated.

Matt Cabral — Credit Suisse — Analyst

Got it. That’s helpful. And then shifting over to gross margins. Just wondering if you could dig a little bit more into some of the pressure points that you’re seeing. And I know you guys called out supply chain issues as one of the factors. I’m wondering if you could quantify that impact? And I guess similar to my last question is as we look out longer term, historically, this business had been one that supported gross margins kind of around that 40% range prior to COVID. I guess I’m curious, do you think that’s still an achievable level going forward? Or has something structurally changed as we think about emerging on the other side of COVID from a profitability standpoint?

Xavier Heiss — Executive Vice President and Chief Financial Officer

Yes. So I will start with your first question, which is around what has driven the gross margin difference in this quarter here. So as you have seen it, the product mix, which is more equipment sales revenue. By the way, with very strong news on equipment sales here. John mentioned it, but we gained market share on both what we call the base business, the ESR type of business, but also on NPS So we are a leader in our segment in our territory. And this is quite important because it clearly shows the correction between employers wanting to have employees being back, investing in their infrastructure, so they can operate when they are back in the office.

Regarding the specific element or specific impacts that we have on gross margin. So product mix is the number-one. The second one is we have faced, as a lot of industry, some increased freight on delivery costs, specifically related to certain tension in containers on the cost of shipment here. As you know it as well, third element is FUJIFILM. We have a lower royalty from FUJIFILM, even if we have had some good news from a cash point of view in our free cash flow on Fuji. But from a profit point of view, we had lower royalty. On last item, and it’s more year-over-year compare. Government subsidies were at the highest point in quarter two last year, at the peak of the pandemic, they have been lowered, as I mentioned it in my initial comment here.

So now back to the gross margin, your gross margin question, what is a normalized view. Clearly, there is a straight correlation between revenue, our ability to drive the revenue growth on the gross margin and specifically on post revenue. So is it possible to go back to the gross margin with all the activity — gross margin we had before with all the activities that we are driving both from a point of view and also supporting post sales activity? Yes, the trend is going and will be favorable for the second half of the year.

Operator

Thank you. Our next question comes from the line of Samik Chatterjee from JPMorgan. Your question, please.

Angela Jen — JPMorgan — Analyst

Hi. Good morning. This is Angela Jen [Phonetic] for Samik Chatterjee. You reiterated that your full year guidance is $7.2 billion in revenue. Thank you for that guidance. So what do you see our risk to the upside and downside of that target?

Xavier Heiss — Executive Vice President and Chief Financial Officer

So we are quite confident in this — confidence, Angela, in this guidance here. So obviously, there are things that we can control and there are things that are more difficult to control. So the things we can control is the way we will execute the presence to the office is something that we feel, I would say, quite strong. However, it is dependent on, I would call that one element, which is the pandemic is still present and the Delta variant could have an impact. But so far, what we have seen is that the impact on our existing impact on the geography we are managing is quite manageable.

The second element will be supply/demand. So far, we have a clear line of sight on how we can manage it here. But if the supply demand on some of the tension on certain components on raw material will stay specifically in the fourth quarter, then we will consider the action. But so far, we are managing. Even in Q2, I mentioned it, we have had a little bit of supply chain tension here. We manage it. We find alternative ways and supplier to overcome the challenge and we feel confident that we can deliver the $7.2 billion.

Angela Jen — JPMorgan — Analyst

All right. Great. Thank you. And just a quick follow-up question. So what is your view on print market consolidation broadly speaking?

Xavier Heiss — Executive Vice President and Chief Financial Officer

Okay. So this is a trend that we have seen. This is like a historical. I always use this expression by saying in order to dance, you have — you need to have two parties. You know that we have been active on this one. And we are clearly open to, I call that, dance here on finding the right parties. But industry consolidation is a long items in this print industry, and this is something that will happen over time.

Angela Jen — JPMorgan — Analyst

Great. Thank you so much.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Katy Huberty from Morgan Stanley. Your question, please.

Katy Huberty — Morgan Stanley — Analyst

Yes. Thank you. Good morning. With the return to the office in the fourth quarter of this year and the behavior of print in the office that you mentioned earlier, should we assume that post sales revenue in 4Q ’21 can look more similar to 4Q ’19 pre-COVID levels, obviously, assuming the Delta variant doesn’t impact current return to office plans? I just want to understand how you’re thinking about that.

John Visentin — Vice Chairman and Chief Executive Officer

Yes, Katy, in our model for our guidance, we’re not assuming 2019 and to go back to 2019 numbers and 4Q. We’re assuming a more modest return and then off to 2022.

Katy Huberty — Morgan Stanley — Analyst

Okay. And then in a normal environment, EPS is typically about flat in 3Q relative to 2Q? How should we think about the EPS trajectory in the September quarter this year?

Xavier Heiss — Executive Vice President and Chief Financial Officer

So normal environment, usually, first, EPS is mainly driven by revenue. So when revenue is coming, EPS is expanding. So — and then we manage via Project Own It, all the cost element of the company. Usually, quarter three is a softer quarter, usually prior to pandemic, a softer quarter than quarter two, the two highest quarter being quarter four and then quarter two.

So this year is a little bit special, because we see this gradual recovery. As an example, schools and certain firms have not been open for quite a long time, open to present and the office or present in schools. And it will be one of the trends that we will monitor the quarter. So if I look at how we look at the quarter, we said gradual recovery. And specifically by gradual, we expect September to show clearly a pickup versus last year, and then quarter four to follow this trend here.

Katy Huberty — Morgan Stanley — Analyst

And just quickly, the tax rate was much lower in 2Q. Can that sustain into 3Q? Or should we assume that the tax rate comes up, and that’s going to be a headwind to the sequential EPS?

Xavier Heiss — Executive Vice President and Chief Financial Officer

Yes. So you know, Katy, is that we manage our tax rate on a global basis. We are present in a lot of different countries here. Here, we have an international, I will call that the exceptional items, which is related to a low change in one of our European countries. That give us the opportunity to get a one-off credit of a deferred tax asset. After this depending on how this low change are applied country by country, we will obviously follow the tax guidance here on the adjusted tax rate. But I do not expect quarter three to be as positively impacted as what we have in quarter two.

Katy Huberty — Morgan Stanley — Analyst

Thank you very much.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Thank you, Katy.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Shannon Cross from Cross Research. Your question, please.

Shannon Cross — Cross Research — Analyst

Thank you very much. I wanted to see what’s going on with regard to channel inventory. Xavier, I think you said something about some of the sales in the reseller channel was — were those companies looking to replenish probably in anticipation of demand, I would assume. But I’m just curious where you see inventory at right now. Thank you.

Xavier Heiss — Executive Vice President and Chief Financial Officer

Yes. So what we have seen on — this is mainly compared versus last year. If you remember, in quarter two last year, channel depleted their inventory mainly to protect their cash position. So we have seen it all across the industry. And step-by-step, this inventory has been rebuilt. What we are pleased with is that in quarter two, this inventory rebuild a little bit stronger than what we saw in former quarter. However, this is not like, I call that a very high number. I mean, our — we track what we call a week of inventory. On the week of inventory are still at this stage lower than some of the highest points we could have had pre-COVID. So channel are coming back, but step-by-step, gradual as well.

As I mentioned it and you saw that, on SMB, on mid entry, which is mainly office type of activity, we gained share, and channel part of this share gain being able to drive our revenue up quarter-over-quarter.

Shannon Cross — Cross Research — Analyst

Okay. Thanks. And then both of you, I think, during your script mentioned investments in growth areas, as use of cash and some impact on margin. Can you be a bit more specific on exactly where you’re putting your investment dollars and how we should think about ways to track return on investment? Or how quickly you expect to see benefit from that? Thank you.

Xavier Heiss — Executive Vice President and Chief Financial Officer

So as you know, we invest in three, I would say, areas of business. And by the way, this is the area of business that we informed you in the past, I think we will expand these businesses. This is XFS software on innovation. And I’m pleased to report that in each of these areas of business, we achieved milestone and we continue, despite the environment, we continue to invest in the business.

I will give you two examples here. On the XFS, I believe we mentioned that in our presentation, in XFS, we grew originations and the portfolio is growing. When you do that, it means that you use free cash flow. And we have used this quarter, $60 million of free cash flow in order to support this activity. What does that mean? It means that we are building for the future of the portfolio because all this origination will drive future revenue and profit growth for XFS.

In innovation, we carry on our investment. And I’m sure you remember that we announced in quarter Q2, Eloque. Eloque is this joint venture that we have with the Australian Victoria government here. And this joint venture is now running, has been enabled, and we have a commitment from the government to invest AUD50 million in the infrastructure and to set up more of this bridge sensor that we are developing here.

So it’s just example, sharing that in RD&E, some of our costs despite the current environment on free cash flow, we carry on investing in order to develop the future revenue growth of the company. And yes, in November, as you know Shannon, we announced that in November, we’ll have an Analyst Day, and we will provide you more detail on each of these towers.

Shannon Cross — Cross Research — Analyst

Okay. Thank you.

Operator

Thank you. This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to John Visentin for any further remarks.

John Visentin — Vice Chairman and Chief Executive Officer

Okay. Thank you all for your questions. Look, the events of the past 18 months have tested the Xerox team in ways we never imagined possible. But these unexpected challenges make the team stronger. So the resiliency of this team, paired with our sound strategy, gives me confidence that Xerox’s future continues to be bright. Be safe and be well.

Operator

[Operator Closing Remarks]