Good morning and welcome to the Xerox Holdings Corporation Fourth 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 Holdings Corporation, today’s conference call is being recorded. Other recording and/or rebroadcasting of this call are prohibited without the express permission of Xerox. After the presentation, there will be a question-and-answer session. [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 fourth quarter 2019 earnings call. Last February, we put a three-year plan in place, guided by our strategic initiatives to optimize our operations, drive revenue, reenergize our innovation engine, and focus on cash. 2019 was focused on building a strong foundation that will position us for sustainable long-term growth. And among other things, we expanded Project Own It, our enterprise-wide transformation initiative to optimize our operations, drive investments back into our business, and create a culture of continuous improvement. We’ve monetized our illiquid 25% stake in Fuji Xerox for over 20 times that asset’s annual cash flow, unlocking significant unrealized value. We implemented a more frictionless, high-velocity supply chain to increase flexibility and customer responsiveness. We invested in technology enhancements and product launches designed to increase revenue in core and adjacent markets, as well as new areas of innovation for future growth. We stood by our commitment to innovate and put the brainpower of our best scientists and engineers on solving some of the biggest challenges the modern world is facing, and we promoted and attracted new talent at all levels of the organization to elevate our game. We ended 2019 stronger, delivering full-year results that are ahead of schedule on almost all financial metrics. Our employees are excited about the future and direction of their Company and clients increasingly seek us out for workplace solutions. Our full-year results position us well to deliver on our three-year commitment of expanding adjusted margins by 200 basis points, growing adjusted EPS annually by more than 7%, generating more than $3 billion of cumulative free cash flow, and achieving flat year-over-year revenue in 2021. In the fourth quarter, we grew earnings per share, increased cash flow, expanded adjusted operating margin, and maintained the momentum to…

Thanks, John. We delivered a strong finish to the year. In the fourth quarter, we exceeded our expectations for EPS and revenue, and we delivered cash flow and adjusted operating margin in line with our expectations. Overall, we are pleased with the quarter and resulting full year performance. On a full year year-over-year basis, adjusted operating margin expanded 180 basis points, adjusted EPS was up 23%, free cash flow grew 19% and we saw improvement in the rate of revenue decline in the second half of the year as investments in our business began to gain more traction, and we expect this momentum to continue in 2020. Before going into details of our income statement, I want to remind everyone that in the fourth quarter, we completed a series of transactions to restructure our relationship with Fujifilm, which included the sale for more than 20 times related to cash flows of our 25% equity interest in Fuji Xerox, as well as the sale of our 51% partnership interest in Xerox International Partners, XIP, which was fully consolidated. Consequently, the financial results presented here are from continuing operations and exclude the financial results attributable to our former equity stake in Fuji Xerox and our XIP business, which are now presented as discontinued operations. Also, I’d like to point out that the reported numbers include the benefit of an upfront OEM license fee of $77 million we negotiated from Fuji Xerox, which was received in the fourth quarter in connection with restructuring that relationship. This benefit was included in our updated 2019 guidance measures filed with the U.S. Securities and Exchange Commission on Form 8-K on December 3, 2019. That reflected adjustments resulting from the transactions with Fujifilm. Looking at the income statement. Total revenues in the quarter declined 1.6% in constant…

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 line for questions now.

[Operator Instructions] Our first question comes from Matt Cabral of Credit Suisse. Your line is now open.

Thank you. John, on the HP acquisition, you touched on this in your prepared remarks, but I’m wondering if you could dig a little bit deeper into what you see as the biggest benefits of industry consolidation? And just what gives you confidence in at least $2 billion of incremental cost takeout created through the combination?

Yes. Matt, we’ve -- when we looked at the combination of $2 billion, one thing that’s clear is you only get that -- you only get that $2 billion, if the two companies combine together. And what we did is a detailed analysis per pillar of what we believe would be savings of combining the two companies together, and in our document that we presented to the shareholders, we went into a level of detail that talks about it. So, our confidence in the $2 billion is quite high that we can hit that. And if you look at our team and our track record of what we’ve done with Project Own It here, we delivered $1 billion over the last 18 months, and we’re on track to deliver the $450 million plus in 2020. So, we have the track record. This document and this -- that we put together, was built by our team, our management team. So, you look at who’s on our management team, and these are a lot of folks that have done restructuring in the past. I can tell you that the shareholders, they see the logic in the proposed transaction. They’ve told us that the combination of the two companies bring tremendous value. Inside of our business case, we only focus and we only use the cost savings, but there are synergies that are detailed as well that we believe we can get by combining the two companies together.

Got it. And then now that you’ve exited the JV with Fuji, I’m wondering if you could talk a little bit about what that supplier relationship looks like going forward, and how you’re thinking about opportunity in Asia after the technology agreement ends with them in March of 2021?

Hey, Matt, it’s Bill. So, we look at the renegotiation of the -- our relationship with Fujifilm, and it is clearly a positive from a supplier perspective. Many benefits, a more normal type of relationship now with supplier, customer as opposed to before, we also had to factor in the 25% interest. As far as -- and the -- when we renegotiated the relationship, there are actually benefits in the product or supply arrangements we have with them going forward. There were certain terms that existed in the prior agreements that we negotiated on more favorable terms going forward. And as we’ve discussed before, these product supply arrangements go out from a period of five to seven years and really the earliest, any of them come up for renewal on a staggered basis is 2023. As far as looking forward, and the impact is we can go into the Asia Pacific market, under -- without -- for products other than xerographic products. For xerographic-related products, we could potentially go in as early as April 2021 under the Xerox name. However, if they choose to extend for two years the use of the Xerox name, we could still go into the Asia Pacific markets with xerographic products but not under the Xerox name. So, more likely, we’d be going in a more significant way, two years later in April 2023.

Thank you. And our next question comes from Ananda Baruah of Loop Capital. Your line is now open.

Hi. Good morning, John, Bill. Congratulations on the solid results in the second straight quarter of top line momentum. Two for me, if I could, just starting back out -- back with HP, John, what would be Xerox’s next preferred action given the letter with regards to Board level elections that you guys published? Would it be to engage in conversations or would it be to kind of go into the summer with the Board level elections? And then, I have a business model follow-up.

Yes. Ananda, I can say the meetings we’ve had with the HP shareholders have been quite positive. And they understand our transaction, and they believe in the combination. Their concern as is ours is the refusal to engage in a normal course of action at this point in the process. So, we’re hoping to engage with the HP executives, and we’ve offered that to engage with them and have a discussion on how we bring this to closure because we both see the logic of this combination and we’re not where we ought to yet.

That’s helpful. I appreciate that context. And then, with regards to the 2020 guidance and John, you alluded -- or you didn’t allude to it, you made mention of still existing goal of getting to flat constant currency revenue growth in 2021. The 4% guide for 2020, while quite favorable as I think you’re probably trending a little bit ahead of schedule right now, how do you go from -- how do you see footing from the 4% in 2020 to the flat in 2021? And as part of that conservatism -- actually, let me just stop there, and then I have a quick one on the margins and free cash flow for 2020 as well. Thanks.

Yes. Look, we’re confident in the revenue guidance. And if you think of our continued demand for high-end production systems, our strength in the SMB channel, our new product launches that we’re going to be doing, our new investments in 2020, so we’re executing on the strategy. And while transformation is not linear, we’ve seen that there’s been bumps along the way, like we had in the first quarter of last year, but we’re building an organization to respond quickly to this Ananda. And for 2021, our road to flat revenue is just we believe that we can get there, and we’re going to do it by improving the organic revenue, and like I said, the traction on the above topics.

And just to add on, Ananda. In 2020, we’re expecting really minimal impact from inorganic. As you know, last year we did approximately $40 million of tuck in acquisitions, we’ve guided towards $100 million this year, but we’re expecting little impact. But in 2021, factored into getting to flat when you have $100 million target in 2020 and 2021 that that would also have a favorable impact on getting to flat by 2021.

Yes. Got it, understood. And then, Bill, just quickly on the 2020 op margin guidance and free cash flow guidance. I think, you’ve put the part of this to the 13% margin, which is flat and the free cash flow, which is kind of relatively flat. It sounds like the -- at least part of that -- the reason for the flatness is that you’re backing -- you’re sort of saying as you take out the license impact from Fuji Xerox, it actually -- the margin would actually be up in 2020. And I guess, you are pointing out to this slight increase in free cash over 2020. But, can you just sort of backfill for us, particularly given the $450 million of gross cost saves, why perhaps the op margin expansion will be greater and the free cash flow expansion will be greater? And that’s it for me. I appreciate it.

Yes. Great. So, from an operating margin perspective, just taking a step back, we laid out our three-year plan last February. We said, in year one we’d do 100 to 150 basis-point improvement. This year, after you take out the OEM fee, we actually did 110 basis-point improvement going from about 11.3 to 12.4, so on plan with our three-year plan. And we’re also involved -- in taking into account 110, we are also able to make significant investments in our back office and in revenue on our top line and still achieve that 110 basis-point expansion, in line with our 100 and 150 basis-point guidance. As far as next year, you hit on the main point that taking out that OEM fee, it’s really about a 60 basis-point improvement. And according to our three-year plan, we said 100 to 150 in year one, and then approximately 50 basis points plus in year two and year three, 60 basis points being in line with that and a lot of that continuing to come from Project Own It initiatives, which we’re retargeting $450 million in 2020. So, we think -- we believe that we’re clearly on plan with respect to our adjusted operating margin expansion.

And the next question comes from Shannon Cross of Cross Research. Your line is now open.

John, I was curious, obviously going forth with HP, HP has indicated that the offer significantly undervalues what they believe the valuation of their assets are? So, now that you have your slate of directors out there, is there a willingness to revisit your offer, just how are you thinking about that? And I’m also curious as to -- and this is -- I’m not actually sure what the answer is. I’m curious to how the two boards would work together, post deal. So, do we assume that the directors you put out for HP are kind of short-term to get the deal done, or would you assume you have a significantly expanded board following a combination of HP and Xerox? Thanks. And I have a follow-up.

Yes. I would say our slate is a group of highly qualified accomplished individuals. And they understand what the challenges are of a global enterprise. And that’s what we’ve brought forward as we said, and that was after we got the $24 billion secured. On price, we’re not going to speculate on potential actions. We said many times that we would be willing to meet with HP to begin negotiating a transaction. And we’re asking HP to engage in a constructive dialogue, so that we could explore ways on maximizing value for both our shareholders.

Okay. So, if they don’t, then it just -- it moves to the board that I guess you don’t anticipate. Anyway, you’re not going to negotiate on the phone with me. So, that’s fine. I guess, the question I have to -- for Bill is, in terms of cash flow, finance receivables was about $175 million of cash, I think in 2019, which I believe was down year-over-year, but still obviously was a source of cash, but it was used in fourth quarter. I know these things can sort of be -- are not linear by any means. But, that combined with a $58 million in cash that you got from the sale of IT, provides somewhat of a headwind when you look to next year. So, I’m curious how much more benefit you think you can get from working capital? Is there any sort of one-timers we should think about for next year in cash flow, or is the vast majority of it just going to come from the improvement in operating profit? Thank you.

Yes. As far as the working capital improvements for next year, the main thing that we’re focusing on is improved working capital. In particular, we had over $100 million improvement this year in inventory. We expect to have some continued improvement next year in inventory, but as well we think there are significant opportunities in receivables and payables. As far as finance receivables, $175 million source, obviously that’s a source that is not a good source. In fact, we [indiscernible] the source, and it’s part of our modeling for next year with the improved revenues and ESR. In originations, we are in our model factoring in less of a finance receivable source, which is a good headwind to have, means that we’re getting a more ESR and more miss out there. And you’re right, it’s about $58 million of the one time for the OEM. So, the two of those being headwinds, we expect to still overcome those, mainly through improvements, not only in our cost structure, but also in working capital components of AR, AP. And although we had over $100 million this year improvement in inventory, we still think there’s some improvements that we can get in inventory for next year.

And our next question comes from Katy Huberty of Morgan Stanley. Your line is now open.

Bill, question for you on revenue, the 4% in constant currency decline in 2020. How do you compare that to the 3% decline you talked about at the Analyst Day a year ago? Are those comparable? And if so, how would you explain the difference?

Yes. So, there have been adjustments obviously with the Fujifilm transaction and disc ops and everything. But at a high level, just taking a step back, I think that we’re probably about 100 basis points off where we would have liked to have been. We guided 3%, and lot of it’s due to various reasons. And with the bumpy start at the beginning of the year with the disruptions we talked about on the XBS side, then improved during the second half. And there’s clearly room for improvement, continued improvement in XBS going forward in 2020. But, we believe we have levers in place, rates improvement, still get the blast by 2021. But you’re correct, just taking a step back, it’s probably about 100 basis points less than where we would liked to be at this point.

And you mentioned in the slide deck and also on this call that investments are beginning to impact revenue, you saw that in the back half of 2019. Any context for how much incremental revenue you were able to generate in 2019 or what the incremental revenue impact is in 2020?

So, at a high level, those investments played out in various areas, somewhat in ESR. we had significant improvements in the second half of the year with respect to ESR, on the 1% to 2% decline range versus the first half. Q1 was down around 5%, Q2 around 8%. So, investments there, but in the post sale area, in particular and we’ve talked about this quite a bit, in supplies in particular, unbundled supplies. Most of our supplies are part of bundled arrangement, so over 75% of arrangements relate to bundled supplies. But, there are what we called unbundled or unattached supplies. And earlier this past year, we expanded our organization, really created an organization to sell with respect to those unbundled supply agreements. And we saw significant improvement from where we were like, in the first two quarters 9% to 12%, year-over-year declines to significant low-single-digit decline in supplies. So, we saw significant improvement in the second half of the year, based upon our investment in the supplies area, and we started to see some improvement in the IP services area. We’ve made investments in expanding that from where we had 3 of our XBS quarters to 10 by the end of the year and early this year will be pretty much all of XBS selling IT services.

Thank you. And then just one last question, separate from discussion around valuation and what you’d ultimately be willing to pay. Any feedback from the banks who provided the debt commitment around whether there’s the potential to take on even more debt or what leverage ratio they’d be willing for you to exit a deal with HP?

We believe that we have flexibility. We lined up the $24 billion in financing commitment. We believe our arrangements with those financial institutions allow us flexibility if need be.

Yes. And you could imagine, Katy, the amount of analysis that the banks went through before they agreed to give us a $24 billion in financing, the due diligence that they had to go through with us to give them confidence.

Thank you. And our next question comes from Paul Coster of JP Morgan. Your line is now open.

So, a couple of quick ones, just building on Ananda’s questions from earlier on. You’ve explained why operating margins, the improvements is attenuating a little bit in 2020. Can you just talk a little bit about the Own It, so payback on gross savings? Is still sort of $0.65 on every dollar or is that also attenuating as you move into 2020?

So, I think you’re referring to, Paul, the cost of our savings. And we’ve said that our cost to get those gross savings is less than $0.40 of a dollar. It was about $0.35 last year, but it’s a little less than $0.40. Looking to next year, that $450 million of gross savings that we expect a similar type of cost in $0.35 to $0.40 range in order to achieve those savings.

Okay. So, no change in the payback on those savings, gross savings?

No.

Okay. Got it. And then, the other question I got is, as you look to 2021, assuming the business as is, you’re looking for 300 basis-point plus year-on-year improvement in revenues. And I maybe missed a little bit of the nuances earlier on. But, can you just talk to us about why the sudden inflection? Is it that these new initiatives all suddenly mature at the same time, or is there some other reason why you have that confidence?

So, if you look at what we’re guiding towards in 2020 versus a normalized 2019, we’re guiding towards about 150 basis-point improvement year-over-year to get there approximate 4%. And that’s minimal inorganic involved in that. As I said, there was a little last year to have a rollover. And, there’s just -- we’re not factoring in that much for this year. We do expect those investments to accelerate. So, that 150 basis-point improvement year-over-year from ‘19 to ‘20 we could see being in the 200 to 300 basis-point improvement in 2021 versus 2020. But, we will also -- part of it, as I said earlier factors in that we’ve allocated approximately $100 million per year of tuck-ins. It can be more or less in any given year. As I said last year was only $42 million. But that we would expect, those come to fruition. And by the way, those tuck-ins, we’re not just looking at the U.S., we are looking in certain countries in Europe and expanding the XBS models to those countries. But, we could see that having a point, 2 points of benefit also potentially in 2021.

Got it. One quick question, it just popped out, and maybe the high end 8% year-on-year improvement in black-and-white printers was -- that was amazing change there. Is it just simply the lumpiness of that business in the enterprise accounts, or do you think that’s sustainable?

High end has overall had some significant improvement. In the second half of the -- for the full year, we actually grew our high end ESR in the -- for the full year and in Q3 and Q4. But if you take step back, and we’ve talked about a lot of things that the new year -- the relatively new year that product’s been out for about a year or so now, strong demand for that. Baltoro, our high end inkjet machine, cut sheet inkjet, significant demand for that. And our iGen. We refreshed certain features on the iGen, iGen 5, That has also contributed. So, the hand is clearly a success area for us full year, year-over-year growth from ESR and in the third and fourth quarters, 2% to 3% growth from an ESR perspective.

Sorry. I was referring to the black-and-white segment in particular in high ends. Is that just simply enterprise accounts lumpiness or is that…

You could have still -- on the high-end enterprise, you could still have some of the iGen machines. Yes.

Sorry. I’m referring to black-and-white, but we can take this offline.

Okay.

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to John for any closing remarks.

Thank you for your time today. As we start 2020, Xerox is positioned to make further progress against our three-year plan. We’ve built a strong team and even stronger foundation. We will continue our efforts to achieve success someone thought was impossible at Xerox. So, we’re moving forward. Thanks, everybody.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.