Xerox Holdings Corporation

Good morning, and welcome to the Xerox Holdings Corporation's second quarter 2020 earnings release conference call, hosted by John Vincentine, Vice Chairman and Chief Executive Officer. He is joined by Bill Osborne, Chief Financial Officer. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com forward slash 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. After the presentation, there will be a question and answer session. To ask your questions at that time, please press star one at any time during this call. You can withdraw your question by pressing the pound key. 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. Byzantine. Mr. Byzantine, you may begin.

Good morning, and thank you for joining Xerox's Q2 2020 earnings call. I hope everyone is safe and healthy. For the second quarter, revenue totaled $1.47 billion, down 34.6% in constant currency year over year. Company-wide cash preservation efforts allowed us to deliver positive cash flow, earnings per share, and operating margin. Free cash flow for the quarter totaled $15 million, down $245 million year over year. Adjusted earnings per share totaled 15 cents, down 64 cents year-over-year. And adjusted operating margin was 4.2%, down 820 basis points year-over-year. I'm proud of our team. It was not easy to deliver profitable results and continue investing in key areas of growth while the bulk of our markets were fully or partially shut down during the quarter. The fact that we did speaks volumes about the progress we have made in transforming this company and culture into one of continuous improvement. This is an extraordinary time in our lives, one that has challenged each of us to be better, do more, and demonstrate that the situations we face only improve when all of us are working together. That's true for the pandemic. and for the continuing battle against racial inequality. Xerox has approximately 26,000 employees located in more than 40 countries working at approximately 250 of our own facilities and onsite at thousands of customer locations, many of whom deliver essential services. After we initially closed our offices in March to all but essential workers, we stood up a dedicated team that quickly developed comprehensive safety protocols to keep employees and clients safe. While taking a cautious, methodical, and phased approach, we have now reopened roughly half of our own facilities, and more than 50% of our active employees have resumed working on-site in some capacity. We continue to monitor COVID-19 transmission trends to ensure employees engaged in onsite work remain safe. A new solution we developed, Xerox Teams Availability App, provides a real-time view of each employee's work location, availability, and compliance with the company's health and safety protocols. Our Pass Forward plan has been a tremendous undertaking, but it's one that is necessary to ensure we can continue to safely conduct our business support our partners, and service our clients. No one can control or accurately predict what will happen next in the pandemic. There is ongoing uncertainty about the spread of the virus globally. Some places around the world that have previously not experienced outbreaks or had improved dramatically are now seeing a rise in cases. We have modeled numerous scenarios to ensure that we have flexibility no matter how the pandemic continues to impact global business. Given the uncertainty, it is difficult to predict the timing and pace of the recovery and the full impact on our financial results this year. We are not providing financial guidance for 2020 at this time. However, we expect we will continue to deliver positive free cash flow during the second half of 2020. We remain 100% committed to driving system-wide efficiencies throughout the company and investing in new capabilities that allow us to capitalize on growing demands and technology, many hastened by the sudden shift to remote work. This includes security, remote IT support, collaboration tools, and other tools that ensure employees are productive and can work securely no matter where they are. Despite the overnight impact the pandemic had on most industries, our Q2 results demonstrate the discipline we've instilled in the business over the last two years. Our four strategic initiatives remain at the core of our approach. Optimizing operations, drive revenue, re-energize the innovation engine, focus on cash flow, and increasing capital returns. Project Own It has imparted a strong sense of ownership across the company as we streamline and optimize the business. As a result, the company entered into this pandemic in a position of strength and was able to nimbly balance cash expenditures with investments needed to position Xerox for future growth. We remain on track to deliver at least another $450 million in gross savings this year, which will bring the total of three years to at least $1.4 billion. A key part of optimizing our business is investing in technologies that increase efficiency and responsiveness to customers. One area where investments are accelerating is automation. Today, bots are now performing more than 1.2 million transactions a quarter at Xerox. automating processes within parts of the supply chain, remote solve, technical service, and more. We are expanding adoption of this technology throughout the company and beginning to provide similar support to clients. Today, Xerox has flexibility at its core, allowing us to scale up and down depending on market realities. It is the reason the business could quickly respond to the pandemic, immediately instituting a cash preservation plan in March, and it's the reason we are confident we can manage this business successfully throughout any scenario presented. We remain intensely focused on positioning the business for continued success in printing and future success in related and entirely new areas. Today, there is a major debate happening around the role of the office in the future. Will we all work remotely going forward? Will companies give up their offices for good? We don't see that happening. Many surveys, including a Xerox Future of Work survey conducted in May, suggest most employees will eventually return to the workplaces once it's safe. It also found companies have gotten more comfortable with remote working than they were in the past, so we are likely to see more flexibility to work from home. Increasingly, companies are articulating the drawbacks of working from home as long-term solutions. While some are keeping people home in the short term for safety reasons, we believe the office will continue to play a vital role for the years to come. It is the reason companies bring people together on a regular basis to build culture and community, develop talent, drive faster decision-making, and deliver strong results. That said, ensuring security and enabling productivity will be key in a hybrid work environment. IT decision makers included in our survey also said they are accelerating their digital transformations and prioritizing investments in cloud-based software, remote IT support, and workflow automation. This is where the industry has been headed and where our focus has been in recent years. At the heart of the Xerox ecosystem is the hardware, software, and services that will help companies transition from largely paper-based processes to digital ones that turn information into knowledge. We have seen some healthcare clients, particularly hospitals, accelerate digitization projects to turn paper-based information into a digital format that's easier for secure processing and follow through. One large hospital system in the U.K., needed to expedite implementing a solution that would provide seamless delivery of critical patient communications while support staff worked remotely. A solution like this integrates into our larger digital patient offering, allowing us to expand the work we do with healthcare providers to address their immediate and future needs. Other digital offerings, such as XMPIE and DocuShare, are seeing stronger pickup as companies seek to collaborate, digitize paper-based processes, and rapidly share information with a dispersed workforce. Revenue in these areas increased year over year, and they have expanding pipelines. We have a growing pipeline for our virtual print management services, launched earlier this year. By allowing companies to rapidly replace expensive legacy on-premises print servers with Xerox's secure cloud infrastructure, IT organizations can save up to a third of their typical print server cost. IT services are now offered in the US, Canada, and the UK, and we are seeing that business grow. Outside technical expertise is especially important to the SMB community, as they seek to support remote workforces face growing security concerns, and automate manual workflows to reduce costs. Revenue and IT services has expanded this year, and we've built a strong backlog for the second half. While the core printer business will continue to face pressure, the company's strong, diverse portfolio continues to beat competitors in winning business by offering differentiated capabilities at all levels. In Q2, we saw renewals improve from prior year, and equipment backlog increased from last quarter. Demand in federal and health care remained strong, with enterprise ESR growing in both. Strong interest in the embellishment market, where Xerox is a leader in helping clients produce higher-value pieces at an affordable price, remained. The recent introduction of the Adapted CMYK Kit for diverse sound puts these capabilities within clients' reach for a reasonable price. Eleven toners with one million possibilities provides enormous differentiation potential for Xerox customers. This enhancement is now available on three entry production devices. In the workplace, we will continue to differentiate our multifunction printers with apps and solutions that speed digital transformation and support workers in and out of the office. This quarter's launch of the next generation AltaLink is one example. Combined with ConnectKey apps, including connections to the most popular cloud solutions, the AltaLink can help the businesses as they shift from physical to digital enterprises. The world of A4s is shifting, too, from a home printer product to a work-from-home printer that provides increased capability, security, and ability to connect seamlessly to the office network. Longer-term innovations remain focused on addressing some of business and society's biggest needs. In the second quarter, our teams made progress across the innovation pillars with IoT predictive analytics, AI-infused platform, cleantech, and 3D printing, among other things. The impact of COVID-19 has accelerated needs in many of these areas. For example, COVID-19 has highlighted the risk of globally dispersed supply chains for many businesses, with many experiencing delays in getting parts and products during the crisis. Integrating a localized 3D printing solution can improve supply chain resiliency, flexibility, and responsiveness, and can minimize the risk of disruption. Xerox's liquid metal 3D printing solution will allow manufacturers to make production-grade parts using off-the-shelf alloys without sacrificing quality, strength, or safety standards. The team remains on track to deliver its first product by year-end. In IoT, we are engaging customers that are interested in our industrial asset health monitoring and predictive maintenance solutions in continuous manufacturing and the critical infrastructure markets. Our solutions allow companies to monitor their assets, plan their maintenance operations to reduce planned and unplanned downtime, and increase operational safety and efficiency. We are testing solutions internally now and expect to start external pilots with select customers by year end. In Cleantech, the team working on our early stage technology to improve the energy efficiency of air conditioners is on track to complete the prototype by the end of the year. Air conditioning is one of the single biggest causes of greenhouse gases, and advancing a potential solution is an example of how we are re-energizing our innovation routes to create benefits for businesses and society. The healthcare initiative stood up during the quarter. Specifically, hand sanitizers and disposable ventilators are gaining traction. We planted double production capacity for hand sanitizers in September from our capacity today. While taking longer to obtain regulatory approval to sell global markets, there is a growing interest in disposable ventilators we are manufacturing, and external distributors have signed up to sell these products globally. The team has consistently demonstrated its ability to manage cash well. It is an area of strength, and it will remain so as we maintain a strong balance sheet and liquidity throughout the crisis. The cash preservation plan put into effect in March allowed us to close the quarter with approximately $2.3 billion of cash and cash equivalents and a $1.8 billion undrawn revolver. This month, we financed $340 million of debt and approximately $740 million of debt maturing in the balance of 2020 that we also expect to refinance. Core debt levels remain within an investment-grade credit metric range. We remain committed to our shareholders return policy, including the current dividend rate, and plan to return at least 50% of annual free cash flow. There is 700 million of share repurchase authority outstanding, and we currently plan to complete at least 300 million of share repurchases in the second half. I covered many of these frequently asked questions in my earlier comments, so I will quickly recap a few key points. The company's strategic initiatives have prepared us as best as possible for this unprecedented situation. No one had a pandemic baked into their outlook this year or any year. That said, the hard work this team has done in recent years to transform Xerox proved instrumental in moving quickly to respond. We have evaluated numerous recovery scenarios to ensure we are prepared for whatever happens next. Today, Xerox is nimbler and more efficient. The sudden move to remote work revealed technology gaps in many industries Xerox is well-positioned to help address. We have the technology, the long-term relationship, and the trust to help clients speed their digital transformation from paper to digital while also powering up a flexible workforce. We remain focused on growing the business through a mix of organic and inorganic investments using the same disciplined approach we have in the past. Now I'd like to hand it over to Bill to cover our financial results in detail.

Thank you, John. As we stated during our Q1 earnings call, we assessed the impacts on our business under numerous recovery scenarios, and we expected COVID-19 to have a significant impact on our business in Q2 based upon the impact that we experienced from the one month of business closures in the first quarter and the expectation that closures would continue through most of Q2. We saw signs of recovery later in the quarter as parts of the U.S. and some countries in Europe began to lift lockdowns, thereby allowing businesses to reopen offices. And our current base case scenario reflects a slow, gradual recovery in the second half of the year. Our focus on cash and expense management has only intensified as we managed through the crisis. In order to mitigate the impact on our revenue from the crisis, we implemented cost reduction actions beginning in mid-March. Through Project Own It, we have developed not only a strong cost discipline, but also a more flexible cost structure that allows us to scale up or down quickly to ensure the strength of our business, which enabled us to deliver positive earnings and free cash flow in the second quarter. The cash preservation actions in response to COVID-19 are aimed at discretionary items and and are incremental to the initiatives under our Project Own It program, and both programs are continuing. The speed with which we are able to identify discretionary areas of cost that could be cut without impacting our future, develop actions, and execute on those actions is a testament to our team and the discipline developed through Project Own It. Under our cash preservation program, we also identified opportunities to use certain temporary government assistance programs to provide cost relief while enabling us to thus far minimize financial impact on our employees. Although our revenue declined approximately $800 million in the quarter compared to the same quarter in 2019, we were able to generate $15 million of free cash flow in the quarter and $165 million of free cash flow in the first half of this unprecedented year. Importantly, our balance sheet remains strong and we have sufficient liquidity including an undrawn $1.8 billion revolving credit facility that matures in August of 2022 and approximately $2.3 billion of cash, cash equivalents, and restricted cash at the end of the quarter. Now looking at our financial results. Total revenue in the quarter declined 34.6% at constant currency. The decline reflects sustained business closures during the quarter that delayed purchasing decisions and installations of orders in hand, as well as the impact of lower print volumes as people were not in the office printing. Turning to profitability, all the ratios and measures presented here were significantly impacted by the decline in revenue resulting from the pandemic. Let me start with adjusted operating margin, which was 4.2% in Q points lower year over year. The impact of lower revenue was partially offset by cost reductions from our project owner program and from the actions implemented to mitigate the impact of COVID-19, including cost relief from temporary government assistance programs. Gross margin of 38.5% decreased 60 basis points, which is primarily from lower revenue, in particular from lower post-sale revenue, which carries higher margins. as well as headwinds from price reductions that are in line with prior quarters, transaction currency, and tariffs. Benefits from project-owned inactions and other incremental actions taken to mitigate the impact of COVID-19 partially offset the impact from the decrease in revenue and other headwinds. SAG, as a percentage of revenue, increased 630 basis points year-over-year, reflecting lower revenue, which was partially offset we put in place. Also, it is important to note that in the first quarter, we increased our bad debt provision by $61 million to cover the potential impact to our customers from the pandemic. During the second quarter, we reviewed our bad debt reserve and determined it to be sufficient and consistent with future expectations regarding the impacts from the COVID-19 crisis. Therefore, no incremental reserves were required and bad debt expense for the second quarter of 2020 of $13 million was effectively flat as compared to the second quarter of 2019. We will continue to monitor developments regarding this crisis in future periods to ensure appropriate reserve levels. Last, RD&E as a percent of revenue increased 130 basis points, reflecting the lower base of revenue. RD&E expense declined $12 million year-over-year, partially due to cost reductions on older generation products, consolidation of core R&D activities in the prior year, and the timing of investments. And as John mentioned, we continue to make progress in our five innovation areas. Below operating profit, other expenses net of $7 million was $31 million better than the prior year, due to lower non-service retirement-related costs of $18 million and lower non-financing interest expense of $8 million. The lower non-service retirement-related costs were driven by lower losses from pension settlements in the U.S. and lower non-financing interest expense as a result of lower average debt balance. Our second quarter adjusted tax rate at 23.4% compared to 26.6% in the prior year. The lower tax rate year-over-year is primarily due to the geographic mix of profits, as well as the impact of discrete items on lower pre-tax income. Adjusted EPS of 15 cents was down 64 cents compared to the same quarter last year, driven by the impact of COVID-19 on our operations, which more than offset the benefit from cost reductions, lower interest expense, lower tax rate, and lower shares. Gap EPS of 11 cents per share was $0.49 lower year-over-year, including the aforementioned $0.64 decline in adjusted EPS, partially offset by a net benefit in non-GAAP-adjusted items, primarily from lower restructuring and related costs, lower non-service-related pension expense, and lower tax on these adjustments. Non-GAAP adjustments to EPS include restructuring related costs, the amortization of intangible assets, non-service retirement-related costs, and transaction and related costs net, as well as the income tax on those adjustments. In Q2, we recorded $3 million of restructuring and related costs, which includes a $9 million reversal from prior period estimates. Moving to slide seven, I'll discuss cash flow. In Q2, we generated $34 million of operating cash flow from continuing operations, which was $242 million lower than prior year due to lower net income and a use from cash from working capital that was partially offset by lower finance assets and lower cash taxes. Working capital cash was $68 million worse than prior year due to increased use of cash from inventory and accounts payable, which was partially offset by an increase in cash from accounts receivable. Inventory reflects lower sales volumes and reduced purchases by indirect channel partners who are managing their inventory levels to protect liquidity during the crisis. And accounts payable reflects decreased spending and the timing of payments to vendors, while accounts receivable is primarily due to lower revenue. Restructuring payments of $17 million were in line with prior year. CapEx was $19 million in the quarter, and free cash flow was $15 million. We expect CapEx will be in line with our prior year guidance for full year 2020, supporting the programs to drive our strategic growth plan, including continued investment in our IT infrastructure. There were no acquisitions in the quarter. However, we continue to assess our pipeline of tuck-in acquisitions and strategic M&A. We spent $193 million in Q1 to expand our SMB strategy internationally, and we expect full year spend for tuck-in M&A will be in line with prior guidance. Within financing cash flows, we repaid a $313 million senior unsecured bond with cash in the quarter and effectively refinanced this bond in July through a finance receivable securitization. We returned $57 million in dividends to shareholders, and we did not repurchase shares in the quarter. We managed capital conservatively this quarter, given the uncertainty of the pandemic and the expected impact it would have on our business. We executed on our cost management initiatives and preserved our cash, ending the quarter with $2.3 billion of cash, cash equivalents, and restricted cash. Let's turn to slide eight for more detail on our revenue. Second quarter revenue declined 34.6% at constant currency and reflects the impact of widespread business closures that extended through the quarter and caused delayed customer purchasing decisions and lower print volumes. Geographically, we saw larger revenue declines in Europe, where more of our sales are through indirect channel partners who are protecting their liquidity and managing their inventories in response to lower demand. In North America, we have more sales through direct channels, and there is a higher percentage of large enterprise customers, including government and healthcare customers, that continue to operate through the crisis. Equipment sales revenue was down 38% in constant currency. While we saw improvement in North America and Europe in June as countries and certain offices began to reopen, we are cautious in projecting a trend based upon June, given the recent outbreaks of the virus in certain parts of the U.S. and developing markets, although we do expect performance to improve gradually in the second half. In the U.S., our large enterprise business continued to see growth in sales to federal government and healthcare customers who have been operational through this crisis. Also, as we mentioned last quarter, we were unable to install approximately $100 million of purchased orders as a result of business closures in March. Approximately 40% of those orders were installed in the second quarter, and we expect to install another 45% in the second half of this year, with the remainder either canceled or delayed beyond 2020. Looking at product categories, mid-range was most impacted by office closures. as this category of products is mostly used in offices and shared workplaces. Mid-range sales decreased in indirect channels, which, as I mentioned, impacts Europe more than North America. However, the U.S. was also down significantly, reflecting delays in purchasing decisions. In the high end, we had good activity in black and white production, supporting transactional printing applications. But production color sales were down, reflecting primarily lower sales of our Brassante entry production color system and Iridesse production press due to the impact of the crisis on our distribution channels and lower demand caused by the pandemic. Next, revenue from entry products, both black and white and color, was down, reflecting the impact on our indirect channel partners and continued lockdowns in Latin America. The decline was partially offset by higher sales in the low end of the portfolio, which supports work-from-home offerings. Post-sale revenue declined 33.6% in constant currency. Our post-sale revenue is largely contractual and our contracts generally include a fixed minimum charge as well as a variable component for services and supplies that is based upon print volume. Historically, on average, the variable component is approximately 50% of our contractual revenue stream. The widespread business closures due to the pandemic had a significant impact on page volumes. which is evident in the decline in our post-sale revenue this quarter. We saw the greatest impact in April and May in moderation in the rate of decline of pages from contractual agreements in June. Unbundled supplies, paper, and other sales, which are largely sold through our indirect channels, also decreased approximately 50% in the quarter, reflecting lower demand caused by the crisis, which is driving channel partners to reduce their inventory and purchases also in order to protect cash. Xerox services revenue declined approximately 28% year-over-year in constant currency, with new business signings down due to delays in customer purchasing decisions. We had growth in services renewals in the quarter, which is the second consecutive quarter of higher renewals, although the rate of increase was lower in the second quarter as we experienced existing contracts citing the uncertainty of the environment. We have a building pipeline which gives us confidence that our business will continue to improve as the economy rebounds. Last, our investments in IT services, software, and digital services are gaining traction. The expansion of IT services with an XBS channel in the U.S. and through recent acquisitions in Canada and the U.K. contributed to increased sales in the second quarter compared to the first quarter. even with restrictions to enter some of our customers' locations. These offerings, which also support a flexible work environment, are resonating with customers, and our IT services pipeline is growing. Next, turn to slide nine and our profit and earnings. Adjusted operating margin was 4.2% in the quarter, which was 50 basis points lower than the first quarter. We expected the pandemic to have a sizable impact on our business in Q2, and in March, we quickly began to implement actions to manage costs and preserve cash, focusing on discretionary spend. As I mentioned, these actions are incremental to the planned actions under our Project Own It transformation program and, among other areas, targeted marketing expense and reducing the use of contract employees across the organization. In addition, We use certain temporary government programs in the U.S., Canada, and Europe to provide cost relief without further use of cash while minimizing the impact on our employees. We are continuing actions to reduce costs and preserve cash through the second half. We were able to act quickly in response to the pandemic as a result of the progress on our Project Own It transformation program. Through this program, we have developed a disciplined approach to cost management and a more flexible cost structure. Project-owned initiatives are continuing, and the program is on track to deliver at least $450 million in gross cost savings this year. Adjusted EPS at 15 cents declined 64 cents year-over-year, and as discussed earlier, reflects the impact of COVID-19 on our operations, which offset the benefits of cost reductions, lower interest expense, lower tax, and lower shares. Moving on to slide 10 and a review of our capital structure. We ended the quarter with $4 billion of debt, of which $3 billion supports customer financing activities. And therefore, we break down our debt between financing debt and core debt. Financing debt is allocated by applying a 7 to 1 leverage to our finance receivables and equipment under operating lease. which together comprised our total finance assets. Core debt was approximately $1 billion, and we ended the quarter with approximately $2.3 billion of cash, cash equivalents, and restricted cash, which puts us in a net cash position of approximately $1.3 billion when netting cash against core debt. In May, we repaid a $313 million senior unsecured bond with cash, which is why our debt is approximately $300 million lower than year-end. However, in July, we effectively refinanced the May bond with a $340 million finance receivable securitization. This was an attractive transaction that provides match funding for a portfolio of U.S. finance receivables. For the balance of 2020, we have approximately $740 million of bonds maturing, which we plan to refinance. Our liquidity position remains strong with approximately $2.3 billion of cash, cash equivalents, and restricted cash, and a $1.8 billion bank revolver, which is fully available to us. Our pension-funded status is updated annually, and as of December 31, 2018, our net unfunded pension liability was $1.2 billion, which included approximately $815 million of unfunded pension liabilities for plans that by design are not funded. In 2019, we contributed $141 million to worldwide pension plans and expect 2020 contributions will be in line with prior guidance. Last, turn to slide 11 for some thoughts on the balance of 2020. For the second half, under our current base case scenario, we are expecting a slow, gradual recovery. Our outlook considers the continuing impact from the virus, particularly in certain areas of the U.S. and in developing markets, and the current pace of business reopenings and capacity limitations within offices and other shared workplaces. Accordingly, we do not anticipate a recovery in our revenues to pre-COVID-19 levels this year. Although, it is expected we will continue to deliver positive free cash flow in the second half of 2020. While we are planning for our gradual recovery in the second half, we have evaluated our business under numerous scenarios to be ready to manage through a more elongated recovery, if required. As we demonstrated in the second quarter, we are resilient and we are prepared to execute on additional levers to manage through longer recovery scenarios. Given what we know today, it is difficult to predict the timing of recovery and the full impact on our financial results this year. Therefore, as John advised, we are not providing financial guidance for 2020 at this time. On capital allocation, we remain committed to our dividend and our policy of returning at least 50% of free cash flow to shareholders. and we plan to repurchase at least $300 million of our shares during the second half of this year. We have a strong balance sheet and liquidity which supports our dividend policy and the resumption of our share repurchases in the second half. I will now turn it back to John before going to Q&A. Thank you, Bill.