Welcome to the Xerox Corporation Fourth Quarter 2014 Earnings Release Conference Call hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Kathy Mikells, Executive Vice President and 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. [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. Before turning the meeting over to Ms. Burns, Jim Lesko, Vice President of Investor Relations, has a few words.

Before Ursula begins, I would like to remind everyone that as a result of the pending sale announced on December 18 of our ITO business to Atos and having met applicable accounting requirements, Xerox is now reporting the ITO business as a discontinued operation. We will be reporting today our Q4 and full year 2014 results on a continuing operations basis. Prior period results have been revised to reflect this change, details of which can be found on our Investor Relations website at www.xerox.com/investor. Ursula?

Thanks, Jim. Good morning thanks for joining our call. Today we're reporting fourth quarter and full year 2014 earnings. A lot has happened in the last 90 days and overall we're pleased with where we ended the year. We're reporting solid results that in some places exceeded expectations. I'll give a quick overview of our financials, provide some perspective on the year and share updates on key initiatives contributing to our results before turning it over to Kathy to go into more detail on the financials. We delivered strong profit and cash for the year and we closed strong in services revenue and margin. Services revenue growth improved through the year and we saw improved margin performance. Services signings increased as well driven by renewals in BPO and we ended the year with strong Document Outsourcing signings of over a $1 billion. In fact, our Canadian operation closed its largest ever multimillion-dollar MPS deal with the Government of Canada in November. In Document Technology, we delivered strong margin throughout the year, reflecting both our continued focus on profitability as well as a favorable environment and for the fifth consecutive year we're the leader in equipment sale revenue. Demand has been strong for our iGen and the new Versant products in the U.S. and Europe. These products provide our graphic communications customers with the ability to produce digital color prints at scale with a high level of personalization, quality and reliability. As you know, Xerox has been focusing on the segments where we have the most competitive advantage and we have been steadily shifting our portfolio mix. As an example, we announced the pending divestiture of our ITO business through a sale to Atos. This will allow us to focus squarely on Business Process Services and Document Outsourcing and provide additional…

Thanks, Ursula and good morning, everyone. We were pleased with the progress we made this quarter. Both Services revenue growth and margin improved and with the announcement of the planned sale of our ITO business to Atos, we took a key step in our portfolio management strategy. In addition, our Document Technology business continued to deliver strong profitability. The positive results in Services and Document Technology yielded earnings higher than our expectations and strong cash flow. I'll cover the segments and cash flow in a moment, but first let me walk through our fourth quarter earnings. As noted earlier with the pending sale of our ITO business, my commentary will be on a continuing operations basis excluding ITO. Total revenue in the quarter was down 3% at actual currency and 1% at constant currency. This compares to down 2% at both actual and constant currency in the third quarter. Underlying constant currency growth improved from the third quarter driven by better Services performance. And as expected, we saw the impact of actual currency rates turn negative in the quarter. Gross margin of 32.1% was up 10 basis points year-over-year as the positive benefit in Document Technology from productivity initiatives, currency and pension expense more than offset the greater mix of services at a lower margin. RD&E was modestly lower year-over-year as increased investments in Services were more than offset by reductions in Document Technology. SAG was lower in both segments as we benefited from productivity initiatives as well as lower bad debt and pension expenses. These improvements resulted in our fourth quarter operating margin increasing a 100 basis points year-over-year and operating profit growth of almost 7%. And for the full year, operating profit improved $72 million and operating margin was up 60 basis points. Moving down the income statement,…

Thanks, Kathy. I want to get to your questions, so I will summarize quickly. Our fourth quarter shows our strategy is sound and the decisions we've made have put us on the right path forward. We're seeing the benefits of strong operating profit from Document Technology and improving profits and revenue in Services, where we're making visible progress. Our Services business is now better positioned for future growth. We know 2015 is already bringing some headwinds. As we mentioned earlier, we're watching the unprecedented movements in currencies especially the euro as Kathy outlined, but as always, we will manage with a disciplined approach. We will work hard and make the necessary adjustments to our operations. Our commitment remains the same and our diversified portfolio and strong cash flow, combined with our operating model, guides our priorities. In Services, building on the momentum to increase sales and profits through portfolio management improved productivity and excellent offerings. In Document Technology, capitalizing on the most advantaged segments of the business to maintain our leadership position in the industry, while maintaining strong profitability and we will continue to generate healthy cash flow to deliver shareholder value. Thank you and now over to you, Jim.

Thanks, Ursula. Joining Ursula and Kathy today is Bob Zapfel, Head of our Services business. Also let me point out that we have several supplemental slides at the end of our deck. They provide more financial detail to support today's presentation and complement our prepared remarks. For the Q&A, I ask participants to limit follow-on and multipart questions so we can get to everyone and 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.

[Operator Instructions]. Our first question comes from the line of George Tong with Piper Jaffray. Your line is now open. Please proceed with your question.

We saw nice Services margin expansion this quarter, both on the year-over-year and quarter-over-quarter basis. Can you discuss what's changed this quarter to yield a positive inflection in Services margins and the work you have in the pipeline to sustain the positive momentum?

Sure. I'll start and then maybe Bob can add some color. Overall, we have been working throughout the year in terms of building initiatives, especially around reducing our overall cost structure from a productivity perspective, looking to get greater growth out of the areas where we have higher margins and as we pivot forward towards 2015, organizationally; changing our go-to-market approach, focused by industry and putting together operating capabilities that go across the company in order to help us to drive further productivity enhancements. One of the factors was clearly our overall government healthcare solutions business, stabilizing for us. It came in I would say very consistent with our expectations and our overall margins came in consistent with our expectations as well. So we feel good about the fact that our government healthcare business is performing a little bit better. Obviously, we had a lot of pressure in that business in 2014 and it's one of the areas as we look to 2015 that we're expecting continued improvement. So as you look towards 2015, our fourth quarter performance I think is right in-line with what we expected in Services and it gives us that much more confidence in our 50 basis point margin expansion expectations for next year. Bob, I don't know if you want to add more color.

Yes, I would just add we had good cost management generally across the board by our teams and in government healthcare we as Kathy said, had stabilization and were really able to absorb investments that we were making in advance on New York and still fit if you will, inside the targeted margins that we want to deliver. So overall, the plays that we've developed relative to global capabilities and managing our cost structure seemed to have reasonable yield last quarter.

And then as a follow-up, we're seeing Xerox take a more verticalized industry approach in its Services business. Can you discuss progress you are seeing with this initiative and discuss how verticalization may impact pipeline performance on a near-term and intermediate-term basis?

Let me briefly cover that. This is Bob, obviously. I would say we're seeing already better cross-selling opportunities. So as we go to market and we've moved out of our large number of independent business units and we have a sales force that has a broader responsibility of all the offering set to those clients, we're seeing better cross-selling opportunities. We had the whole team together for a big sales kickoff and I think that that's off to a fair start. I would say relative to pipeline as you saw from our release, our overall pipeline numbers are down marginally. There are a lot of moving parts relative to pipeline with taking ITO out and trying to count once validated as opposed to just earlier in the cycle, once noticed. But I would expect our pipeline to grow during the year as a result of the sales force additions and the focus on customers in vertical markets.

Our next question comes from the line of Shannon Cross with Cross Research. Your line is now open. Please proceed with your question.

A question with regard to acquisitions for Ursula and Kathy and I guess Bob too, actually. Given the $900 million bogey that you've put out there for the year and then the history that we've seen over the past few years, how are you thinking about ramping it up? Is this -- you've got in the hopper a couple of large ones, so you feel like it can be done? Again, it's a much larger number than you've done in the past and then if you can't get there, I assume share repurchase is a focus, but would you want to keep the cash for some other purpose? Thank you.

It's a good question. We have been improving our acquisition flow, $150 million to $350 million to $900 million this year. It will be a difficult run for us, but it is one that we're absolutely committed to and we're putting in place activities, meaning people, incentives to the line people, people focused on deals as well to make sure that we can actually get up to the $900 million that we have laid out. This is a good problem to have, meaning we have the money and we will get a lot of it in the middle of the year and we want to spend it and people know. So we're working through it. I won't comment on any deals that we have in the hopper just to say that we're working on making sure that we can spend all $900 million. If we don't spend it -- I'll actually turn it over to Kathy. The strategy that we have is pretty much in place, but she can actually just reiterate it.

Yes. One other thing I would comment on which I'm sure I've mentioned before, we have a desire to do what I would describe as chunkier deals. We're never going to get there just doing deals at $25 million at a crack, right? That's just infeasible. So that's clearly part of the overall strategy. And as Ursula mentioned, the fact that we've loudly broadcast this hopefully helps to generate a little bit bigger pipeline. We're also very actively engaging the business people, right? Bob certainly would tell you it's something that's a top priority in the business people. So we're working collectively across the organization in order to make this happen. Finally on timing, we recognize that this is a big step up for us in 2015 in terms of what we're trying to accomplish. By the way, the incremental money is not coming in the door until the middle of the year, so just a note for folks on that. So there is a possibility that we won't get 100% of the $900 million spent this year. Our expectation is we would look to flow that over, in trying to accomplish more in the first quarter of 2016. We've already announced that we're going to do roughly $1 billion in share repurchases this year. We ended the year with a strong cash balance to enable us to again be more consistent in terms of being in the market consistently. So that's what we expect to do with the money and we're all working hard to get it deployed as fast as possible.

And then as a follow-up, can you talk a little bit about what your metrics are around potential acquisitions? How we should think about accretion, what you're focused on from a financial standpoint when you look at prospective acquisitions.

First and foremost, we're focused on what I would call return-adjusted, risk-adjusted returns. We're interested in doing good deals. We've been historically very disciplined, we're certainly not going to change that in our approach. So first and foremost that's what we're interested in. Of course, we always look at what's the accretive, dilutive nature of the transaction, how much are we paying for it etcetera, we're focused on trying to do deals that generate synergies because then we have more dollars to play with in what's a pretty competitive marketplace. But those are some of the things that we're focused on overall and I say before any of the math, we're focused on buying companies that are a great strategic fit for us.

Our next question comes from the line of Mr. Huang with JPMorgan. Your line is now open. Please proceed with your question.

It's Tien-tsin. Just want to ask on the Services margin front again, just all the different puts and takes. I know there is a lot of government healthcare expenses, etcetera you've got some project delays with Texas and Florida. So can it be higher if we normalize for government and healthcare and some of these unusual items? Trying to understand what's going on underneath the business in Services on the margin front, if that makes sense.

Well the overall margins are still lower as a result of our margin dynamics in government healthcare. So without question the Services portfolio runs at an overall higher margin than we publish as a result of the investments that we're still making in government healthcare. But I think as we said, we've got that stabilized. We had improvement both sequentially and quarter-to-quarter. But as we're looking to ramp up, you'll remember from the investor conference a reasonable source of our targeted improvement in 2015 this year was coming out of GHS. We talked about that as being 25 to 40 basis points of potential improvement. So that is still our focus and we think we have got strong plans to yield that.

One other comment I would add is, if you went back to the investor conference along the things that we're targeting -- improvement in government healthcare, delivering productivity through our now horizontal operational capabilities, continuing portfolio management, investing in our platforms, there is a yield we expect from that beyond 2015 as well, right? So 50 basis point solid improvement is what we're trying to put up on the board this year with an expectation that that would continue.

Just my follow-up then on Texas, Florida. How much visibility do you have on the timing of that? To the extent that those things are pushed out, could that have any revenue and margin impact? What's the cushion there? Thank you.

I think you mean New York and Florida, not Texas and Florida, but Bob will answer it.

Yes, we built the 2% to 4% revenue growth commitment that we've made with a plan to get both Florida and New York to come to closure in the first half. We're still very much on track with both of them in terms of meeting the milestones. So I would say that we're on track with both. They are in our range and we don't expect either of them to not be successful in terms of us being a partner with those clients both with Medicaid in New York State and with tolling in Florida.

Our next question comes from the line of Ben Reitzes with Barclays Capital. Your line is now open. Please proceed with your question.

I wanted to ask about puts and takes for the guidance a little more for 2015. In the fourth quarter, it looks like bad debt year-over-year was a $0.025 benefit, and now moving into 2015, I was wondering what bad debt was for the year versus currency. If that goes the other way with what's going on in some of the economies you serve. I was wondering if the guidance actually had offsets for if that goes the other direction. And then I had a quick follow-up. Thanks.

Sure. As we look at our fourth quarter beat in Doc Tech, we recognize that some of the beat is coming out of bed debt; some of the beat was coming out of pension, right? So we ended the year at a higher level overall for the full year than what we would have talked about at our investor conference last November. So we're taking that into account then as we look at what the year-over-year changes are expected to be. So my commentary around -- as we stare at our margin guidance of 11% to 13%, back at the investor conference I would have been more bullish on the higher end of that range versus now talking about coming down towards the middle, that's taking into account. Ben, both the fact that bad debt will be a year-over-year headwind for us. We expect bad debt overall I will call it, the rate of bad debt to continue to be just fine. It's improved over the last couple of years and that should continue, but certainly we had a phenomenal 2014 in terms of what the overall bad debt expense is and so we're reflecting that in our margin guidance.

And then just a quick follow-up on Document Technology. Are you seeing price competition from Japan based competitors who can flow through the benefits of the yen? If so, how is that flowing through your margin guidance as well which you just commented on for that segment?

We have been asked this question I feel like every quarter for the last -- since the yen moved from 85. We haven't seen any meaningful change overall in the competitive environment. We always have pricing impacts that range 5% to 10%. Clearly big enterprise deals are always more hotly competed; but overall, we haven't seen a meaningful shift in the market.

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

Just two if I could. The first is just, Bob with regard to any potential operating margin impact when you go ahead and sign both New York and Florida. Can you give us some sense of whether we should expect any standup impact to manifest and what kind of contingencies you might have been able to put in place heading into those? You just seem to have pretty good visibility to standing them up. And then I guess just the second one is when you guys announced the sale of ITO, I think the commentary was that at that point you expected to be able to make up any impact to 2016 through the combination of buyback and efficiencies on the EPS line. Now that FX is impacting EPS by about $0.05 to $0.06, do you think there is anything you can do as you go through 2016 to make up that incremental $0.05 to $0.06? And those are my two questions. Thanks.

Let me start with the first question, relative to standing up both Florida and New York, we've built that into our guidance when we shared with you and the rest of the community our target to be a 50 basis points improvement in the 9% to 10% range. We've already absorbed some of that hit in the fourth quarter with New York because we wanted to invest in advance. So do we have to? Do we not run at as high a margin upfront in standing new contracts? Absolutely. But that's part of our design and sourcing model and you should not need to expect any degradation as a result of winning that business. We want to win it, we plan for it and we have the cost in our outlook. Kathy, I'll turn to you on the Atos and 2016 question.

Yes. At the time that we announced the ITO sale to Atos, we brought our guidance down to reflect the impact of the dilution which we would only be able to slightly offset this year with an expectation that we would offset the remainder in 2016. So that's really about getting the share repurchases deployed and getting the M&A accomplished as well as, I would say offsetting some of the friction costs associated with the transaction, stranded costs that we then need to attack. So we're still absolutely there in terms of offsetting that impact. The second question you asked was really about currency and our ability to offset the currency impact. Embedded in our guidance for 2015 already is an expectation we're going to offset a little bit of that impact. You heard me in my prepared remarks say it's worth a little over $0.06. We're bringing down our EPS guidance by $0.05. So we're expecting that we're going to drive harder to offset some of that impact and it's built-in already.

Our next question comes from the line of Keith Bachman with Bank of Montreal. Your line is now open. Please proceed with your question.

A question and a clarification, the clarification first. Kathy, the $0.06 that you talk about for FX, does that include the benefit of the yen to cost of goods sold for the printing side? And how much is that benefit in 2015 due to the yen?

So it includes everything and so as you can imagine for any global company, everything is a big everything. It includes all the translation impacts, right? So we talked a lot about impacts to revenue and those impacts have some flow-through to profit. The ultimate margin impact of that is a little bit dampened because it's hitting both revenue as well as profit. And it includes all of our purchasing and the hedging that we do associated with purchasing. So it is all-in.

My question is -- I'm going to direct it to Bob. If you think about the sale of the ITO business, Bob, if you look back over the last two years and I realize you haven't been there over the two years. But if you think about the BPO side of the business, is there a way that you could quantify how that BPO business was tied to ITO? In other words, when you think about the work of -- how much of the ITO business or the BPO business had ITO tied to it? And what I'm really going back to is the thought process around -- how is the sale of ITO going to impact the ability of Xerox to win BPO business as you look forward to? I understand you can outsource to folks like Cognizant or [inaudible] I should say to Cognizant, but I'm just wondering how it might impact your win-rate by not having in-house ITO capabilities. Thank you.

Yes. No, I appreciate the question. This was a really big strategic thought for us, because obviously we're betting a lot on our ability to drive growth in BPO and Document Outsourcing. When we looked -- I won't just do the two years, I will go at our portfolio. We had ITO in a little over half of our BPO revenue stream but at a very, very modest amount. So most of our big BPO plays had little server management. I'm not on the ITO contracts themselves which were big contracts for us. And we really have found in the -- I guess we're 30 days plus, 40 days, we have a very good customer reaction. So as we go around with our clients and say our future delivery model includes Atos as a delivery partner as a piece of this delivery ecosystem. I do not view it as something that's going to compromise or put us at a competitive disadvantage. They bring a lot of assets relative to the ITO space and we think that that team is an even better team for our BPO business than going it alone.

Our next question comes from the line of Brian Essex with Morgan Stanley. Your line is now open. Please proceed with your question.

I guess the first question for Kathy. As we think about some of the headwinds in particular to cash flow this year, whether it's FX or pension expenses and we talk about normalized cash flow being over $2 billion cash from operations, how do we think about how some of those pieces may move? Or how do you think about them as we're forecasting for 2016 and beyond? I guess which ones would you expect to be more prominent in 2015 given where interest rates and FX are? And when might we see a greater inflection or will we see a greater inflection towards normalized cash flow in '16 and beyond? Particularly post the sale of ITO.

I'm going to just start with a discussion about free cash flow, right? We brought our free cash flow guidance down by $100 million. Part of that obviously reflects the sale of the ITO business. We would expect to start to offset that as we do more M&A, basically utilizing the proceeds. So I would call that impact transitory impact, right? Clearly we've said we think we'll be able to offset some of the currency impacts in 2015, reflected in the guidance that we gave with respect to free cash flow. But the company is an incredibly, I would say solid and consistent cash flow producer and the sale of the ITO business is really just a modest, transitory impact on cash flow. I'm not going to try and call where currencies go in 2016, but obviously we're going to do everything that we can to offset the currency impact as much as possible. Overall with regard to pension, we're increasing our pension funding this year by about $50 million. I would expect our pension funding starts to stabilize at that point, unless there is an opportunity to do something more materially with our pension which at this point I don't necessarily see. So I think the overall factors around our cash flow are very solid. We've reduced it at the moment for some transitory issues, but I wouldn't expect those to last forever.

Okay. And can we get a sense of the capital intensity that ITO accounted for? And where might that have been offset by redeploying those funds into other areas?

Yes. Our ITO business was in the Services side clearly our most capital-intensive business, lower ROIC business for us which strategically is much of behind the sale. Not to mention we were a subscale player in ITO relative to some of our competitors. So from that perspective, its impact on free cash flow is much less and its impact on operating cash flow which is part of the reason we only brought it down modestly. We would expect we're going to deploy it into BPO which is not nearly as capital intensive.

Our next question comes from the line of Bill Shope with Goldman Sachs. Your line is now open. Please proceed with your question.

There are obviously a few moving parts in the technology business this year, so I wanted to understand the timing of some of the puts and takes you've talked about. So could you give us a bit more color on how we should think about the revenue trajectory margin path and some of these product cycle dynamics as we progress through the year? And I guess particularly how we think about the dynamics as we move from first half to second half.

Sure. As we progress through the year, just in terms of the revenue dynamics going on in Doc Tech, we'll get a bit of a benefit as a result of just from a year-over-year comp perspective. You know not doing the forward receivable sales anymore. So that had in the third and the fourth quarter about point of negative impact in 2014. So we will get an easier comp towards the back half of the year. From a foreign currency perspective on Doc Tech with regard to top line, translation impacts to top line have been immediately. The flip side of that is what's going on in transaction impacts. The transaction impacts don't hit us immediately as a result of our hedging program. So that's a little bit more back half it gets worse relative to front half as a result, that's obviously a profit and a margin constraint as opposed to a revenue constraint. So hopefully that gives you a little bit of color.

Our next question comes from the line of James Friedman with Susquehanna. Your line is now open. Please proceed with your question.

I just had a housekeeping question; I'll ask all mine upfront. So Kathy, I just want to make sure that -- am I correct that the New York Medicaid is not in the signings number at this point? My next question for Bob was if you could comment about the pricing environment. And also, Bob, are there any problem contracts [inaudible] Nevada or Texas that you would call out at this point? Or if that's too specific if you could talk about the risk management at the firm overall? Thank you.

I can probably answer all of those. So yes, Jamie, you're right, New York is not in those signings numbers neither New York nor Florida and while our overall signings were strong and the numbers were very positive, we do need to get new business ramped up and that's a big piece of that. Relative to the problem contract question, I would say we've made real progress in terms of the new systems implementations. We've got a strong team that we've added in 2014 that's really been driving that. So you can never say never in terms of issue in a given implementation. But overall we've made very good progress there and we're optimistic that we won't have big financial hits as a result of future problem contracts.

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

The signings number was very impressive for the quarter. A lot of times there is seasonality to them and maybe some deferrals that come in and things like that and so if you look at one quarter, your snapshot is very, very impressive. If you look at a trailing 12 month quarter run rate, you still have down 13%ish for a trailing 12 quarters. So can you help us bridge the gap of that trailing 12 months versus a very strong quarter and the outlook for surfaces and your confidence to grow that Services? Thank you.

Jim, no, I would agree. We were happy with the quarter and the year-to-year growth that we had in the quarter, but still as you represented, we're down double digits on a trailing 12-month basis. And again the big piece that would have changed that is if we would have had a little bit earlier timing in either New York or Florida, but those are in front of us as opposed to already booked and in our signings numbers. But the renewals have been really strong. We have seven out of the last eight quarters in BPO that we've been over 90%, so we're very positive on the renewal rates and it's really a new business, getting more traction in our new business initiatives and we believe we will do that in 2015. That is a critical, critical element for us, maybe more on our 2016 revenue than on 2015, but it's a critical element for us and we're very focused on it.

And then as a quick follow-up, you have a couple big contracts and on the call you made some references to New York and Florida that are not in the signings and I understand that correctly. But once they come into signings is there also a little bit of a timing item we should be aware of as far as when they get included into your revenues? I.e., like immediately when they sign, then the next day you can start to recognize revenues? Or is there a, hey, you signed it and then you have to sit down and talk about phases and timing and sometimes a quarter or two? Because each of those look to be quite substantial and I don't want to get too excited or maybe I should that they immediately start to enter the revenue stream.

Yes, we generally begin to recognize revenue pretty quickly, but there is a ramp. So it's that you're not at full annualized revenue in the first quarter after the signing, but I would expect in both and the way we've built our track is we expect in both New York and Florida to sign in the first half, to then start a revenue flow, not at high margins, but that's all built into our guidance. But it does take a little bit of time, typically about two quarters before you get to the annualized run-rate.

Thank you. That's all the time we have for questions today. Thank you for your interest And Ursula, anything more to wrap up?

Yes. In summary, we have a clear and consistent plan in place and in 2014 we were successful in advancing our strategic initiatives. We have a focused management team, you've heard from them today, prepared to deliver the plan and in 2015 we're committed to enhancing our overall Services business while maintaining our market leadership in Document Technology. Additionally, we will continue to make investments to move the business forward.

Thanks, Ursula. That concludes our call today. And if you have any further questions, please contact me or any member of the Investor Relations team. Thank you. Have a great day.