Good morning, and welcome to the Xerox Corporation Second Quarter 2019 Earnings Release Conference Call hosted by John Visentin, Vice Chairman and Chief Executive Officer. He is joined by Bill Osbourn, 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 express 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 Mr. Visentin. Mr. Visentin, you may begin.

Good morning, and thank you for joining our Q2 2019 earnings call. This quarter, we delivered improvements in earnings per share, adjusted operating margin and free cash flow, largely underpinned by our enterprise-wide transformation initiative Project Own It. These results have enabled us to increase planned investments for the second half of the year to advance our revenue roadmap. We expect to see returns from these investments over the near-term. But in light of the performance in the first half, we believe it is more prudent to adjust our full year revenue guidance down to approximately 6% at constant currency, while maintaining all of our other full year guidance measures. Adjusted operating margin for the quarter was 12.7%, up 170 basis points year-over-year. Margin expansion contributed to adjusted EPS of $0.99 in the quarter, up $0.19 or approximately 24% year-over-year. We are pleased with our cash performance. We generated $313 million of operating cash flow in the quarter, an increase of $78 million from a year ago. Free cash flow in the quarter was $297 million, up $94 million year-over-year. While we continued to see improvements in these three key areas, revenue for the quarter was down 7.2% at constant currency year-over-year. Results were due to weaker economic conditions in Western Europe and certain developing markets and continued operational impacts in the United States, we identified last quarter, albeit improving as the quarter went on. Our strong margin expansion year to date has allowed us to increase the level of investments we plan for the year from approximately $0.32 of EPS to approximately $0.40 cents of EPS. These increased investments will primarily be in support in of revenue generating initiatives. With anticipated annual growth savings of at least $640 million, Project Own It is offsetting some of the impact of…

Thanks, John. Looking at our financial results. We continue to see improvements in adjusted operating margin, free cash flow and earnings per share. Margin improvement reflects the progress from Project Own It initiatives that are now mature programs delivering the results we expected. Combining adjusted operating margin improvement with benefits from higher equity income and lower shares resulted in strong adjusted earnings per share expansion of 24% year-over-year year. While revenue for the quarter was below expectations, as John discussed, given our first half results we are adding to planned investments this year from the initial plan $0.32 in EPS to approximately $0.40. The majority of these additional investments are targeted to improve our revenue trajectory for the balance of 2019 and beyond. Importantly, we are maintaining our full year adjusted EPS guidance of $3.80 to $3.95 and annual free cash flow of $1 billion to $1.1 billion, although we now expect full year revenue to be down in the range of approximately 6% at constant currency. Let me emphasize that we remain focused and committed to transforming the business and are making investments for the long-term, while sustaining a profitable business in the near-term. I will now review the income statement in more detail. Total revenue declined 7.2% at constant currency and 8.8% at actual currency. The constant currency decline was in line with what we experienced in the prior quarter but as mentioned was below our expectations. We saw areas that performed well, such as high end color systems fueled by continued demand for our Iridesse Production Press and areas where our new revenue initiatives are starting to gain traction, such as in our software and services business and our win rate for new business signings improved in the quarter. However, we did see continued impact from the…

Thanks, Bill. In summary, we see strong sign in our long term strategy is gaining traction and that the hard work of many people across our company, it’s paying off. Xerox is getting stronger and more focused on developing and delivering the technology that businesses large and small, will need for years to come. We will now open the line for questions. Ann?

Thanks, John. Before we get to the Q&A with John and Bill, I will point out that we have in the appendix to our materials additional supplemental reconciliations, and posted on our Xerox Investor Relations website a full set of earnings materials. Operator, please open the line for questions now.

Thank you. [Operator Instructions] And our first question will come from the line of Shannon Cross of Cross Research. Your line is now open.

Thank you very much. So I guess I just want to understand a bit more about what’s going on in the top line. What you saw toward the end of the quarter? How quickly you think some of the incremental investments you’re making will start to run through the model? I guess because at some point, obviously, you can’t sort of offset the top line declines with all the cost cuts. So when we look out a year or two, do you still feel comfortable with what you laid out at the Analyst Day? I don’t know, John, if you can just sort of talk to your thoughts sort of top line?

Yes. Hi, Shannon, we’re still focused on the trajectory that we laid out in February. And if you think on the revenue side, we’re doing a lot of things, whether it’s expansion in channels. I talked about what we’re doing with American Express, even with HP, both on the DocuShare side, some of the large accounts we’ve done. We’re building more e-commerce capabilities. We’re hiring software sales specialists, some of it’s tactical. We’re expanding on our IT as servicing – services. And these investments, while we’re reporting them in the place now, some of these will take time, like we had discussed back in February, but it will provide top line benefits near the end of 2019, but also we’re expecting the returns to come in 2020 and 2021 on these.

Yes. Just to add on, Shannon, the investments John mentioned, we will see, and certain of those, some impact in the second half, but a lot more in 2020 and beyond. But some other things, specifically related to the second half, we brought it up on the call, I can’t emphasize enough, the rate of improvement we saw later in the quarter, particularly at XBS and the rate of decline and the lessening of the impact of just all the transition that we’ve gone through in the company in connection with Project Own It. So that is key, and we saw that improvement coming later in the quarter, particularly in June, and we expect that to continue. That gives us confidence in improvement in the second half. There were some certain large deals that were delayed in EMEA that we expect to close in the second half to have a favorable impact, and we’re expecting continued strong demand for Iridesse and the just launched Baltoro to help. And then finally, the OEM business, I know we’ve talked about it for a lot of quarters, but it is lessening the impact and the first quarter – first half was about 0.8%, and we expect that to be closer to about 0.5 point. So there are various things that give us the confidence in the improvement in the second of revenue trajectory and it’s well ahead – the investments we’re making in the revenues area is starting to have some impact in the second half.

Okay. So all of that is – you started to see as the quarter has – your – it’s July 30, so through the first month of the quarter, you’re feeling comfortable?

Yes.

Okay. And then just curious, John, you had mentioned in the talk, I think, initially on leasing to make better use of the balance sheet. So I am curious as to what you mean by that? I understand you’re not going to talk a lot about the leasing business because you’re still analyzing what to do there, but what kind of views are you thinking about? And obviously, acquisition – sorry, share repurchase and dividends have been a big focus. How are you thinking going forward? Thank you.

Yes. So Shannon, we’re not going to comment publicly on it. But what I would say is, we’re focused also on M&A pipeline that’s going to support our strategic initiatives. And we’ve done a few tuck-ins. We’ve also done the acquisition of Vader on a 3D metal print. And in each case, we’re just going to take a disciplined approach that will drive the highest IRR. That said, again, we’re not going to comment on x-ray, and we’re not – we cannot provide details on what that would look like because we haven’t set a deadline for making a final determination. It’s an important decision, and we’re taking a methodological approach that’s focused on doing the appropriate amount of due diligence on it, so and you know…

And just to reiterate, I mean, it is premature, there may or may not be a leasing transaction. Use of proceeds was the key question. If there were to be one, that would be addressed appropriately. But we are committed, as we said in our prepared remarks, to maintaining a strong balance sheet for the company. It’s important for us and our growth plans from a top line perspective.

Great. Thank you very much.

Thanks, Shannon.

Thank you. And our next question will come from the line of Matt Cabral with Credit Suisse. Your line is now open.

Thank you. Just on the partnership you announced with HP in the quarter, wondering if you could talk a little bit more about how the agreement came to be? Just what you see is the biggest benefit? And just how we should think about the ramp of the relationship from here?

Yes, I would – look, this is a multifaceted arrangement and it’s really going to – and it helps us unlock growth opportunities. So if you think of what we’re doing, we’re diversifying our supply chain. We’ll source the A4 and the entry three products from HP. We’re adding volume to our toner operations, which we have. We’re broadening our IT portfolio because we’ll become a desk specialist in HP’s Partner First program and we’re expanding our software presence where they will make DocuShare Flex, our cloud enable contact, available for all their SMB PCs. So we’re looking at this as a new channel of opportunity for revenue, while diversifying our supply chain. I wouldn’t read in – I wouldn’t read more than that into it. It’s really just - it’s a partnership that made sense for us and made sense for HP.

Got it. And then on free cash flow, so you’re up about $100 million through the first half of the year versus last year. I think even at the high end, though, you’re still guiding for less than that on a full year basis. Just wondering if you could help us think through the cadence of cash flow in the second half? And just why we shouldn’t expect the pace of year-over-year improvement to continue?

Yes, Matt, it’s Bill. So as you’re well aware that our strongest cash flow quarter of the year is the fourth quarter, so we are expecting the strongest cash flow in that quarter. With that said, when you’re comparing, we’re similar in line to last year in cash flows that we guided to, the $1 billion to $1.1 billion this year similar to the approximate $1.1 billion last year. The second half of last year did have some unusual cash flows that came back in related to the Fuji Xerox transaction. So you don’t have – it makes it a little bit tougher compare year-over-year. But we’re also – it goes back to the investments we’re talking about making in the company. And we want to do it right, but those investments not only cause an EPS hit, that we talked about, the $0.32 being up to approximately $0.40, but it also – there’s cash associated with those investments. And overall, as we said, we’re comfortable with reiterating our guidance and given the CapEx rate of spend being towards the higher end of the range.

Thank you.

Thanks, Matt.

Thank you. Our next question will come from the line of Ananda Baruah with Loop Capital. Your line is now open.

Hi, good morning, guys. I appreciate all the detail of transactions, that’s really, really helpful. So I appreciate that. A few, if I could, just starting out with just kind of the EPS. I just want to understand – make sure that I understand the mechanics. So the $0.08 of incremental investment in the sales initiative, is this straightforward of saying that $0.08 that comes out of whatever EPS would have been? And so is that’s the right way to think about it? And then I have a couple questions on just how to think about the second half of the year as well. Typically, historically, let’s say, September quarter has been a little bit softer from an EPS perspective. But the last couple years, you’ve actually seen – seeing relative to Jerry, the last couple of years, though, we’ve actually seen improvement Q-over-Q in EPS. So how would you like us to think about September this year, meaning this quarter, number one, in light of sort of the dynamics the last couple years, and then also in light of the $0.08 that you’re incrementally spending? And I have a couple of follow-ups. Thanks.

Yes. Ananda, it’s Bill. So, yes, we are very pleased with clearly the Q2 and the year-to-date adjusted EPS performance, especially on a year-over-year basis. With that said, we’re holding our guidance at $3.80 to $3.95 in spite of – we don’t give specific quarterly guidance on adjusted EPS. There is consensus numbers out there and this compares favorably to that. But the thing is and that is the reason why we haven’t upped the full year guidances, specifically for what you mentioned, to a certain extent that we do plan on reinvesting some of these savings that we’ve been able to achieve from Project Own It and the overachievement in EPS in the first half. We plan on investing those smartly, we’ll do it in a smart way in various revenue-generating investments in the second half. And Q3, Q4, typically, Q4 is the strongest quarter of the year, as you’re familiar with, though we don’t really give quarter to quarter EPS guidance, but full year, we’re still very comfortable with our range of $3.80 to $3.95.

And I just wouldn’t want people to – I mean, to be honest with you, I’ll have to take this offline with you and myself, but I feel like right now we could all be – September quarter, there could be like a $0.10 range that people could set at $0.05 down from the $0.99 to $0.05 up and I just wouldn’t want incentives. Whatever – I mean, I think, whatever it should be, we’d like to get some visibility to it, like see it. Intellectually, people could set it anywhere in that range, I think, similarly…

Well, I mean, other factors, we mentioned, people can go through and calculate what the impact of the share repurchases are on our EPS. Therefore, we said the incremental share repurchase, the $300 million, will be weighted towards the latter part of the year. So it won’t have much of an impact on this year nor Q3. And you’ll start also lapping the share repurchases that started in the second half of last year.

Okay. And let me just ask a quick follow-up here, on your leasing business context. Guys, to what extent are you also taking into consideration what the impact to – of simplifying the story is? And so what the multiple to the stock could be, if you were to do something? I’d just love to get your view on that. And then to the extent you are considering those types of things, how are you going about actually sort of gathering the information, which you use to sort of – in these considerations? And that’s it for me. Thanks.

Yes, I think we said, we’re considering optionality with the leasing business. There’s nothing definitive. But there are a couple of factors at least. One is simplifying our business. As this is a core area, we need to be and operate and it has been a good area. And we may still continue staying in this business, but this is something that we have to have as a document technology company. Clearly, many of our peers do not do this in-house, so that’s something we’ll have it. The other thing you bring up is that we do believe that the debt associated with this is often from an investment thesis perspective will get screened out because of that debt related to the leasing business and that is a consideration and whether we would do a leasing transaction or not.

Got it. Okay. Okay, great. Thanks a lot.

Thanks, Ananda.

Thank you. Our next question will come from the line of Jim Suva with Citigroup. Your line is now open.

Thank you very much, John and Bill. The question I had was regarding the incremental investment that you’re doing. It sounds like it’s going into your sales force, your sales channel, your go-to-market strategy, something like that. Can you help us understand like maybe some specifics on where this incremental investment is going? Because you had a very good grasp on the earnings and the cost synergies and reducing costs, but the story of Xerox being revenue-challenged has been a persistent theme under several managements’ tenure. So can you help us understand what specifically some of these actions are, so we can have a little more confidence and conviction of your ability to improve the sales trajectory? Thank you.

Yes, so Jim – good morning, Jim. I would say that, first of all, it’s the investments we’re making in different aspects. So if you think what we announced, whether it’s with American Express or HP, our focus on channels, our focus on new types of channels to get to our clients, those are all investments we’re making now that will bring benefit in the future. And some of these that we’re talking about, we’re not expecting a lot of revenue in 2019, but helps us with the growth. So it’s really part of our driving revenue that we talked about even back in February. You know we’re improving in our core technology business; our offerings, you’ve heard some of them that we just came out with and more to come; our direct sales coverage, yes, we’re adding specialists not only in the sales force, but we’re also adding specialists that can help us continue to grow in some of our areas and software and services. We talked about our channels. SMB is a big play for us not only in the U.S., but also in Europe and in other areas. We’re looking at a innovation in new business in M&A and the innovation pipeline, we’re starting to move the innovation pipeline that we’ve talked about and we give an example of one of the first ones we’re looking at, which is the sensor electronics and we’re seeing how and what are the business cases to possibly get this to commercialized now that we’ve had it implemented in a few pilot clients, if you’d like or in few of our clients, and how do we go about bringing that in. All of that takes now investments to assure that in the future we can go get the revenue trajectory. That said, that said, that’s why we’re confident in keeping – maintaining our guidance, but at the same time, we thought it’d just be prudent to bring revenue guidance down. It’s not easy, it’s not short term, it’s not going to happen in a quarter, but we want to see improvements in all these areas as we move forward.

Yes. Just to point in a little bit more detail. I mean some of the investments, I mean we are hiring individuals and the software sales area specialists to help us grow our software sales revenue. Our – expanding our IT services offerings, we had a few cores within our XBS operations that we’re already selling this. We’re going to be expanding it over the second half of the year to over a third of our – or approximately a third of our XBS operations. There’s costs in getting people trained and hiring people on to offer those services. So there are real costs being incurred as we ramp up. And the other area – another area specifically that we’ve actually built up in the first half and pay folks on is the transactional supplies area. We have a transactional supplies focusing on getting better attached rate – attachment rates on bundled contracts and we’ve invested in personnel in that area also.

Great. Thanks so much for the detail. That’s greatly appreciated.

Great. Thanks, Jim.

Thank you. Our next question will come from the line of Paul Coster with JPMorgan. Your line is now open.

Hi. Thanks. This is Paul Chung, on for Coster. Thanks for taking our question. So first just on mid-range declines. Can you give us a sense of what you think demand in sales would have been kind of excluding some of the impacts from some of the sales transition and order changes? I know you had a tough comp there, but how should market share held up and just your sense of overall industry health there in the mid-range would be helpful.

Hey, Paul, it’s Bill. The largest impact on mid-range really came from, we talked about, the XBS area year-over-year and they did have a strong Q2 last year, so it was a tough compare. With that said, it’s hard to say what would have been exactly without versus the installs being down 12%. But certainly I think without any impact, we would have expected it to be more in the mid-single digits, down and worse, but we clearly saw improvement in XBS in June. We expect that to continue and they are one of the key drivers in mid-range. You also have some of the deals over in Europe that were delayed that we expect to close into the second half that will also help improve the mid-range area.

Got you. And then just a follow-up on the post sales revenue kind of given your equipment sales declines kind of accelerated in the first half. Just obviously impacting your overall installed base, but what are the leverage you can kind of pull to stem some of the pressure on post sales? And then any update on some of those growth initiatives you presented at Analyst Day, anything becoming more material. Thank you.

Yes. From a post sale perspective and the causals of what happened in the second quarter, I think, of it really in two parts. First of all, there is a transactional part of post sales supply – the unbundled supplies, paper, some of the IT services sales. And we did see weaker revenues in the transactional side, particularly the indirect sales channels in the U.S. and EMEA and in certain of developing markets where we saw a slowdown due to economic uncertainties. In the contractual side, the service rental, other outsourcing, a lot of it was dependent on page volume, clicks, et cetera, we saw a similar rate of decline to Q1, which was above the 2018 pace, but it still was similar to Q1. And there are several factors, which we’ve discussed in the past, that contributed to this, whether it’s slower machines and field, higher mix of lower usage products, lower enterprise signings in recent quarters. And we’re attacking this specifically as a part of our strategy, but we know that this area isn’t something that turns around quickly, but it is an area that we’re attacking. And specifically when you’re looking at post sale, and we believe it can do better in the second half than the first half. I talked about earlier the investments we made in the supplies area. We have a specific group that’s looking – that is working to get higher attach rates on the unbundled contracts and there are certain things in the post sale, there is IT services, contracts that we can look to that are happening in Q3 and into Q4 that give us confidence in improvement in the rate of decline in the second half versus the first half.

I think we have time for one last question.

Yes, ma’am. Our last question will come from the line of Katy Huberty with Morgan Stanley. Your line is now open.

Yes. Thank you. What did you bake into the second half outlook as it relates to the weakening macro data points? It sounds like there were some sale cycle delays in 2Q that clearly could continue into the back half, so that you are able to close the deals that delayed, there could be continued delays in 3Q and 4Q. So just wondering does your outlook bake that in or do you need a stable macro demand environment to hit that second half outlook?

Yes, Katy, it’s Bill, I’d say there’s two main things, one thing and probably the largest thing that gives us the confidence that the second half is the trend at XBS that we saw in the latter part of Q2 and just what XBS has been able to achieve historically. We know the changes that we made from Project Own It respective are good for the company for the long term, but still adjusting to those changes in the short term had some impact and we’re confident that XBS can get back to levels of recent quarters prior to the first two quarters of this year. As far as the delay deals, there is some – we are expecting some of those to close in the second half, it will have some favorable impact, I would say the bigger impact is really coming from the better responsiveness to the organizational impacts of Project Own It on the XBS side.

And as you look into 2020, the $450 million of incremental savings that you’ve earmarked, where did those savings come from relative to the $640 million in 2019?

Yes, Katy, it’s a little bit – we showed some of it when we did the February Analyst Day. But if you think about it, we have more work we can do on the supply chain side. On our infrastructure, we’re investing not only in robot, we’re investing in cloud-enabled solutions. So there’s a lot of back office, if you’d like, that we have more investments to do that take time, some of these take time. And then there’s always optimization that we continue to do. So it’s still in the same areas.

Great. Thank you.

Great. Thank you, Katy. That’s all the time we have for questions today. And we really appreciate the interest of everyone who has participated. John, anything to wrap?

Yes, I just want to say thank you to everybody. Our transformation continues to drive improvements in EPS, operating margin and free cash flow. The investments we are making in our business is setting us to improve our revenue trajectory, which gives us confidence in our ability to return Xerox to growth over the long term. Thank you again for joining us today.

Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude our program and we may all disconnect. Everybody, have a wonderful day.