XEROX HOLDINGS CORPORATION Throughout the MD&A, references to "Xerox Holdings " refer toXerox Holdings Corporation and its consolidated subsidiaries while references to "Xerox" refer toXerox Corporation and its consolidated subsidiaries. References herein to "we," "us," "our," the "Company" refer collectively to bothXerox Holdings and Xerox unless the context suggests otherwise. Currently,Xerox Holdings' sole direct subsidiary is Xerox and therefore Xerox reflects the entirety ofXerox Holdings' operations. Accordingly, the following Management's Discussion and Analysis (MD&A) solely focuses on the operations of Xerox and is intended to help the reader understand the results of operations and financial condition of Xerox. The MD&A is provided as a supplement to, and should be read in conjunction with, the Condensed Consolidated Financial Statements and the accompanying notes. Throughout the MD&A, references are made to various notes in the Condensed Consolidated Financial Statements which appear in Item 1 of this form 10-Q, and the information contained in such notes is incorporated by reference into the MD&A in the places where such references are made. Currency Impact To understand the trends in our business, we believe that it is helpful to analyze the impact of changes in the translation of foreign currencies intoU.S. Dollars on revenue and expenses. We refer to this analysis as "constant currency", "currency impact" or "the impact from currency." This impact is calculated by translating current period activity in local currency using the comparable prior year period's currency translation rate. This impact is calculated for all countries where the functional currency is the local country currency. We do not hedge the translation effect of revenues or expenses denominated in currencies where the local currency is the functional currency. Management believes the constant currency measure provides investors an additional perspective on revenue trends. Currency impact can be determined as the difference between actual growth rates and constant currency growth rates. Impact of COVID-19 on Our Business Operations The global COVID-19 health crisis significantly impacted our first quarter 2020 financial results due to business closures during the month of March that impacted our customers' purchasing decisions and caused delayed installations and lower printing volumes on our devices. The third month of any quarter is typically our strongest, when the largest proportion of equipment is sold and profit is recorded, therefore our first quarter 2020 was significantly impacted by the ramping up of office closures in March which limited our ability to deliver and install equipment. Further, as more businesses required employees to work from home the use of Xerox equipment declined, impacting our post sale revenue. While we continue to implement actions to mitigate the effect of this crisis on our business and operations, the uncertainty around the duration and economic impact of this crisis, makes it difficult for the company to predict the full impact on our business operations and financial performance. We have modeled the potential impacts on our business of several recovery scenarios. Our base model assumes the greatest impact to our revenues from business closures to be during the second quarter, with an inflection point late in that period, and a gradual recovery during the third quarter. For the fourth quarter, we expect to get closer to our planned levels for that period. The most significant near-term impact from the crisis is on our equipment and unbundled supplies sales which are transactional in nature. Sales are expected to decline significantly as businesses hold off or delay purchases during the closure period. However, we expect this portion of the business to rebound in the second half as businesses reopen. The impact on revenues from lower equipment and supply sales is somewhat mitigated by bundled services, which are more contractual in nature. Our bundled services contracts, on average, include a minimum fixed charge and a significant variable component linked to print volumes. The variable charges are impacted by our customers' employees not being in the office and using our equipment due to current lock-down restrictions, however, we expect the contractual relationship with our customers will enable us to ramp up quickly for them when businesses resume operations. We expect that as closures are lifted, we will see more normalized trends emerge over the course of 2020. Xerox 2020 Form
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Overview
First Quarter 2020 Review
Total revenue of $1.86 billion for first quarter 2020 declined 14.7% from first
quarter 2019, including a 0.8-percentage point unfavorable impact from currency.
The decrease in revenue reflected a decrease of 11.4% in Post sale revenue,
including a 0.9-percentage point unfavorable impact from currency, and a
decrease of 27.5% in Equipment sales revenue, including a 0.5-percentage point
unfavorable impact from currency. As previously noted, the economic disruption
caused by the global COVID-19 health crisis significantly impacted our first
quarter 2020 revenues due to business closures during the month of March that
impacted our customers' purchasing decisions, and caused delayed installations
and lower printing volumes on our devices.
Net (loss) income attributable to Xerox Holdings and adjusted1 Net income
attributable to Xerox Holdings were as follows:
Three Months Ended March 31,
(in millions) 2020 2019 B/(W)
Net (loss) income attributable to Xerox Holdings (1)
50 158 (108)
First quarter 2020 Net income attributable to Xerox Holdings decreased $86
million as compared to first quarter 2019 reflecting the impact from lower
revenues, primarily associated with COVID-19 related business closures that were
only partially offset by lower costs and expenses, as well as higher Transaction
and related costs, net, and lower Income tax benefits. In addition, first
quarter 2020 included a $61 million increase in bad debt provision as a result
of the expected impact from the COVID-19 health crisis on our receivable
portfolio. These impacts were only partially offset by lower Restructuring and
Other expenses, net. First quarter 2020 Adjusted1 net income attributable to
Xerox Holdings decreased $108 million as compared to first quarter 2019,
reflecting lower revenues, which were only partially offset by lower costs and
expenses and lower income tax expense partially offset by the increased bad debt
provision.
Cash flows provided by operating activities of continuing operations for the
three months ended March 31, 2020 were $173 million , as compared to $222 million
in the prior year period primarily reflecting lower net income, as result of the
global COVID-19 health crisis, which was partially offset by improved working
capital, net3. Cash used in investing activities for the three months ended
March 31, 2020 was $214 million including capital expenditures of $23 million
and acquisitions of $193 million . Cash used in financing activities for the
three months ended March 31, 2020 was $60 million primarily reflecting dividend
payments of $58 million .
2020 Outlook
As a result of the uncertainty created by the global COVID-19 health crisis, we
are withdrawing our previously disclosed outlooks for full year 2020 revenue,
earnings, operating cash flow and capital allocation as disclosed in our 2019
Annual Report. At this time, we remain committed to paying our dividend on
common shares and our policy of returning at least 50% of operating cash flows,
after capital expenditures, to shareholders.
____________________________
(1)Net (loss) income from continuing operations
(2)See the "Non-GAAP Financial Measures" section for an explanation of the
non-GAAP financial measure.
(3)Working capital, net reflects Accounts receivable, net, Inventories and
Accounts payable.
Xerox 2020 Form 10-Q
36-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Management's Discussion and Analysis of our financial condition and results of operations (MD&A) is based on the condensed consolidated financial statements and accompanying notes that have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As discussed in our MD&A, during the first quarter 2020, the company was significantly impacted by the economic disruption caused by the COVID-19 health crisis. This disruption required us to review all of our estimates to ensure we appropriately considered the impacts caused by the COVID-19 health crisis. The following is a discussion of several key estimates with respect to revenue recognition, allowance for doubtful accounts and credit losses, income taxes and goodwill. As the extent and duration of the impacts from the COVID-19 health crisis remain uncertain, the Company's estimates and assumptions may evolve as conditions change. Revenue Recognition As disclosed in our 2019 Annual Report, revenues associated with our service arrangements - maintenance and document management - are generally recognized as maintenance and printing services are rendered, which is generally on the basis of the number of images produced. Accordingly, this recognition methodology requires us to estimate customer usage at the end of a period since the customer is typically not invoiced for that usage until the following period. Normally this estimation process is straightforward and objective based on our significant history with different types of customers and device usage as well as the fact that a majority of our devices have connectivity to Xerox so we can remotely read and collect usage data. In addition, as disclosed in our 2019 Annual report, our service arrangements normally include a minimum volume charge together with a variable charge, so the estimation process is limited to the variable component, which will vary based on channel and geography. However, the impacts from the COVID-19 economic disruption in the first quarter 2020 as well the related shutdowns of some of our customers required us to further review our estimation process for the variable component to ensure we properly and objectively captured the impacts of the decline in volumes particularly noted over the last two weeks of March and not solely rely on historical usage data. As we progress into 2020, we will continue to assess the usage data of our customers to ensure we properly adjust historical averages and recognize revenue consistent with those revised usage patterns and ultimately what is invoiced to the customer. Allowance for Doubtful Accounts and Credit Losses As disclosed in Notes 8 - Accounts Receivable, Net and Note 9 - Finance Receivables, Net, consistent with our adoption of ASU 2016-13 effectiveJanuary 1, 2020 (refer to Note 2 - Recent Accounting Pronouncements), the allowance for doubtful accounts and credit losses is based on an assessment of past collection experience as well as consideration of current and future economic conditions and changes in our customer collection trends. In assessing the level of reserve in first quarter 2020, we had to critically assess current and forecasted economic conditions in light of the COVID-19 health crisis to ensure we objectively included those expected impacts in the determination of our reserve. Our assessment also included current portfolio credit metrics and the level of reserves and write-offs we recorded on our receivable's portfolio during the credit crisis in 2008/09 as additional reference points to objectively determine the adequacy of our allowance. Refer also to Selling, Administrative and General Expenses (SAG) for additional discussion regarding the incremental bad debt provision recorded in the first quarter 2020 primarily related to the economic impact of the COVID-19 health crisis. Income Taxes As disclosed in our 2019 Annual Report, we record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and the amounts reported, as well as net operating loss and tax credit carryforwards. Deferred tax assets are assessed for realizability and, where applicable, a valuation allowance is recorded to reduce the total deferred tax asset to an amount that will, more-likely-than-not, be realized in the future. We apply judgment in assessing the realizability of these deferred tax assets and the need for any valuation allowances. In determining the amount of deferred tax assets that are more-likely-than-not to be realized, we considered historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary difference and tax planning strategies. Similar to other estimates during the first quarter 2020, we needed to determine if any change in valuation allowances was required based on the rapid change in the economic environment and the expected changes in our financial projections for 2020 resulting from the impacts of the COVID-19 health crisis. During the first quarter 2020, Xerox 2020 Form 10-Q 37
-------------------------------------------------------------------------------- Table of Contents it was determined that no material adjustments were required to our valuation allowances atMarch 31, 2020 . However, we will continue to monitor expected 2020 projections and their potential impact on our assessment regarding the recoverability of our deferred tax asset balances. In response to the COVID-19 pandemic, many governments have enacted or are contemplating measures to provide aid and economic stimulus. These measures may include deferring the due dates of tax payments or other changes to their income and non-income-based tax laws as well as providing direct government assistance through grants and forgivable loans. The Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which was enacted onMarch 27, 2020 in theU.S. , includes measures to assist companies, including temporary changes to income and non-income-based tax laws. In the first quarter 2020, there were no material impacts, tax or pre-tax, to our condensed consolidated financial statements as it relates to these government based COVID-19 initiatives. However, the Company is evaluating the impact of these various government assistance programs to determine if we qualify and the extent of potential support. With respect to the CARES Act, we currently expect to benefit from the deferral of certain payroll taxes through the end of calendar year 2020.Goodwill We perform our annual goodwill impairment testing in the fourth quarter of each year. During the fourth quarter 2019 impairment testing, our estimated fair value of the Company was significantly in excess of our net book value. However, in the first quarter 2020 we determined that the negative impacts as a result of the COVID-19 pandemic on our current operations and the impacts expected on our future operations as well as the significant decline in our market capitalization required us to qualitatively assess whether a triggering event had occurred and whether it was more likely than not that our goodwill was impaired as ofMarch 31, 2020 . As disclosed in our 2019 Annual Report, our qualitative assessment of the recoverability of goodwill considers various macroeconomic, industry and market-specific and company-specific events and factors. After assessing the totality of events and factors, if we determine that it is not more-likely-than-not that the fair value of the Company is less than its net book value, no further assessment is performed. If we determine that it is more likely-than-not that the fair value of the Company is less than net book value, we move to a quantitative assessment or test of goodwill. In addition to the factors previously noted, we also reviewed our previous forecasts and assumptions updated based on our current models, which are subject to various risks and uncertainties including: (1) forecasted revenues, expenses and cash flows, including the duration and extent of impact to our business from the COVID-19 pandemic, (2) current discount rates, and (3) the reduction in our market capitalization. Based on our interim qualitative assessment as ofMarch 31, 2020 , we determined that it was more-likely-than-not that the fair value of the Company was greater than net book value and that we did not have a "triggering event" requiring a quantitative or Step 1 assessment of goodwill. Although our assessment of the qualitative considerations clearly indicate that Xerox is and will be significantly impacted by the economic disruption caused by COVID-19 in 2020, based on a review of macroeconomic and industry considerations, business is expected to rebound towards the second half of the year and recover further in 2021 with the expectation of a return to normal trends by 2022. The Company's revised modeling for 2020 reflects this recovery pattern and that analysis is consistent with the review performed as part of our assessment of bad debt reserves for the first quarter 2020. In addition, we believe we have sufficient liquidity to withstand the downturn and be in a positive position when businesses are expected to recover. Further, although our market capitalization is currently below our net book value, we believe the implied premiums that would be indicated at net book value or at our estimated fair value are reasonable. There is significant uncertainty regarding the economic disruption caused by the COVID-19 health crisis and its impacts on the global growth forecast, our industry, Xerox's ability to recover in line with those considerations and our revised models for 2020 projections. In addition, there is significant uncertainty regarding the timing of economies reopening and the impacts from government and central bank actions. Notwithstanding these uncertainties, the above represents our best assessment of our current position. We will continue to monitor developments in the second quarter 2020 including updates to our forecasted revenues, expenses and cash flow as well as our market capitalization and an update of our assessment and related estimates may be required in the future as the situation evolves. If the extent and duration of the economic disruption caused by the pandemic is longer or more severe there could be a material impact to our revenues and expected cash flows and in turn the recoverability of our goodwill balance. Xerox 2020 Form
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Financial Review
Revenues
Three Months Ended
March 31, % of Total Revenue
(in millions) 2020 2019 % Change CC % Change 2020 2019
Equipment sales $ 325 $ 448 (27.5) % (27.0) % 17 % 21 %
Post sale revenue 1,535 1,732 (11.4) % (10.5) % 83 % 79 %
Total Revenue $ 1,860 $ 2,180 (14.7) % (13.9) % 100 % 100 %
Reconciliation to Condensed Consolidated Statements of (Loss) Income: Sales
$ 565 $ 724 (22.0) % (21.2) % Less: Supplies, paper and other sales (240) (276) (13.0) % (11.7) % Equipment sales$ 325 $ 448 (27.5) % (27.0) % Services, maintenance and rentals$ 1,236 $ 1,393 (11.3) % (10.5) % Add: Supplies, paper and other sales 240 276 (13.0) % (11.7) % Add: Financing 59 63 (6.3) % (5.6) % Post sale revenue$ 1,535 $ 1,732 (11.4) % (10.5) % Americas$ 1,239 $ 1,410 (12.1) % (11.8) % 67 % 65 % EMEA 575 712 (19.2) % (17.6) % 31 % 33 % Other 46 58 (20.7) % (20.7) % 2 % 2 % Total Revenue(1)$ 1,860 $ 2,180 (14.7) % (13.9) % 100 % 100 % Memo: Xerox Services$ 776 $ 853 (9.0) % (8.1) % 42 % 39 % _____________ CC - See "Currency Impact" section for a description of Constant Currency. (1)Refer to the "Geographic Sales Channels and Product and Offerings Definitions" section. Total revenue for the three months endedMarch 31, 2020 decreased 14.7%, as compared to the first quarter 2019, including a 0.8-percentage point unfavorable impact from currency and an approximate 0.8-percentage point favorable impact from recent partner dealer acquisitions. The global COVID-19 pandemic crisis significantly impacted our first quarter 2020 revenues due to business closures during the month of March that impacted our customers' purchasing decisions, and caused delayed installations and lower printing volumes on our devices. While the global pandemic affected our European and North American operations only in March, the impact to our financial performance is disproportionate, as a significant portion of our revenues and profits are typically earned during the last month of the quarter as a result of purchase patterns and relatively complex installations of printing solutions at our customers' sites. Geographically, our European operations were more heavily impacted in the current quarter due to the earlier onset of the pandemic and subsequent business closures in the region that affected the entire month of March, while inNorth America , business shutdowns impacted our operations in the second part of the month only, consistent with the timing of the health crisis. In addition, our North American operations include a larger mix of government and other large customers (including healthcare accounts) some of which are considered essential service providers or support the front lines of the fight against COVID-19 and were therefore less affected by business closures; our European operations are also more heavily mixed to indirect channel partners which drastically lowered their purchases in March to manage their cash and inventories in response to the crisis. First quarter 2020 total revenue reflected the following: Post sale revenue Post sale revenue primarily reflects contracted services, equipment maintenance, supplies and financing. These revenues are associated not only with the population of devices in the field, which is affected by installs and removals, but also by the page volumes generated from the usage of such devices, and the revenue per printed page. Post sale revenue also includes transactional IT hardware sales and implementation services from our XBS organization. For the three months endedMarch 31, 2020 Post sale revenue decreased 11.4% as compared to the first quarter 2019, including a 0.9-percentage point unfavorable impact from currency. The global COVID-19 Xerox 2020 Form
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pandemic crisis significantly impacted our Post sale revenue during the first
quarter 2020. The decline at constant currency1 reflected the following:
•Services, maintenance and rentals revenue includes rental and maintenance
revenue (including bundled supplies) as well as the post sale component of the
document services revenue from our Xerox Services offerings. These revenues
decreased 11.3% as compared to the first quarter 2019, including a
0.8-percentage point unfavorable impact from currency. The decline at constant
currency1 reflected a lower population of devices (which are partially
associated with continued lower Enterprise signings and lower installs in prior
and current periods), an ongoing competitive price environment, and lower page
volumes (including a higher mix of lower average-page-volume products) which are
worse than recent decline trends due to the impact of business closures during
the month of March associated with the COVID-19 crisis. While these revenues are
contractual in nature, on average, our bundled services contracts include a
minimum fixed charge and a significant variable component based on print
volumes.
•Supplies, paper and other sales includes unbundled supplies and other sales.
These revenues decreased 13.0% as compared to the first quarter 2019, including
a 1.3-percentage point unfavorable impact from currency and reflected lower
supplies revenues associated with lower page volume trends. The decrease in
supplies was significantly impacted by lower sales to indirect channels, which
drastically lowered their purchases in March to manage their cash and
inventories in response to the crisis.
•Financing revenue is generated from financed equipment sale transactions. The
6.3% decline in these revenues as compared to the first quarter 2019 reflected a
continued decline in the finance receivables balance due to lower equipment
sales in prior periods and included a 0.7-percentage point unfavorable impact
from currency.
____________
(1)See the "Non-GAAP Financial Measures" section for an explanation of the
non-GAAP financial measure.
Equipment sales revenue
Three Months Ended
March 31, % of Equipment Sales
(in millions) 2020 2019 % Change CC % Change 2020 2019
Entry $ 40 $ 53 (24.5)% (24.1)% 12% 12%
Mid-range 218 302 (27.8)% (27.3)% 67% 67%
High-end 64 89 (28.1)% (27.5)% 20% 20%
Other 3 4 (25.0)% (25.0)% 1% 1%
Equipment sales $ 325 $ 448 (27.5)% (27.0)% 100% 100%
_____________
CC - See "Currency Impact" section for a description of Constant Currency.
Equipment sales revenue decreased 27.5% for the three months ended March 31,
2020 as compared to the first quarter 2019, including a 0.5-percentage point
unfavorable impact from currency. The global COVID-19 pandemic crisis
significantly impacted our equipment sales revenue during the first quarter 2020
as a result of business closures during the month of March that impacted our
customers' purchasing decisions and caused delayed installations. While the
global pandemic affected our European and North American operations only in the
last month of the quarter, the impact to our financial performance is
disproportionate, as a significant portion of our revenues and profits are
typically earned during that period. The decline at constant currency1 reflected
the following:
•Entry - The decrease was primarily due to lower sales of devices through our
indirect channels in EMEA and the U.S. partially affected by the COVID-19 crisis
and partially offset by the benefit of large order deals from Eurasia that
occurred earlier in the quarter.
•Mid-range - The decrease was driven by lower sales of devices partially as a
result of the COVID-19 crisis, which more significantly affected our European
operations due to the earlier timing of business closures in that region, and a
heavier mix of businesses through indirect channel partners, who drastically
lowered their purchases in March to manage their cash and inventories in
response to the crisis. In North America , the majority of the decrease came from
our XBS and indirect channel organizations, which primarily serve SMB customers.
•High-end - The decrease reflected lower sales of production systems primarily
from our EMEA operations impacted by competitive pressures in the market,
partially offset by demand for our recently launched Baltoro
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Inkjet press and higher sales of our iGEN and Continuous Feed Color systems. The
COVID-19 pandemic affected our sales of high-end devices primarily in the lower
end of the range, due to the impact on office closures and indirect distribution
dealer activity, however, our revenues from our U.S. Enterprise organization
grew, as customers in this segment include certain government, education,
healthcare and other essential businesses that are less impacted by the
pandemic, and in some instances, had higher demand for products to support their
response to the health crisis.
Total Installs
Installs reflect new placement of devices only (i.e., measure does not take into
account removal of devices which may occur as a result of contract renewals or
cancellations). Revenue associated with equipment installations may be reflected
up-front in Equipment sales or over time either through rental income or as part
of our Xerox Services revenues (which are both reported within our post sale
revenues), depending on the terms and conditions of our agreements with
customers. Installs include activity from Xerox Services and Xerox-branded
products shipped to our XBS sales unit. Detail by product group (see Geographic
Sales Channels and Product and Offerings Definitions) is shown below:
Entry
•20% decrease in color multifunction devices reflecting lower installs of
ConnectKey devices through our indirect channels in the U.S. and in EMEA.
•2% increase in black-and-white multifunction devices reflecting large order
deals from Eurasia partially offset by lower activity from our U.S. indirect
channels.
Mid-Range(1)
•26% decrease in mid-range color installs primarily reflecting lower installs of
multifunction color devices partially offset by strong demand for our recently
launched PrimeLink light-production devices.
•14% decrease in mid-range black-and-white reflecting in part global market
trends.
High-End(1)
•52% decrease in high-end color installs reflecting primarily lower installs of
our lower-end Versant production systems, along with lower installs of our
Iridesse systems, partially offset by higher installs of our iGen and strong
demand for our recently-launched Baltoro inkjet press.
•31% decrease in high-end black-and-white systems reflecting in part global
market trends.
_____________
(1)Mid-range and High -end color installations exclude Fuji Xerox digital
front-end sales; including Fuji Xerox digital front-end sales Mid-range color
devices decreased 26% and High-end color systems decreased 53%.
Geographic Sales Channels and Product and Offerings Definitions
Our business is aligned to a geographic focus and is primarily organized on the
basis of go-to-market sales channels, which are structured to serve a range of
customers for our products and services. In 2019 we changed our geographic
structure to create a more streamlined, flatter and more effective organization,
as follows:
•Americas, which includes our sales channels in the U.S. and Canada , as well as
Mexico , and Central and South America .
•EMEA, which includes our sales channels in Europe , the Middle East , Africa and
India .
•Other, primarily includes sales to and royalties from Fuji Xerox, and our
licensing revenue.
Our products and offerings include:
•"Entry", which includes A4 devices and desktop printers. Prices in this product
group can range from approximately $150 to $3,000 .
•"Mid-Range", which includes A3 Office and Light Production devices that
generally serve workgroup environments in mid to large enterprises. Prices in
this product group can range from approximately $2,000 to $75 ,000+.
•"High-End", which includes production printing and publishing systems that
generally serve the graphic communications marketplace and large enterprises.
Prices for these systems can range from approximately $30,000 to $1,000 ,000+.
•Xerox Services, includes solutions and services that span from managing print
to automating processes to managing content. Our primary offerings are
Intelligent Workplace Services (IWS), as well as Digital and Cloud Print
Services (including centralized print services) and Communication and Marketing
Solutions.
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Costs, Expenses and Other Income
Summary of Key Financial Ratios
The following is a summary of key financial ratios used to assess our
performance:
Three Months Ended March 31,
(in millions) 2020 2019 B/(W)
Gross Profit $ 712 $ 877 $ (165)
RD&E 84 92 8
SAG 541 546 5
Equipment Gross Margin 26.3 % 35.7 % (9.4) pts.
Post sale Gross Margin 40.8 % 41.4 % (0.6) pts.
Total Gross Margin 38.3 % 40.2 % (1.9) pts.
RD&E as a % of Revenue 4.5 % 4.2 % (0.3) pts.
SAG as a % of Revenue 29.1 % 25.0 % (4.1) pts.
Pre-tax (Loss) Income $ (5) $ 73 $ (78)
Pre-tax (Loss) Income Margin (0.3) % 3.3 % (3.6) pts.
Adjusted(1) Operating Profit$ 87 $ 239 $ (152) Adjusted(1) Operating Margin 4.7 %
11.0 % (6.3) pts.
_____________
(1)See the "Non-GAAP Financial Measures" section for an explanation of the non-GAAP financial measure. Pre-tax (Loss) Income Margin First quarter 2020 pre-tax (loss) income margin of (0.3)% decreased 3.6-percentage points as compared to first quarter 2019. The decrease primarily reflected the impact of lower adjusted1 operating margin (see below), as well as higher Transaction and related costs, net, partially offset by lower Restructuring expenses and Other expenses, net. Adjusted1 Operating Margin First quarter 2020 adjusted1 operating margin of 4.7% decreased 6.3-percentage points as compared to first quarter 2019 primarily reflecting the impact of lower revenues primarily as a result of the significant effect of the COVID-19 health crisis on our business and a 3.3-percentage point unfavorable impact due to an increase in bad debt expense of$61 million to reflect the expected impact to our customer base and related outstanding trade and finance receivable portfolio as a result of the economic disruption caused by this health crisis. These negative impacts were partially offset by cost and expense reductions associated with our Project Own It transformation actions as well as additional cost reduction actions, to mitigate the impact of the crisis. ______________ (1)Refer to the Operating Income and Margin reconciliation table in the "Non-GAAP Financial Measures" section. Gross Margin First quarter 2020 gross margin of 38.3% decreased 1.9-percentage points as compared to first quarter 2019, reflecting the impact of lower revenues (including from our higher margin post sale stream) primarily as a result of the significant effect of the COVID-19 health crisis due to business closures, as well as the impact of price reductions, transaction currency and tariffs, partially offset by the benefits from our Project Own It transformation actions. Gross margins are expected to continue to be negatively impacted in future periods as a result of an increase in the cost of our imported products due to higher import tariffs. We currently estimate an approximate$30 million cost impact from these higher tariffs for the full year 2020. First quarter 2020 equipment gross margin of 26.3% decreased 9.4-percentage points as compared to first quarter 2019, reflecting the impact of lower sales primarily as a result of COVID-19 related business closures that more pronouncedly affected our higher gross margin in SMB channels, causing an adverse mix. The decline also reflected the impact of pricing incentives and incremental tariff costs partially offset by the benefits from our Project Own It transformation actions. Xerox 2020 Form 10-Q 42
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First quarter 2020 Post sale gross margin of 40.8% decreased 0.6-percentage
points as compared to first quarter 2019, reflecting the impact of lower
revenues (primarily as a result of COVID-19 related business closures) and
pricing pressure on contract renewals, partially offset by productivity and
restructuring savings associated with our Project Own It transformation actions.
Research, Development and Engineering Expenses (RD&E)
Three Months Ended
March 31,
(in millions) 2020 2019 Change
R&D $ 68 $ 77 $ (9)
Sustaining engineering 16 15 1
Total RD&E Expenses $ 84 $ 92 $ (8)
First quarter 2020 RD&E as a percentage of revenue of 4.5% increased by
0.3-percentage points as compared to first quarter 2019, primarily due to the
impact of revenue decline that outpaced the benefits of cost reductions.
RD&E of $84 million decreased $8 million as compared to first quarter 2019
partially reflecting timing of investments.
Selling, Administrative and General Expenses (SAG)
SAG as a percentage of revenue of 29.1% increased by 4.1-percentage points as
compared to first quarter 2019, including a 3.3-percentage point unfavorable
impact due to an increase in bad debt expense of $61 million reflecting the
economic disruption resulting from the COVID-19 health crisis. The remainder of
the increase is primarily driven by the effect of lower revenues, due to
COVID-19 related business closures during the month of March that impacted our
customers' purchasing decisions, and caused delayed installations and lower
printing volumes on our devices. These headwinds were partially offset by the
benefit from productivity and restructuring associated with our Project Own It
transformation actions and from additional cost reduction actions, including
lower compensation incentives and targeted marketing expenses, to mitigate the
impact of the crisis.
The global health crisis is expected to have a severe impact on economic
activity and result in a significant contraction in the GDP's of countries
worldwide. As a result, our bad debt provision of $74 million increased by $61
million as compared to first quarter 2019, primarily reflecting the expected
impact to our customer base and related outstanding receivable portfolio as a
result of the economic disruption caused by this health crisis. Consistent with
our expectations for our own business, our bad debt provision reflects a
significant decrease in global GDPs in the second quarter 2020 followed by a
recovery in the second half of 2020. It also reflects estimated impacts from
potential requests for payment deferrals and delayed payments as businesses
recover from the worldwide lockdowns. The majority of the increased provision is
related to finance receivables due to their larger balance and longer-term
nature. The increased provision resulted in a bad debt expense of approximately
2.5 percent of total receivables on a trailing-twelve-month basis (TTM), as
compared to recent trends of less than one percent in 2019. Our estimates may be
updated in future periods as we continue to monitor the development of this
crisis, including expectations for lifting of business closures and mitigating
government support actions.
SAG of $541 million decreased $5 million as compared to first quarter 2019,
reflecting productivity and restructuring savings associated with our Project
Own It transformation actions and from additional cost reduction actions,
including lower compensation incentives and targeted marketing expenses, to
mitigate the impact of the crisis. These savings were partially offset by the
increase in bad debt expense as described above.
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Restructuring and Related Costs
We incurred restructuring and related costs of $41 million for the first quarter
2020 as compared to $112 million for first quarter 2019. These costs were
primarily related to implementation of initiatives under our business
transformation projects including Project Own It. The following is a breakdown
of those costs:
Three Months Ended
March 31,
(in millions) 2020 2019
Restructuring and severance(1) $ 32 $ 12
Asset impairments(2) 2 36
Other contractual termination costs(3) 1 14
Net reversals(4) (6) (8)
Restructuring and asset impairment costs 29 54
Retention related severance/bonuses(5) 7 9
Contractual severance costs(6) 4 38
Consulting and other costs(7) 1 11
Total $ 41 $ 112 _____________
(1)Reflects headcount reductions of approximately 300 and 150 employees worldwide in three months endedMarch 31, 2020 and 2019, respectively. (2)Primarily related to the exit and abandonment of leased and owned facilities. The charge includes the accelerated write-off of$1 million and$26 million for the three months endedMarch 31, 2020 and 2019, respectively, for leased right-of-use assets and$1 million and$10 million for the three months endedMarch 31, 2020 and 2019, respectively, for owned assets upon exit from the facility, net of any potential sublease income and other recoveries. (3)Primarily includes additional costs incurred upon the exit from our facilities including decommissioning costs and associated contractual termination costs. (4)Reflects net reversals for changes in estimated reserves from prior period initiatives. (5)Includes retention related severance and bonuses for employees expected to continue working beyond their minimum notification period before termination. (6)2019 amounts reflect estimated severance and other related costs we were contractually required to pay in connection with employees transferred as part of the shared service arrangement entered into with HCL Technologies in the first quarter 2019. (7)Represents professional support services associated with our business transformation initiatives. First quarter 2020 actions impacted several functional areas, with approximately 40% focused on gross margin improvements, approximately 50% focused on SAG reductions and the remainder focused on RD&E optimization. First quarter 2019 actions impacted several functional areas, with approximately 25% focused on gross margin improvements, approximately 70% focused on SAG reductions and the remainder focused on RD&E optimization. The restructuring and related costs reserve balance as ofMarch 31, 2020 for all programs was$113 million , which is expected to be paid over the next twelve months. Refer to Note 12 - Restructuring Programs in the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs. Transaction and Related Costs, Net We incurred$17 million of Transaction and related costs, net during first quarter 2020 primarily related to legal and other professional costs associated with our recently terminated proposal to acquire HP Inc. (see the "Termination of Proposed Transaction with HP Inc." section for further details). Amortization of Intangible Assets Amortization of intangible assets for the three months endedMarch 31, 2020 of$11 million decreased by$4 million as compared to the prior year period as a result of the write-off of trade names in prior periods associated with our realignment and consolidation of certain XBS sales units as part of Project Own It transformation actions. Worldwide Employment Worldwide employment was approximately 26,300 as ofMarch 31, 2020 and decreased by approximately 700 fromDecember 31, 2019 . The reduction resulted from net attrition (attrition net of gross hires), of which a large portion is not expected to be backfilled, as well as the impact of organizational changes. Xerox 2020 Form
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Other Expenses, Net
Three Months Ended
March 31,
(in millions) 2020 2019
Non-financing interest expense $ 21 $ 28
Non-service retirement-related costs 1 13
Interest income (8)
(4)
Gains on sales of businesses and assets (1)
(1)
Contract termination costs - IT services 3
-
Currency losses, net 2
2
Loss on sales of accounts receivable - 1 All other expenses, net 5 - Other expenses, net$ 23 $ 39 Non-Financing Interest Expense First quarter 2020 non-financing interest expense of$21 million was$7 million lower than first quarter 2019. When combined with financing interest expense (Cost of financing), total interest expense decreased by$9 million from first quarter 2019 primarily due to a lower debt balance. Refer to Note 13 - Debt in the Condensed Consolidated Financial Statements, for additional information regarding the interest expense. Non-Service Retirement-Related Costs Non-service retirement-related costs for the three months endedMarch 31, 2020 decreased$12 million compared to the prior year period, primarily driven by lower losses from pension settlements in theU.S. Refer to Note 16 - Employee Benefit Plans in the Condensed Consolidated Financial Statements, for additional information regarding non-service retirement-related costs. Interest Income First quarter 2020 interest income was$4 million higher than first quarter 2019, primarily reflecting interest on a higher cash balance as a result of cash proceeds received from the sales of our indirect 25% equity interest inFuji Xerox Co., Ltd. ("FX") and indirect 51% partnership interest inXerox International Partners ("XIP") completed in fourth quarter 2019, partially offset by lower market interest rates. Income Taxes First quarter 2020 effective tax rate was 20.0%. On an adjusted1 basis, first quarter 2020 effective tax rate was 29.4%. This rate was higher than theU.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits as well as the increased impact from various non-deductible and discrete items on lower pre-tax income. The adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. First quarter 2019 effective tax rate was (13.7)% and included a benefit of$35 million related to theJanuary 2019 finalization of regulations that govern the repatriation tax from the 2017 Tax Cuts and Jobs Act (the "Tax Act"). On an adjusted1 basis, first quarter 2019 effective tax rate was 26.3%. This rate was higher than theU.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits. The adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, Amortization of intangible assets and non-service retirement-related costs as well as other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section, which included the impact of the Tax Act. Our effective tax rate is based on nonrecurring events as well as recurring factors, including the taxation of foreign income. In addition, our effective tax rate will change based on discrete or other nonrecurring events that may not be predictable. _____________ (1)Refer to the Effective Tax Rate reconciliation table in the "Non-GAAP Financial Measures" section. Xerox 2020 Form
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Equity in Net Income of Unconsolidated Affiliates
In November 2019 , Xerox Holdings sold its remaining indirect 25% equity interest
in Fuji Xerox, which had been previously accounted for as an equity method
investment. Refer to Discontinued Operations below and Note 6 - Divestitures, in
the Condensed Consolidated Financial Statements for additional information
regarding the sale of Fuji Xerox. Accordingly, our remaining investment in
Affiliates, at Equity at March 31, 2020 largely consists of several minor
investments in entities in the Middle East region.
Three Months Ended
March 31,
(in millions) 2020 2019
Equity in net income of unconsolidated affiliates - Fuji Xerox(1)
$ - $ 43 Equity in net income of unconsolidated affiliates - continuing operations
2 2
Total Equity in net income of unconsolidated affiliates $ 2 $ 45
Fuji Xerox after-tax restructuring and other charges $ - $ 12 _____________
(1) Equity in net income for Fuji Xerox for 2019 is reported in Income from discontinued operations, net of tax. Net (Loss) Income from Continuing Operations First quarter 2020 Net loss from continuing operations attributable toXerox Holdings was$2 million , or$(0.03) per diluted share. On an adjusted1 basis, Net income from continuing operations attributable toXerox Holdings was$50 million , or$0.21 per diluted share and included the impact of a$61 million pre-tax increase in bad debt expense (approximately$43 million after-tax) as compared to first quarter 2019, primarily reflecting the expected impact to our customer base and related outstanding receivable portfolio as a result of the economic disruption caused by the COVID-19 health crisis. First quarter 2020 adjustments to net loss from continuing operations included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. First quarter 2019 Net income from continuing operations attributable toXerox Holdings was$84 million , or$0.34 per diluted share. On an adjusted1 basis, Net income from continuing operations attributable toXerox Holdings was$158 million , or$0.66 per diluted share and included adjustments for Restructuring and related costs, Amortization of intangible assets and non-service retirement-related costs, as well as other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. Refer to Note 20 - (Loss) Earnings per Share in the Condensed Consolidated Financial Statements, for additional information regarding the calculation of basic and diluted earnings per share. _____________ (1)Refer to the Net (Loss) Income and EPS reconciliation table in the "Non-GAAP Financial Measures" section. Discontinued Operations InNovember 2019 ,Xerox Holdings completed a series of transactions to restructure its relationship with FUJIFILM Holdings Corporation ("FH"), including the sale of its indirect 25% equity interest inFuji Xerox Co., Ltd. ("FX") for approximately$2.2 billion as well as the sale of its indirect 51% partnership interest inXerox International Partners ("XIP") for approximately$23 million (collectively the "Sales"). As a result of the Sales and the related strategic shift in our business, the historical financial results of our equity method investment in FX and our XIP business (which was consolidated) for the periods prior to the Sales are reflected as a discontinued operation and as such, their impact is excluded from continuing operations for all periods presented. Refer to Note 6 - Divestitures in the Condensed Consolidated Financial Statements for additional information regarding discontinued operations. Other Comprehensive (Loss) Income First quarter 2020 Other Comprehensive Loss, Net Attributable toXerox Holdings was$138 million and included the following: i) net translation adjustment losses of$197 million reflecting the significant weakening of our major foreign currencies against theU.S. Dollar; ii)$54 million of net gains from the changes in defined benefit plans; and iii)$5 million of net unrealized gains. This compares to Other Comprehensive Income, Net Attributable toXerox Holdings of$40 million for the first quarter 2019, which reflected the following: i)$37 million of net translation adjustment Xerox 2020 Form
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gains, reflecting the strengthening of our major foreign currencies against the
U.S. Dollar; ii) $2 million of net unrealized gains; and iii) $1 million of net
gains from the changes in defined benefit plans.
Refer to Note 19 - Other Comprehensive (Loss) Income in the Condensed
Consolidated Financial Statements, for the components of Other Comprehensive
(Loss) Income, Note 14 - Financial Instruments in the Condensed Consolidated
Financial Statements, for additional information regarding unrealized gains,
net, and Note 16 - Employee Benefit Plans in the Condensed Consolidated
Financial Statements, for additional information regarding net changes in our
defined benefit plans.
Capital Resources and Liquidity
Our first quarter financial results were significantly impacted by COVID-19
related business closures during the month of March that impacted our customers'
purchasing decisions and caused delayed installations and lower printing volumes
on our devices. However, we believe we have sufficient liquidity to manage the
business through the economic disruption caused by this health crisis:
•A majority of our business is contractually based and our bundled services
contracts, on average, include not only a variable component linked to print
volumes, but also a fixed minimum, which provides us with a continuing stream of
operating cash flow.
•As of March 31, 2020 , total cash, cash equivalents and restricted cash were
$2,665 million and all but the restricted cash was readily accessible for use.
•We have access to an undrawn $1.8 billion Credit Facility that matures in
August 2022 .
•We have expected debt maturities of approximately $1 billion coming due in 2020
and we expect to be able to utilize a combination of cash on hand, capital
markets and securitization to manage those maturities during 2020.
•We have focused our efforts on incremental actions to prioritize and preserve
cash as we manage through this crisis. These actions include the reduction of
discretionary spend, such as compensation incentives, near term targeted
marketing spend and the use of contract employees.
Cash Flow Analysis
The following summarizes our cash, cash equivalents and restricted cash:
Three Months Ended
March 31,
(in millions) 2020 2019 Change
Net cash provided by operating activities of
continuing operations $ 173 $ 222 $ (49)
Net cash provided by operating activities of
discontinued operations - 4 (4)
Net cash provided by operating activities 173 226 (53)
Net cash used in investing activities (214) (18) (196)
Net cash used in financing activities (60) (569) 509
Effect of exchange rate changes on cash, cash
equivalents and restricted cash (29) (1) (28)
Decrease in cash, cash equivalents and restricted
cash (130) (362) 232
Cash, cash equivalents and restricted cash at
beginning of period 2,795 1,148 1,647
Cash, Cash Equivalents and Restricted Cash at End
of Period(1) $ 2,665 $ 786 $ 1,879
_____________
(1) Balance at March 31, 2019 includes $1 million associated with discontinued
operations.
Cash Flows from Operating Activities
Net cash provided by operating activities of continuing operations was $173
million in first quarter 2020. The $49 million decrease in operating cash from
first quarter 2019 was primarily due to the following:
•$185 million decrease in pre-tax income before depreciation and amortization,
restructuring and related costs and defined benefit pension costs.
•$78 million decrease from higher levels of inventory primarily due to lower
sales volume.
•$35 million decrease from accrued compensation primarily related to lower
compensation costs and the year-over-year timing of payments.
•$18 million decrease in transaction and related costs due to payments of $4
million in first quarter 2020 compared to net insurance proceeds of $14 million
in prior year.
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47-------------------------------------------------------------------------------- Table of Contents •$128 million increase from accounts receivable primarily due to lower revenue. •$86 million increase from accounts payable primarily due to the year-over-year timing of supplier and vendor payments partially offset by lower spending. •$18 million increase primarily related to the current year settlements of EUR/GBP derivative contracts reflecting the significant movement in rates during March as well as$4 million related to the settlement of interest rate swaps. •$12 million increase from finance receivables primarily related to a higher level of run-off due to lower originations. Cash Flows from Investing Activities Net cash used in investing activities was$214 million in first quarter 2020. The$196 million change from first quarter 2019 was primarily due to four acquisitions completed in the current year. These acquisitions of local resellers and multi-brand dealers expand our distribution capabilities to small-to-medium sized businesses in theU.K. andCanada . Cash Flows from Financing Activities Net cash used in financing activities was$60 million in first quarter 2020. The$509 million decrease in the use of cash from first quarter 2019 was primarily due to the following: •$404 million decrease from net debt activity primarily due to payments of$406 million on Senior Notes in prior year compared to no Senior Notes payments in the current period. •$103 million decrease due to share repurchases in prior year compared to no share repurchases in the current period. Cash, Cash Equivalents and Restricted Cash Refer to Note 7 - Supplementary Financial Information in the Condensed Consolidated Financial Statements for additional information regarding Cash, cash equivalents and restricted cash. Operating Leases We have operating leases for real estate and vehicles in our domestic and international operations as well as for certain equipment in our domestic operations. Additionally, we have identified embedded operating leases within certain supply chain contracts for warehouses, primarily within our domestic operations. Our leases have remaining terms of up to ten years and a variety of renewal and/or termination options. Refer to Note 11 - Lessee in the Condensed Consolidated Financial Statements for additional information regarding our leases accounted under lessee accounting. Debt and Customer Financing Activities The following summarizes our debt: (in millions) March 31, 2020 December 31, 2019 Principal debt balance(1)$ 4,313 $ 4,313 Net unamortized discount (14) (16) Debt issuance costs (16) (17) Fair value adjustments(2) - terminated swaps 5 1 - current swaps - 1 Total Debt$ 4,288 $ 4,282 _____________ (1)Includes no Notes Payable as ofMarch 31, 2020 andDecember 31, 2019 . (2)Fair value adjustments include the following: (i) fair value adjustments to debt associated with terminated interest rate swaps, which are being amortized to interest expense over the remaining term of the related notes; and (ii) changes in fair value of hedged debt obligations attributable to movements in benchmark interest rates. Hedge accounting requires hedged debt instruments to be reported inclusive of any fair value adjustment. Xerox 2020 Form
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Finance Assets and Related Debt
The following represents our total finance assets, net associated with our lease
and finance operations:
(in millions) March 31, 2020 December 31, 2019
Total finance receivables, net(1)
335 364
Total Finance Assets, net(2) $ 3,476 $ 3,715
_____________
(1)Includes (i) Billed portion of finance receivables, net, (ii) Finance
receivables, net and (iii) Finance receivables due after one year, net as
included in our Condensed Consolidated Balance Sheets.
(2)The change from December 31, 2019 includes a decrease of $48 million due to
currency.
Our lease contracts permit customers to pay for equipment over time rather than
at the date of installation; therefore, we maintain a certain level of debt
(that we refer to as financing debt) to support our investment in these lease
contracts, which are reflected in total finance assets, net. For this financing
aspect of our business, we maintain an assumed 7:1 leverage ratio of debt to
equity as compared to our finance assets. Approximately 35% of our finance
receivables, net balance include lease financing provided to end-user customers
who purchased equipment we sold to distributors and resellers.
Based on this leverage, the following represents the breakdown of total debt
between financing debt and core debt:
(in millions) March 31, 2020 December 31, 2019
Finance receivables debt(1)$ 2,748 $
2,932
Equipment on operating leases debt 293 319 Financing debt 3,041 3,251 Core debt 1,247 1,031 Total Debt$ 4,288 $ 4,282
____________________________
(1)Finance receivables debt is the basis for our calculation of "Cost of
financing" expense in the Condensed Consolidated Statements of (Loss) Income.
Sales of Accounts Receivable
Activity related to sales of accounts receivable is as follows:
Three Months Ended
March 31,
(in millions) 2020 2019
Estimated decrease to operating cash flows(1) $ (77) _____________
(1)Represents the difference between current and prior period accounts receivable sales adjusted for the effects of currency. Refer to Note 8 - Accounts Receivable, Net in the Condensed Consolidated Financial Statements for additional information regarding our accounts receivable sales arrangements.
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Liquidity and Financial Flexibility
We manage our worldwide liquidity using internal cash management practices,
which are subject to i) the statutes, regulations and practices of each of the
local jurisdictions in which we operate, ii) the legal requirements of the
agreements to which we are a party and iii) the policies and cooperation of the
financial institutions we utilize to maintain and provide cash management
services.
Our principal debt maturities are in line with historical and projected cash
flows and are spread over the next five years as follows:
(in millions) Amount(1)
2020 Q2 $ 313
2020 Q3 737
2020 Q4 -
2021 1,063
2022 300
2023 1,000
2024 300
2025 -
2026 and thereafter 600
Total $ 4,313
_____________
(1)Includes fair value adjustments.
Treasury Stock
No shares of our common stock were repurchased by Xerox Holdings in the first
quarter 2020. Since Xerox Holdings' Board of Directors authorized a $1.0 billion
share repurchase program in July 2019 , the cumulative total shares repurchased
by Xerox Holdings is 9.1 million shares for an aggregate cost of $300 million ,
including fees, through March 31, 2020 .
No additional shares of common stock have been repurchased since March 31, 2020 ,
through our filing date, May 7, 2020 .
Shared Services Arrangement with HCL Technologies
In March 2019 , as part of Project Own It, Xerox entered into a shared services
arrangement with HCL Technologies ("HCL") pursuant to which we transitioned
certain global administrative and support functions, including, among others,
selected information technology and finance functions (excluding accounting),
from Xerox to HCL. This transition is expected to continue in 2020 and HCL is
expected to make certain ongoing investments in software, tools and other
technology to consolidate, optimize and automate the transferred functions with
the goal of providing improved service levels and significant cost savings. The
shared services arrangement with HCL includes a remaining aggregate spending
commitment of approximately $1.2 billion over the next 6 years. However, we can
terminate the arrangement at any time at our discretion, subject to payment of
termination fees that decline over the term, or for cause.
During first quarter 2020, we incurred net charges of approximately $45 million
associated with this arrangement. The cost has been allocated to the various
functional expense lines in the Condensed Consolidated Statements of (Loss)
Income based on an assessment of the nature and amount of the costs incurred for
the various transferred functions prior to their transfer to HCL.
Termination of Proposed Transaction with HP Inc.
In November 2019 , Xerox Holdings commenced a proposed business combination
transaction with HP Inc. ("HP"). HP rejected our initial and subsequent
proposals and refused to engage in mutual due diligence or negotiations. In
January 2020 , Xerox Holdings nominated a slate of directors to HP's board to be
voted on at HP's 2020 annual meeting of stockholders and shortly thereafter, it
launched a tender offer to acquire all outstanding shares of HP, as it intended
to continue to pursue the proposed business combination transaction. However,
the ongoing COVID-19 global health crisis and resulting macroeconomic and market
turmoil created an environment that the company determined to not be conducive
to Xerox Holdings continuing its pursuit of an acquisition of HP. Accordingly,
on
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50-------------------------------------------------------------------------------- Table of ContentsMarch 31, 2020 Xerox Holdings withdrew its tender offer to acquire HP and will no longer seek to nominate a slate of candidates to HP's board of directors. In 2020,Xerox Holdings had obtained$24 billion in financing commitments from several banks to support the cash portion of the proposed business combination transaction with HP. OnMarch 31, 2020 , following the withdrawal ofXerox Holdings' tender offer to acquire HP, notice was provided to the banks of the immediate termination of the financing commitment. No termination penalties or other fees were paid as a result of termination. Financial Risk Management We are exposed to market risk from foreign currency exchange rates and interest rates, which could affect operating results, financial position and cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when appropriate, through the use of derivative financial instruments. We utilize derivative financial instruments to hedge economic exposures, as well as to reduce earnings and cash flow volatility resulting from shifts in market rates. We enter into limited types of derivative contracts, including interest rate swap agreements, foreign currency spot, forward and swap contracts and net purchased foreign currency options to manage interest rate and foreign currency exposures. Our primary foreign currency market exposures include the Japanese Yen, Euro and U.K. Pound Sterling . The fair market values of all our derivative contracts change with fluctuations in interest rates and/or currency exchange rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial instruments are held solely as risk management tools and not for trading or speculative purposes. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities. We are required to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. As permitted, certain of these derivative contracts have been designated for hedge accounting treatment. Certain of our derivatives that do not qualify for hedge accounting are effective as economic hedges. These derivative contracts are likewise required to be recognized each period at fair value and therefore do result in some level of volatility. The level of volatility will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the currency and interest rate markets during the period. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities. By their nature, all derivative instruments involve, to varying degrees, elements of market and credit risk. The market risk associated with these instruments resulting from currency exchange and interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. We do not believe there is significant risk of loss in the event of non-performance by the counterparties associated with these instruments because these transactions are executed with a diversified group of major financial institutions. Further, our policy is to deal with counterparties having a minimum investment grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties. The current market events have not required us to materially modify or change our financial risk management strategies with respect to our exposures to interest rate and foreign currency risk. Refer to Note 14 - Financial Instruments in the Condensed Consolidated Financial Statements for further discussion and information on our financial risk management strategies. Xerox 2020 Form
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Non-GAAP Financial Measures
We have reported our financial results in accordance with generally accepted
accounting principles (GAAP). In addition, we have discussed our financial
results using the non-GAAP measures described below. We believe these non-GAAP
measures allow investors to better understand the trends in our business and to
better understand and compare our results. Accordingly, we believe it is
necessary to adjust several reported amounts, determined in accordance with
GAAP, to exclude the effects of certain items as well as their related income
tax effects.
A reconciliation of these non-GAAP financial measures to the most directly
comparable financial measures calculated and presented in accordance with GAAP
are set forth below as well as in the first quarter 2020 presentation slides
available at www.xerox.com/investor.
These non-GAAP financial measures should be viewed in addition to, and not as a
substitute for, the Company's reported results prepared in accordance with GAAP.
Adjusted Earnings Measures
•Net income and Earnings per share (EPS)
•Effective tax rate
The above measures were adjusted for the following items:
Restructuring and related costs: Restructuring and related costs include
restructuring and asset impairment charges as well as costs associated with our
transformation programs beyond those normally included in restructuring and
asset impairment charges. Restructuring consists of costs primarily related to
severance and benefits paid to employees pursuant to formal restructuring and
workforce reduction plans. Asset impairment includes costs incurred for those
assets sold, abandoned or made obsolete as a result of our restructuring
actions, exiting from a business or other strategic business changes. Additional
costs for our transformation programs are primarily related to the
implementation of strategic actions and initiatives and include third-party
professional service costs as well as one-time incremental costs. All of these
costs can vary significantly in terms of amount and frequency based on the
nature of the actions as well as the changing needs of the business.
Accordingly, due to that significant variability, we will exclude these charges
since we do not believe they provide meaningful insight into our current or past
operating performance nor do we believe they are reflective of our expected
future operating expenses as such charges are expected to yield future benefits
and savings with respect to our operational performance.
Amortization of intangible assets: The amortization of intangible assets is
driven by our acquisition activity which can vary in size, nature and timing as
compared to other companies within our industry and from period to period. The
use of intangible assets contributed to our revenues earned during the periods
presented and will contribute to our future period revenues as well.
Amortization of intangible assets will recur in future periods.
Transaction and related costs, net: Transaction and related costs, net are
expenses incurred in connection with i) our announced proposal to acquire HP
Inc. and ii) our planned transaction with Fujifilm/Fuji Xerox, which was
terminated in May 2018 , inclusive of costs related to litigation resulting from
the terminated transaction and other shareholder actions. The costs are
primarily for third-party legal, accounting, consulting and other similar type
professional services as well as potential legal settlements. These costs are
considered incremental to our normal operating charges and were incurred or are
expected to be incurred solely as a result of the planned transactions.
Accordingly, we are excluding these expenses from our Adjusted Earnings Measures
in order to evaluate our performance on a comparable basis.
Non-service retirement-related costs: Our defined benefit pension and retiree
health costs include several elements impacted by changes in plan assets and
obligations that are primarily driven by changes in the debt and equity markets
as well as those that are predominantly legacy in nature and related to
employees who are no longer providing current service to the company (e.g.
retirees and ex-employees). These elements include (i) interest cost, (ii)
expected return on plan assets, (iii) amortization of prior plan amendments,
(iv) amortized actuarial gains/losses and (v) the impacts of any plan
settlements/curtailments. Accordingly, we consider these elements of our
periodic retirement plan costs to be outside the operational performance of the
business or legacy costs and not necessarily indicative of current or future
cash flow requirements. This approach is consistent with the classification of
these costs as non-operating in other expenses, net. Adjusted earnings will
continue to include the service cost elements of our retirement costs, which is
related to current employee service as well as the cost of our defined
contribution plans.
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Other discrete, unusual or infrequent items: We excluded the following items
given their discrete, unusual or infrequent nature and their impact on our
results for each period:
•Contract termination costs - IT Services
•Impacts associated with the Tax Cuts and Jobs Act (the "Tax Act") enacted in
December 2017
We believe the exclusion of these items allows investors to better understand
and analyze the results for the period as compared to prior periods and expected
future trends in our business.
Adjusted Operating Income and Margin
We calculate and utilize adjusted operating income and margin measures by
adjusting our reported pre-tax (loss) income and margin amounts. In addition to
the costs and expenses noted as adjustments for our Adjusted Earnings measures,
adjusted operating income and margin also exclude the remaining amounts included
in Other expenses, net, which are primarily non-financing interest expense and
certain other non-operating costs and expenses. We exclude these amounts in
order to evaluate our current and past operating performance and to better
understand the expected future trends in our business.
Constant Currency (CC)
Refer to "Currency Impact" for a discussion of this measure and its use in our
analysis of revenue growth.
Summary
Management believes that all of these non-GAAP financial measures provide an
additional means of analyzing the current period's results against the
corresponding prior period's results. However, these non-GAAP financial measures
should be viewed in addition to, and not as a substitute for, the company's
reported results prepared in accordance with GAAP. Our non-GAAP financial
measures are not meant to be considered in isolation or as a substitute for
comparable GAAP measures and should be read only in conjunction with our
consolidated financial statements prepared in accordance with GAAP. Our
management regularly uses our supplemental non-GAAP financial measures
internally to understand, manage and evaluate our business and make operating
decisions. These non-GAAP measures are among the primary factors management uses
in planning for and forecasting future periods. Compensation of our executives
is based in part on the performance of our business based on these non-GAAP
measures.
A reconciliation of these non-GAAP financial measures and the most directly
comparable measures calculated and presented in accordance with GAAP are set
forth on the following tables:
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Net (Loss) Income and EPS reconciliation:
Three Months Ended March 31,
2020 2019
(in millions, except per share amounts) Net (Loss) Income EPS Net Income EPS
Reported(1) $ (2) $ (0.03) $ 84 $ 0.34 Adjustments:
Restructuring and related costs 41 112 Amortization of intangible assets 11 15 Transaction and related costs, net 17 - Non-service retirement-related costs 1 13 Contract termination costs - IT services 3 - Income tax on adjustments(2) (21) (31) Tax Act - (35) Adjusted $ 50$ 0.21 $ 158 $ 0.66 Dividends on preferred stock used in adjusted EPS calculation(3)$ (4) $ - Weighted average shares for adjusted EPS(3) 216 240 Fully diluted shares at March 31, 2020(4) 217
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(1)Net (loss) income and EPS from continuing operations attributable toXerox Holdings . (2)Refer to Effective Tax Rate reconciliation. (3)Average shares for the calculation of adjusted diluted EPS for 2020 exclude 7 million shares associated with our Series A convertible preferred stock and therefore earnings include the preferred stock dividend. In addition, adjusted diluted EPS shares for 2020 include 4 million shares for potential dilutive common shares, which are not included in the GAAP EPS calculation since it was a loss. Average shares for the calculation of adjusted diluted EPS for 2019 exclude the preferred stock dividend and include 7 million shares associated with our Series A convertible preferred stock (4)Represents common shares outstanding atMarch 31, 2020 plus potential dilutive common shares as used for the calculation of adjusted diluted EPS for the first quarter 2020. The amount excludes shares associated with our Series A convertible preferred stock as they are expected to be anti-dilutive for the year. Effective Tax Rate reconciliation: Three Months Ended March 31, 2020 2019 Income Tax (Benefit) Effective Income Tax Effective (in millions) Pre-Tax (Loss) Income Expense Tax Rate Pre-Tax Income (Benefit) Expense Tax Rate Reported(1) $ (5) $ (1) 20.0 % $ 73$ (10) (13.7) % Non-GAAP Adjustments(2) 73 21 140 31 Tax Act - - - 35 Adjusted(3) $ 68 $ 20 29.4 % $ 213 $ 56 26.3 %
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(1)Pre-tax (loss) income and income tax benefit from continuing operations. (2)Refer to Net (Loss) Income and EPS reconciliation for details. (3)The tax impact on Adjusted Pre-Tax Income is calculated under the same accounting principles applied to the Reported Pre-Tax (Loss) Income under ASC 740, which employs an annual effective tax rate method to the results. Operating Income and Margin reconciliation:
Three Months Ended March 31,
2020 2019
(in millions) (Loss) Profit Revenue Margin Profit Revenue Margin
Reported(1) $ (5) $ 1,860 (0.3) % $ 73 $ 2,180 3.3 %
Adjustments:
Restructuring and related costs 41 112
Amortization of intangible assets 11 15
Transaction and related costs, net 17 -
Other expenses, net 23 39
Adjusted $ 87 $ 1,860 4.7 % $ 239 $ 2,180 11.0 %
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(1)Pre-Tax (Loss) Income and Revenue from continuing operations
Xerox 2020 Form 10-Q
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