Good morning and welcome to the Xerox Corporation second quarter 2016 earnings release conference call hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Leslie Varon, Vice President and Interim 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 Corporation, today's conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the expressed permission of Xerox. After the presentation, there will be a question-and-answer session. [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 Ms. Burns. Ms. Burns, you may begin.

Good morning. Welcome to Xerox's second quarter 2016 earnings conference call. On our first quarter earnings call, I made our three priorities for the year; achieving our 2016 financial plans, implementing our strategic transformation and executing the separation of the company. I also committed to you that we were pulling all the available levers and taking decisive action to achieve these objectives. Today, I am pleased to report strong second quarter results and significant progress on all of our priorities. We delivered substantial EPS growth, adjusted EPS above our guidance and margin expansion in both our business segments, putting us on track to achieve our full-year guidance. We also reached major milestones in our separation process, and for our strategic transformation program and remain on track to meet our targets for both initiatives. I am more confident than ever in our ability to create two companies better positioned to compete in their respective markets and capture opportunities to enhance shareholder value. Today, I will begin the call with an update on our separation and strategic transformation before moving to the quarter's financial and operating performance. As you know, in January, we outlined a two-part plan to create shareholder value and best position our businesses for the future, which we call our new path forward. The plan includes separating into two Fortune 500 scale, independent publicly traded companies by year-end and implementing a three-year strategic transformation program to deliver $2.4 billion in total cost savings from ongoing and incremental productivity and cost reduction initiatives across our businesses. During the second quarter, we took important steps toward both the separation and our strategic transformation program targets. As a recap, I’m starting with the separation. We named the two companies that will be created through the separation. The Business Process Outsourcing Company will…

Thanks, Ursula, and good morning, everyone. I'll start with the earnings slide and cover the rest of the financials as well as our guidance before handing it back to Ursula to wrap up. Overall, quarter two was strong. Operating profit and earnings both grew with EPS above our guidance range. DocTech trends improved and we're building momentum in our cost initiatives. We have more work to do to capture greater productivity and turn around the revenue trajectory as we prepare to separate our two businesses. But quarter two was a very positive proof point and keeps us on track for the year. Total revenue of $4.4 billion was down 4% at both actual and constant currency, benefiting from a market improvement in Document Technology revenue, which was down 6% in constant currency, while Services revenue declined 1%. I'll speak more about both segments in a moment. Adjusted gross margin of 31.4% was up 20 basis points year-over-year, driven by improvements in both segments, partially offset by a greater mix of services, which structurally has a lower gross margin. Adjusted RD&E was lower by $19 million year-over-year and adjusted SAG was down $53 million or 6%. These expense reductions, combined with the gross margin improvement, resulted in operating margin of 9.3%, up 80 basis points year-over-year and a 5% operating profit growth. Adjusted other net expense was better by $15 million year-over-year, driven by lower interest expense, while equity income of $22 million in the quarter was down $7 million year-over-year. Our second quarter adjusted tax rate of 17.8% was below our guidance range of 26% to 28%, benefiting our earnings by $0.025 due to higher foreign tax credits and the successful resolution of several audits. Bottom line, adjusted earnings of $0.30 was well above our guidance range of $0.24 to…

Thank you, Leslie. In summary, we're very pleased with our second quarter performance, which demonstrates our focus on execution and provides good momentum as we enter the second half. We exceeded our adjusted EPS guidance, made progress on margins and reaffirmed our full-year targets, all while executing at our separation and strategic transformation which will together, strengthen Xerox and the post-separation companies. Moving to the second half of the year, our priorities remain unchanged. We will deliver our 2016 guidance, successfully complete our separation by year-end and meet our cost savings target for 2016 for our strategic transformation program. You will be hearing more from us over the balance of the year as we continue to hit critical milestones. We will now open up the line for questions. Jennifer?

Thanks, Ursula. Joining Ursula and Leslie today, is Jeff Jacobson, Head of our Document Technology business and Bob Zapfel, President, Xerox Business services. Before we get to your questions, let me point out that we have several supplemental slides at the end of our deck, which provide more financial detail to support today's presentation and complement our prepared remarks. For the Q&A, I would ask participants to limit, follow-on and multi-part questions so that we can get to everyone. At the end of our Q&A session, I will turn it back to Ursula for closing comments. Operator, please open the line for questions now.

Thank you. [Operator Instructions] Our first question comes from the line of Matt Cabral of Goldman Sachs. Your line is now open.

Thank you. Ursula, can you give us an update on your thoughts around M&A heading into the split, both in terms of your desire to do acquisition as well as if anything has changed around the view that you had previously that both businesses are not up for sale posts split, and that both make the most sense as independent public companies going forward.

Let me start with the middle question, which is the potential for sale of the businesses post-split. I think that we should probably wait till split to talk to the new leadership of those two companies to figure out what their plans are as we - as they proceed forward. As far as our plans for M&A, we have still $100 million in our plan for M&A, fairly modest plans for 2016. We've acquired $18 million so far this year and we're still in the market and still have plans to try to spend the $100 million both in DocTech distribution primarily and in Services, small tuck-in acquisitions if we can find them in the areas that are important for us. I think I answered all of your questions.

Yes, Matt. It's Leslie. I'll just add a couple of things. Obviously, with the focus on separation, you can appreciate we are focusing less on acquisitions in the near term. But for sure, it is important longer-term for each of the businesses. So Ursula said that we've been light in the first half, having spent $18 million. We do have our sights set on some opportunities in the second half.

Thank you. That's very helpful. And then on the third quarter guidance in particular, can you just drill down a little bit more and help us understand the puts and takes around both revenue and the margin profile for both segments in the September quarter, particularly following the strong performance that you saw in Q2?

Yes. So Matt, you know we have stopped giving quarterly revenue and margin guidance. We stick to full year guidance at the segment level, although we do continue to provide earnings guidance on the quarter. I think what you saw in quarter two and I'll start with DocTech, is an important improvement and moderation in the rate of revenue decline, both for the Technology segment, down 6% versus down 9% in the last - in the earlier two quarters. And importantly as well, down 3%, including Document Outsourcing, which is an indication of what the new Xerox will look like going forward. We continue to expect that revenue trends for the second half of the year will enable us to be in line with the full year expectation for the Tech segment of down 5 to 7. On the margin front, you saw important improvement in the margin in quarter two when you saw margin that's in line with our full year expectation of 12% to 14%. And that's what has underscored our confidence in reiterating the full-year margin. On the Services side, we've said that we expect margin will be toward the high-end of the 8% to 9.5% range. But revenue will be somewhat more muted. In the first half, revenues were flat at constant currency. Our full year range for the Services segment is flat to up modestly. And we’ve said we'd be at the low end of the range. So we believe that quarter two was an important proof point and you will see continued progress in quarter three and for sure in quarter four, which is typically our seasonally strongest quarter.

Thanks, Matt. Operator, next question.

Thank you. Our next question comes from the line of Shannon Cross of Cross Research Group. Your line is now open.

Thank you very much. I wanted to talk about currency and more from a DocTech perspective, in terms of both what you're seeing from a pricing perspective, because given where the yen has gone, one would assume that may be pricing will be a little bit better this year, since the Japanese competitors won't be able to be quite as aggressive. And then also from a Fuji Xerox perspective, clearly you had hit below the line. But just what - how we should sort of think about COGS movement and I know there's a lot of restructuring that can offset it. But I'm just trying to sort of gauge it as we go through the year.

Yes. Hi, Shannon. So a few things on currency. What we said about quarter two was we did see equipment price pressures at the low end of our historic 5% to 10% range. So we saw that as a positive signal. Obviously, the strength of the yen helps us in the competitive arena in the marketplace. Importantly on transaction currency, what we saw in quarter one was, it was a significant pressure on DocTech segment margin and in fact, pressured margin by about 100 basis points. That margin pressure in quarter two was much, much more modest. It was about 20 basis points. And I think you recognize that in terms of the yen, we have both the currency risk sharing arrangement with Fuji Xerox. So it means that we see more modest impacts as we go through the year, both when the yen strengthens as well as when it weakens. And we have hedging in place, which also mitigate some of the impact. So we're pretty pleased with how we're positioned as it relates to the yen vis-à-vis our Japanese-based competitors.

Okay. And so if it stays like 103, do you feel very good about sort of everything that's in place because it’s obviously moved a lot in the last few weeks?

It for sure has. And so once again, we have hedges in place. They obviously run out over time and so we'll mitigate the impacts and a currency risk sharing agreement with Fuji Xerox. And as you pointed out to the extent that the yen is stronger, it actually benefits our translation of Fuji Xerox equity income.

Right. Okay. Great. And then, maybe one for Ursula. Just as you think about and not specific cash flow generation numbers obviously. But the cash flow generation characteristics of the two businesses and as you start to sort of pull the companies apart, has anything sort of changed in the way how you're thinking about it or how we should think about it, as I guess, all the restructuring comes through. I guess I'm just kind of struggling to trying to figure out, what the right split is between the two businesses both sort of now and then when we get through or you guys get through this significant restructuring you're doing.

I think that you can think about these two businesses in the following way. The Technology business is a strong cash-generating business. It's in a very strong annuity based model. While we will be investing more actively in the Document Technology business, it will not substantially or significantly change the ability for us to generate cash in the DocTech business. In the BPO business, its cash generation ability is a little bit weaker than the Tech business. We'll be investing more actively in that business as we separate and they go into Conduent. So nothing has changed from - our perspective hasn't changed on those two businesses on how we view the cash movements there.

So Shannon, the other thing I would mention is that 2016 is not a normal year for operating cash flow generation at Xerox. Our cash expectations of $950 million to $1.2 billion are muted by three things. Number one is the impact of the separation cost, which is a couple of $100 million. Number two is the impact of higher than normal restructuring, which is probably worth another couple of $100 million. And number three are the Health Enterprise settlement payment, which should pressure cash flow this year by about $100 million.

Great. Thanks, Shannon. Operator, next question.

Our next question comes from the line of George Tong of Piper Jaffray. Your line is now open.

Hi. Thanks. Good morning. Ursula and Leslie, you've reiterated guidance for Services revenue growth of 0% to 3% constant currency. Given the deceleration in constant currency services revenue growth you saw in the quarter, what factors in the back half of the year will help you land within your range?

George, it's Bob. So I would say we had a couple of pressure points in the second quarter that will moderate as we go forward. And we were at minus 1 as you know, in constant currency for the second quarter. To be at the low end of the range, we need to be above 0 as we close out the third and the fourth. The pressure points in the second were really around - we had a very tough compare in public sector, the health in terms of some equipment sales that we had, had in prior year. We have the Health Enterprise, Montana, California, things have changed. That will dissipate as we go through the back half of the year. And then we also got out of some kind of revenue flow that was not profit producing that won't really moderate, but will basically - we'll basically be able to cover for with our signings. So we do expect that we can meet the range that we had established. And as you know, we've really been able to translate some of that revenue thoughtfulness in terms of what we want and what we don't want to pretty solid margin improvement and the 240 basis points that we delivered year-to-year in the second quarter, we see the ability to continue to drive at the top end of the margin range.

Got it. That's helpful. And then as a follow-up, can you describe how your pipeline in BPO is performing? And whether you see any large deals or initiatives that can service a near or intermediate term catalyst for bookings and revenues?

I would say our BPO pipeline has improved sequentially during the year. So the good news is that we do see sequential pipeline improvement, both in Document Outsourcing and in BPO. In all honesty, a little bit more aggressive on the Document Outsourcing side. But from a signing standpoint, we expect to drive new business growth in the third quarter. From a signings standpoint, we have seen a little bit of headwinds in terms of with the separation, decisional delays. And we're just working through that. So we expect to deliver better results in the third quarter year-to-year. But I wouldn't say that there's now some next New York MMIS that is so large that it would dramatically change the signings trajectory.

Great. Thanks, George. Operator, next question.

Thank you. Our next question comes from the line of Tien-tsin Huang of JPMorgan. Your line is now open.

Hey, thanks. Good morning. Good to talk to you guys. Just on the Services margins, they're obviously good. It seems like there's a prioritization of margins over revenue growth. I'm curious if there's a lot more that can be done here in terms of moving away from some of the lower margin business, if things are coming up for renewal or what have you. Is there more? Or is this - was there anything unusual that we saw this quarter?

No, I think. I'm sorry, it's Bob again. I think there wasn't anything particularly unusual. We are being more stringent as we look at new opportunities or renewals, if we're not able to make reasonable margin, it's time for renewal. We've got to convince the client that the service is worth more and they should pay more. And if we're unsuccessful with that, then we would rather move in different directions. So I do think that we'll see that. We'd still like to drive more new business growth though. This is not a one-dimensional play. We're trying to not grow and improve margins. We are trying to and expect to see some improvement in the second half of the year in terms of our constant currency revenue growth dynamics.

And the margin improvement is not solely from the fact that we've made decisions on new business or re-signing of contracts. It's also pure operational management, literally looking at the cost base and managing the cost base downward, independent of signing or not signing new business.

Understood. That's good. Just really quickly the sales cycle, just to be clear, just on the BPO front, any big changes in the sales cycle from the past quarter?

I would say we did see some extension, especially in June where not only separation, but where some of the clients, where the Form 10 didn't come out until June 30, wanted to, Ashok is now so that's very helpful in terms of clarity on the new CEO. But we did have a little bit of a push out in June. But as you saw, our overall results were still reasonably okay on a trailing 12-month year-to-year basis. But I would say we did see a little bit of extension in June on some of our pursuits.

Thanks, Tien-tsin.

Thank you. Our next question comes from the line of Jim Suva of Citi.

Thank you and congratulations to you and your team at Xerox. A lot of work I'm sure. I have to questions, and they are kind of related. I'll ask them at the same time. First, on the lower renewal rate, it sounds like, from your prepared comments, that it was a decision not to go after lower profitability of work. Should we expect that to continue, and is that kind of one of the main reasons why the service profitability is underperforming so much, it's just a legacy of bidding too low or going after too low products or contracts? Or is it more that your costs are misaligned or things like that? Then the second question is you just mentioned an extension of some deals did not close in the June quarter. Did they close in early July? It kind of seems hard to believe that someone would wait to close it based upon the new name of the Xerox or who the new CEO is. And if that's the case, it seems like there's a risk that they maybe actually went away to a competitor. So did they close or did they go away? Thank you.

We had a good start in July in terms of conversion of opportunities that we had initially been targeting in June. In fact, very large contract signing just yesterday. So I would say that, that piece and on the renewal rate, I mean, we're 85% year-to-date. We were a little bit lower in the second quarter and I think that we still see the ability to run in the 85% to 90% range. And if you get the right ones. So I would rather be 85% with the right mix that we re-won than be 90% with the wrong mix. And so I think we'll be able to deliver in the range as we look forward in the third and fourth quarters.

Thanks, Jim. Operator next question.

Our next question comes from the line of Ananda Baruah of Brean Capital. Your line is now open.

Thanks guys for taking the question. Two if I could. The first is can DocTech actually get close to flat revenue in the second half of the year? The reason I ask is because you are talking about seeing pretty solid momentum through the June Q, and you just put up - you have new products that are going to ramp I presume through the second half of the year coming out of drupa. And you just put up a 3% decline up from 3% comp, and the comps get pretty easy in the second half of the year. You have 4% to 5% decline constant in the second half of the year. So I'd love to hear your thoughts there. And then if it can't get back to down close to flat, maybe it's down 1% or something like that, not totally flat. I'd love to hear why that can't happen. And then I have a follow-up. Thanks.

Yes, this is Jeff. Good to hear from you. I think we have to remember, so first from the text segment standpoint, we reported guidance of 5 to 7 at constant currency, we're staying with that, I think you’re talking more about that we put Document Technology and DO together, where we did improve from a negative 5 sequentially to negative 3. I think you have to remember is annuity is over 70% of our business, okay? So to turn that ship take some time, so you certainly, we won't be seeing that in the quarter or even next year. I mean, it's going to take a big part of the ESR turning. We do have plans in place for when we come out as Xerox, the new company for things we’ll do will certainly be a little more aggressive in M&A appropriate so, but it will take some time to turn the 70% annuity to where we need it to be to get where you're pointing.

Okay, got it. And you're right. I did read that wrong. So I have a follow-up on that, I'm going to hold that follow-up though because I want to ask this next one. So, a clarification on my math here. If you do the midpoint of the September you guide, the low end of your '16 guide, I think by my calculation you need to be $0.30 QoverQ in December Q, which if I recall correctly, is kind of the highest end of what you guys have done historically. So the question is, number one, given the strength of the June Q, is there some conservatism in any context taken into the September Q. And number 2 if there's not, then how do you actually just walk us through the mechanics of how you do the $0.30 to get to low end of the guidance range for the December Q.

So Ananda, its Leslie. First of all, it's been really hard to hear all of the elements of your question. But I think that jest goes like this. To get to the low end of our guidance using the midpoint of our quarter 3 guidance looks like our typical quarter 4 seasonality. And you would say agree. So the way we're thinking about this is that we will have the normal second half over first half uptick in profitability. And that will enable us to get at a minimum to the low end of the guidance.

Thanks, Ananda.

Our next question comes from the line of Brian Essex of Morgan Stanley. Your line is open.

Good morning. Thank you for taking the question. I have a question for Bob, maybe if I could follow on to the question that Tien-Tsin asked, and maybe dig in a little bit more into the margins side of the Services business. And I think we are relatively comfortable with some of the services. One of the double-edged sword in the Form 10 is you saw how well some businesses were performing but certainly the commercial business stuck out kind of like a sore thumb. So, with regard to improving the performance of that business, I think you focused on a little bit signing better and more profitable contracts, but how much can be done on the cost side and what might be the trajectory of the margin improvement as you kind of work to improve that business? And then I have a follow-up.

Yes, Brian. I'm sorry. So it's Bob. On commercial, as you know, the kind of the largest component from an offering standpoint of our commercial business is customer care. The other components, HR, outsourcing, learning, litigation, F&A are largely making good progress and are reasonable from a margin standpoint. So a big piece of our margin turnaround for the commercial customer set because it really is a customer set that buys a portfolio of offerings is really around the recovery plan that we’re driving in customer care we bought in from the outside a couple of exceptional leaders. We’ve got a big team over this. And we think it's not going to be an immediate that next month, we go from 0% to 10% margins. But we think we got a set of actions in place that we will really lift the margin profile of that component of commercial. We are honestly kind of blessed here. We got a great client set. We are ranked in the top quartile. So our problem is more our internal. So if we got the cost management crisp enough, but it's a business that we're able to win in and we've got the set of actions. And I do believe that we can then elevate back to reasonable margins in the commercial component of our BPO. Not as high as we get in public or healthcare where we got a lot of separate industry based IP and solutions. But reasonable within the portfolio of BPO, co-work, Conduent going forward.

Got it. Maybe as a follow-up - I appreciate the color. As a follow-up, the stuff that's bucketed into other, some of the legacy run-off like student loans and other that are in that "other category", how much of a drag on consolidated corporate margins can we expect from those business? When might that stuff go away and at what rate might we see that decline?

So it will be a significant drag on Conduent quarter 2 financials. So when you see the Form 10 student loan as anticipated is in runoff and declining significantly year-over-year. And we expect that will continue throughout the rest of this year. But by 2017 should no longer be an issue.

How much is student loan? What else is in there?

Any Other.

As it relates to Conduent, student loans.

Perfect thank you.

Thanks, Brian. Operator next question.

Thank you. Our next question comes from the line of Keith Bachman of BMO. Your line is now open.

I wanted to ask about the BPO question. If I look really in two vectors, if I look longer-term post-separation, Bob, if you just think about the pipeline now, is there enough to generate year-over-year growth in that business on an organic basis? And related, if the cash flow - all BPO businesses have a lower cash flow, and M&A is clearly a big part of the industry right now and has been for some time. What is going to be the ability of the Services business to leverage M&A to try to not only increase your growth rate but, more importantly, to increase the capabilities and skill sets and reach and all that goes with it?

So let me start with the pipeline and the organic growth component. I would say that the pipeline is sufficient to get to modest organic growth and we would need to build the pipeline to elevate that growth rate to what would be our more likely long-term targets. I think on the M&A component, it's a little bit too early. We're going to be in the cycle as we get ready for Investor Day to talk more about the capital structure, debt, everything else. So I wouldn't want to comment at this point, relative to what the M&A prospects would be for Conduent.

Let me make something very clear. The strategy for this business, BPO before we decided to separate and post-separation, one plank of the strategy is going to be acquisitions. It is a business that had to acquire to fill out capabilities and to grow revenue and that will continue to be the case as we move into the Conduent business.

Okay. And Ursula, my question was more philosophical, is there going to be enough free cash flow to support that strategy post separation was really the nature of the question.

Keith, that's the question. I mean, that's the strategy. That's the plan. That's how we're going to structure these businesses. That's how we are trying to lay the foundation in '16 and our capital structure that allows us to operate Conduent strategically to win. And one of those elements is clearly to acquire is to have an active M&A business.

Okay. Great. And just one clarification, I wanted to follow-up with. Could you remind us what the limitations, one of the questions was will they remain independent entities post-separation, but what are the limitations from a tax basis on the ability to complete a transaction post-separation, the tax-free nature of the spin?

Well, I think that's something that you should probably call us and talk to Jennifer about later. We have it all comprehended, and Jennifer can bring it you in details. I think it would be a little bit complicated to get through right now.

Fair enough. I'll cede the floor.

Thanks, Keith. Operator, I think we have time for one last question.

Thank you. Our next question comes from the line of James Friedman of Susquehanna. Your line is now open.

Good quarter here. Congratulations on the improvement in the margins. I just wanted to kind of dimensionalize what the possibilities are for the services margin in particular. Bob, I was wondering if you might have any metrics you could share about utilization. You don't disclose that in the Form 10, or at least in the preliminary Form 10. How should we think about that going forward? Your headcount is down a lot. I would think the utilization would be up. Anything you want to quantify if you could qualify it. I'll just do my follow up now. Could you share what percentage of your contracts were - as either a percentage of contracts or percentage of your Services revenue are losing money? Some of your competitors disclose that. It is just very hard to model the services going forward. Clearly great progress but without those two elements. Thank you

Okay. So first on the utilization question. Your right to notice that our headcount dynamics have turned favorable. That is related not only to utilization. Honestly, we probably got more of the headcount reduction out of non-production workers more in the way of middle management, if you will, then just purely on the production worker component. We don't disclose utilization mostly because it's different in every business. The targets between customer care and transaction processing and HR outsourcing. But a big component of our strategic costs transformation play is around robotic process automation and trying to leverage technology to then increase that utilization rate. So we're managing - we're really, really trying to be very, very disciplined on headcount management. And that will clearly be a component of the ongoing margin lift that we need to drive both in Xerox Services and then downstream in Conduent. Relative to what proportion of the contracts are below water. We've really gotten a lot more sophisticated in looking at fully allocated P&Ls, which has helped us in kind of identifying something that may be didn’t look so bad from a contribution margin standpoint we really need to do even better on. I wouldn't want to give you a hard figure, but it's not a high proportion of the contract. It's not as though out of our, you know, out all of our contracts that there is a big number of them that are below water and the ones that are were on kind of very aggressive active recovery plans.

Thanks, Jamie. That's all the time that we have for questions today. Thanks for your interest. Ursula, anything more to wrap up?

Yes. So as Jen said, thank you for your questions. This was a strong quarter for Xerox with margin improvements across our businesses and encouraging signs of improvement in the technology revenue trend. Going into the second half of the year, we are highly confident in our ability to deliver our three priorities, which are meeting our financial guidance, creating two strong companies - two strong independent companies; and driving our strategic transformation. We look forward to providing you with updates on our progress and more detailed looks at the post-separation company financials and business strategies in the coming months. Thank you, everyone for joining our call.

Thanks, Ursula. That concludes our call today. If you have further questions, please contact me or any member of our Investor Relations team.

Ladies and gentlemen thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day everyone.