Xerox Holdings Corp 10-Q

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Throughout the Management’s Discussion and Analysis (MD&A), references to “Xerox Holdings” refer to Xerox Holdings Corporation and its consolidated subsidiaries while references to “Xerox” refer to Xerox Corporation and its consolidated subsidiaries. References herein to “we,” “us,” “our,” the “Company” refer collectively to both Xerox Holdings and Xerox unless the context suggests otherwise. Currently, Xerox Holdings' sole direct subsidiary is Xerox and therefore Xerox reflects the entirety of Xerox Holdings' operations. Accordingly, the following 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 into U.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 In response to the global COVID-19 pandemic crisis, we have prioritized the health and safety of our employees, customers and partners and continue to work to support their needs. While we continue to implement actions to mitigate the effects 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 of the crisis on our business operations and financial performance. We have modeled the potential impacts on our business of numerous recovery scenarios. The most significant near-term impact from the crisis has been on our equipment and unbundled supplies sales which are transactional in nature. Sales are expected to continue to decline significantly as businesses hold off or delay purchases during the closure period and until there is a more certain path to controlling the health pandemic and to economic recovery. However, we expect this transactional portion of the business to begin to recover gradually 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 the current lock-down and capacity restrictions in office buildings as they reopen. We expect that this contractual relationship will continue to enable us to be ready to ramp up and support our customers' needs as businesses resume operations. The continued uncertainty around the spread and resurgence of the virus has changed our prior expectation for an inflection point following the second quarter. While Europe, Canada and some areas of the U.S. are reopening after controlling the rate of new infections, other areas in Latin America and parts of southern and western U.S. are seeing surges that have forced the rollback of business reopenings and impacted their economies. We experienced some signs of recovery, and a moderation in our rate of revenue declines during the month of June, however we expect that our business will continue to be impacted by the ongoing uncertainty. Accordingly, we now expect a slower pace of gradual recovery in the second half of the year. We have a strong balance sheet and sufficient liquidity, including access to our undrawn $1.8 billion revolver as well as to receivables securitization and capital markets. Due to our Project Own It transformation, we have a more flexible cost structure, and have also 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 near term targeted marketing programs and the use of contract employees as well as compensation incentives consistent with lower sales and operating results. Xerox 2020 Form 10-Q 37 Government Assistance and Furlough Programs In response to the COVID-19 pandemic crisis, various governments have enacted or continue to contemplate temporary measures to provide aid and economic stimulus directly to companies through cash grants and credits or indirectly through payments to temporarily furloughed employees. On March 27, 2020, in response to the COVID-19 crisis, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). In addition to including temporary changes to income and non-income-based tax laws, the CARES Act also provides refundable employee retention credits and defers the requirement to remit the employer-paid portion of social security payroll taxes. Similar pay protection programs were enacted in Canada and Europe that primarily provide direct grants to companies to cover the salary and wages of employees (retained or temporarily furloughed). During second quarter 2020, we recognized savings of approximately $60 million from these temporary measures in the U.S., Canada and Europe, including $53 million from various government assistance programs and $7 million from furlough programs. Through the use of these programs, we have thus far been able to provide an offset to our costs, without further use of cash, while maintaining our employee base and minimizing the financial impact to our employees. There were no material impacts to our income tax expense in the second quarter 2020 as a result of the temporary changes included in the CARES Act and we expect to defer payment of the employer-paid portion of social security payroll taxes through the end of calendar year 2020; however, this deferral will be reduced by employee retention credits as earned during 2020. The savings of approximately $60 million were recorded as follows in the Condensed Consolidated Statements of Income: (in millions) Three Months Ended June 30, 2020 Cost of services, maintenance and rentals $ 40 Research, development and engineering expenses 1 Selling, administrative and general expenses 19 Total Estimated savings $ 60 Overview Second Quarter 2020 Review Total revenue of $1.47 billion for second quarter 2020 declined 35.3% from second quarter 2019, including a 0.7-percentage point unfavorable impact from currency. The decrease in revenue reflected a decrease of 34.3% in Post sale revenue, including a 0.7-percentage point unfavorable impact from currency, and a decrease of 38.5% in Equipment sales revenue, including a 0.5-percentage point unfavorable impact from currency. Total revenue of $3.33 billion for the six months ended June 30, 2020 declined 25.2% as compared to the prior year period, including a 0.8-percentage point unfavorable impact from currency. The decrease in revenue reflected a decrease of 22.9% in Post sale revenue, including a 0.8-percentage point unfavorable impact from currency, and a decrease of 33.3% in Equipment sales revenue, including a 0.5-percentage point unfavorable impact from currency. The global COVID-19 pandemic crisis significantly impacted our second quarter 2020 and year to date revenues due to business closures and office building capacity restrictions that began in the first quarter 2020, and continued into the second quarter 2020. As a result, these closures and restrictions impacted our customers' purchasing decisions, and caused delayed installations and lower printing volumes on our devices, with the biggest impact in the first half occurring in the second quarter 2020. Geographically, our European operations had larger revenue declines, partially due to a larger mix of sales through indirect channel partners which, in response to the lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. Our North American operations include a larger mix of government, education, healthcare and other large customers that were less affected by business closures than our SMB customers and, on average, our North American customers have contracts with a higher component of fixed charges. Xerox 2020 Form 10-Q 38 Net income attributable to Xerox Holdings 1 and adjusted 2 Net income attributable to Xerox Holdings were as follows: Three Months Ended June 30, Six Months Ended June 30, (in millions) 2020 2019 B/(W) 2020 2019 B/(W) Net income attributable to Xerox Holdings (1) $ 27 $ 141 $ (114) $ 25 $ 225 $ (200) Adjusted (2) Net income attributable to Xerox Holdings 36 186 (150) 86 344 (258) Second quarter 2020 Net income attributable to Xerox Holdings decreased $114 million as compared to second quarter 2019 reflecting the impact from lower revenues primarily associated with the COVID-19 pandemic crisis that were only partially offset by lower costs and expenses including lower Income tax expense as well as lower Restructuring and related costs and Other expenses, net. Second quarter 2020 A djusted 2 net income attributable to Xerox Holdings decreased $150 million as compared to second quarter 2019, reflecting lower revenues, which were only partially offset by lower costs and expenses and lower Income tax expense. Net income attributable to Xerox Holdings for the six months ended June 30, 2020 decreased $200 million as compared to the prior year period reflecting the impact from lower revenues, primarily associated with the COVID-19 pandemic crisis, and higher Transaction and related costs, net, that were only partially offset by lower costs and expenses, including lower Income tax expense as well as lower Restructuring and related costs and Other expenses, net. In addition, Net income attributable to Xerox Holdings for the six months ended June 30, 2020 includes the first quarter 2020 impact of a $61 million increase in bad debt provision reflecting of the expected impact from the COVID-19 pandemic crisis on our receivable portfolio. A djusted 2 net income attributable to Xerox Holdings for the six months ended June 30, 2020 decreased $258 million as compared to the prior year period primarily reflecting lower revenues, which were only partially offset by lower costs and expenses including lower Income tax expense, partially offset by the increased bad debt provision. Net income attributable to Xerox Holdings for the three and six months ended June 30, 2020 were both positively impacted by savings of approximately $60 million from temporary government assistance measures and furlough programs in the U.S., Canada and Europe. Refer to the Government Assistance and Furlough Programs section for additional information. Cash flows provided by operating activities of continuing operations for the six months ended June 30, 2020 were $207 million, as compared to $498 million in the prior year period primarily reflecting lower net income, as result of the COVID-19 pandemic crisis, partially offset by improved working capital, net 3 and decreases in finance assets. Cash used in investing activities for the six months ended June 30, 2020 was $232 million including capital expenditures of $42 million and acquisitions of $193 million. Cash used in financing activities for the six months ended June 30, 2020 was $432 million reflecting a payment of $313 million on Senior Notes and dividend payments of $115 million. 2020 Outlook As a result of the uncertainty created by the COVID-19 pandemic crisis, in the first quarter 2020 we withdrew 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. We also expect to complete at least $300 million in share repurchases during the remainder of 2020. ____________________________ (1) Net income from continuing operations attributable to Xerox Holdings. (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 39 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 half of 2020 the company was significantly impacted by the economic disruption caused by the COVID-19 pandemic crisis. This disruption required us to review the majority of our estimates to ensure we appropriately considered the impacts caused by the COVID-19 pandemic 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 pandemic 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 straight-forward 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 half of 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 and not solely rely on historical usage data. As we progress into the second half of 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, in the Condensed Consolidated Financial Statements consistent with our adoption of ASU 2016-13 effective January 1, 2020 (refer to Note 2 - Recent Accounting Pronouncements in the Condensed Consolidated Financial Statements), 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 the first half of 2020, we had to critically assess current and forecasted economic conditions as a result of the COVID-19 pandemic 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 the Selling, Administrative and General Expenses (SAG) section 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 pandemic 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. Xerox 2020 Form 10-Q 40 Similar to other estimates during the first half of 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 pandemic crisis. During the first half of 2020, it was determined that no material adjustments were required to our valuation allowances at June 30, 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. 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 second quarter 2020, as a result of the continued negative financial impacts from the COVID-19 pandemic crisis on our current and near term future operations, the expected slower recovery during the latter half of 2020 as businesses return to their respective offices, as well as a sustained market capitalization below our book value, we determined there was a triggering event requiring an interim quantitative evaluation of Goodwill. In prior years' quantitative tests we estimated the fair value of the entity by weighting the results of the income approach (discounted cash flow methodology) and market approach. However, as a result of limited market compares due to companies not providing guidance in this current economic environment, our interim quantitative evaluation of goodwill was based on the income approach to estimate fair value. The income approach, which we believe provides a result that is equally or more representative of fair value in the current circumstances, is based on the discounted cash flow method that uses the Company's estimates for future forecasted financial performance including revenues, operating expenses, and taxes, as well as working capital and capital asset requirements. Projected cash flows are then discounted to a present value employing a discount rate that properly accounts for the estimated market weighted-average cost of capital, as well as any risk unique to the subject cash flows. Our estimates regarding future forecasted cash flows accordingly reflected consideration of the continued negative financial impacts from the COVID-19 pandemic crisis on our current and future operations as well expected recovery scenarios. After completing our interim impairment review, we concluded that Goodwill was not impaired and, based on various forecast models and related sensitivity analysis, which we believe reflect the inherent uncertainty of the future, the excess of fair value over carrying value ranged between 10 and 20 percent. We believe the discount rate applied in our cases was an appropriate risk adjusted cost of capital and considers the current lower debt interest rates in the market. Although our internal forecasts clearly indicate that Xerox is and will be significantly impacted by the economic disruption caused by the COVID-19 pandemic crisis in 2020, based on a review of macroeconomic and industry considerations, the business is expected to continue to recover in the second half of the year and recover further still in 2021 with the expectation of a return to normal trends by 2022. In addition, consistent with our historical results, we believe we have the ability, within a relevant range, to offset potential further delays in the recovery of our revenue base with cost reductions and productivity improvements to help manage and maintain our projected level of cash flows. Lastly, although our estimates of the fair value of the entity were in excess of our market capitalization, we believe the implied premiums that would be indicated at net book value or at our estimated fair values are reasonable. In performing its assessment, the Company believes it has made reasonable estimates based on the facts and circumstances that were available as of the reporting date in light of the developing situation resulting from the COVID-19 pandemic crisis. However, the determination of fair value includes assumptions that are subject to risk and uncertainty. The discounted cash flow calculations are dependent on several subjective factors including the timing of future cash flows and the discount rate. If assumptions or estimates in the fair value calculations change or if future cash flows vary from what was expected, including those assumptions relating to the duration and severity of the financial impact from the COVID-19 pandemic crisis, this may impact the impairment analysis and could reduce the underlying cash flows used to estimate fair values and result in a decline in fair value that may trigger future impairment charges. We will continue to monitor developments in the third 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 than currently estimated there could be a material impact to our revenues and expected cash flows which in turn could negatively impact the recoverability of our Goodwill balance. Xerox 2020 Form 10-Q 41 Financial Review Revenues Three Months Ended June 30, Six Months Ended June 30, % of Total Revenue (in millions) 2020 2019 % Change CC % Change 2020 2019 % Change CC % Change 2020 2019 Equipment sales $ 310 $ 504 (38.5) % (38.0) % $ 635 $ 952 (33.3) % (32.8) % 19 % 21 % Post sale revenue 1,155 1,759 (34.3) % (33.6) % 2,690 3,491 (22.9) % (22.1) % 81 % 79 % Total Revenue $ 1,465 $ 2,263 (35.3) % (34.6) % $ 3,325 $ 4,443 (25.2) % (24.4) % 100 % 100 % Reconciliation to Condensed Consolidated Statements of Income: Sales $ 460 $ 800 (42.5) % (41.8) % $ 1,025 $ 1,524 (32.7) % (32.0) % Less: Supplies, paper and other sales (150) (296) (49.3) % (48.1) % (390) (572) (31.8) % (30.6) % Equipment sales $ 310 $ 504 (38.5) % (38.0) % $ 635 $ 952 (33.3) % (32.8) % Services, maintenance and rentals $ 949 $ 1,402 (32.3) % (31.6) % $ 2,185 $ 2,795 (21.8) % (21.1) % Add: Supplies, paper and other sales 150 296 (49.3) % (48.1) % 390 572 (31.8) % (30.6) % Add: Financing 56 61 (8.2) % (7.5) % 115 124 (7.3) % (6.5) % Post sale revenue $ 1,155 $ 1,759 (34.3) % (33.6) % $ 2,690 $ 3,491 (22.9) % (22.1) % Americas $ 990 $ 1,504 (34.2) % (33.6) % $ 2,229 $ 2,914 (23.5) % (23.1) % 67 % 66 % EMEA 428 709 (39.6) % (38.5) % 1,003 1,421 (29.4) % (28.0) % 30 % 32 % Other 47 50 (6.0) % (6.0) % 93 108 (13.9) % (13.9) % 3 % 2 % Total Revenue (1) $ 1,465 $ 2,263 (35.3) % (34.6) % $ 3,325 $ 4,443 (25.2) % (24.4) % 100 % 100 % Memo: Xerox Services $ 604 $ 853 (29.2) % (28.2) % $ 1,380 $ 1,706 (19.1) % (18.1) % 42 % 38 % _____________ 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 ended June 30, 2020 decreased 35.3% as compared to the second quarter 2019, including a 0.7-percentage point unfavorable impact from currency and an approximate 1.0-percentage point favorable impact from recent partner dealer acquisitions, while total revenues for the six months ended June 30, 2020 decreased 25.2% as compared to the prior year period, including a 0.8-percentage point unfavorable impact from currency and an approximate 0.9-percentage point favorable impact from recent partner dealer acquisitions. The global COVID-19 pandemic crisis significantly impacted our revenue in both the first and second quarters of 2020 due to business closures and office building capacity restrictions that impacted our customers' purchasing decisions and caused lower printing volumes on our devices. Geographically, our European operations had larger revenue declines for both the three and six months ended June 30, 2020 due in part to the earlier onset of the pandemic. In this region, larger revenue declines were partially due to a larger mix of sales through indirect channel partners which, in response to the lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. Our North American operations include a larger mix of government, education, healthcare and other large customers that were less affected by business closures than our SMB customers and, on average, our North American customers have contracts with a higher component of fixed charges. Total revenue for the three and six months ended June 30, 2020 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 ended June 30, 2020 Post sale revenue decreased 34.3% as compared to the second quarter 2019, including a 0.7-percentage point unfavorable impact from currency, while Post Sale revenue Xerox 2020 Form 10-Q 42 decreased 22.9% for the six months ended June 30, 2020, including a 0.8-percentage point unfavorable impact from currency. The global COVID-19 pandemic crisis significantly impacted our Post sale revenue during the first half of 2020, however its impact on our Post sale revenue slightly moderated later in the second quarter, as businesses started to reopen in certain geographical areas in the U.S. and Europe, resulting in a gradual moderation of our page volume declines. The decline 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. ◦ For the three months ended June 30, 2020, these revenues decreased 32.3% as compared to the second quarter 2019, including a 0.7-percentage point unfavorable impact from currency. The decline at constant currency 1 reflected a lower population of devices (which is 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) that are worse than pre-COVID-19 decline trends due to the impact of business closures during the quarter. 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. The rate of decline of these revenues slightly moderated later in the quarter as businesses started to reopen in certain geographical areas in the U.S. and Europe. ◦ For the six months ended June 30, 2020, these revenues decreased 21.8% as compared to the prior year period, including a 0.7-percentage point unfavorable impact from currency. The decline at constant currency 1 reflected a lower population of devices (which is 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) that are worse than pre-COVID-19 decline trends due to the impact of business closures since March 2020. 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. The rate of decline of these revenues slightly moderated late in the first half of 2020 as businesses started to reopen in certain geographical areas in the U.S. and Europe. • Supplies, paper and other sales includes unbundled supplies and other sales. ◦ For the three months ended June 30, 2020, these revenues decreased 49.3% as compared to second quarter 2019, including a 1.2-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 in response to the lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. We expect that indirect channels will maintain low purchase levels and continue to reduce their inventories until there is a stable recovery in sales activity. ◦ For the six months ended June 30, 2020, these revenues decreased 31.8% as compared to the prior year period, including a 1.2-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 in response to the lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. We expect that indirect channels will maintain low purchase levels and continue to reduce their inventories until there is a stable recovery in sales activity. • Financing revenue is generated from financed equipment sale transactions. For the three months ended June 30, 2020, these revenues declined 8.2% as compared to second quarter 2019, including a 0.7-percentage point unfavorable impact from currency, while Financing revenue for the six months ended June 30, 2020 decreased 7.3%, including a 0.8-percentage point unfavorable impact and from currency and reflected a continued decline in the finance receivables balance due to lower equipment sales in prior periods. ____________ (1) See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. Xerox 2020 Form 10-Q 43 Equipment sales revenue Three Months Ended June 30, Six Months Ended June 30, % of Equipment Sales (in millions) 2020 2019 % Change CC % Change 2020 2019 % Change CC % Change 2020 2019 Entry $ 34 $ 52 (34.6)% (33.5)% $ 74 $ 105 (29.5)% (28.7)% 12% 11% Mid-range 209 350 (40.3)% (40.1)% 427 652 (34.5)% (34.2)% 67% 68% High-end 64 97 (34.0)% (27.5)% 128 186 (31.2)% (30.7)% 20% 20% Other 3 5 (40.0)% (40.0)% 6 9 (33.3)% (33.3)% 1% 1% Equipment sales $ 310 $ 504 (38.5)% (38.0)% $ 635 $ 952 (33.3)% (32.8)% 100% 100% _____________ CC - See "Currency Impact" section for a description of Constant Currency. Equipment sales revenue decreased 38.5% for the three months ended June 30, 2020 as compared to second quarter 2019, including a 0.5-percentage point unfavorable impact from currency as well as the impact of price declines of approximately 5%, while for the six months ended June 30, 2020, Equipment sales revenue decreased 33.3%, as compared to the prior year period, including a 0.5-percentage point unfavorable impact from currency as well as the impact of price decline of approximately 5%. The global COVID-19 pandemic crisis significantly impacted our equipment sales revenue during the first half of 2020 as a result of business closures and office building capacity restrictions that impacted our customers' purchasing decisions and caused delayed installations. The global pandemic affected our operations in March 2020 and throughout the second quarter 2020, however, its impact on our equipment sales lessened later in the second quarter, as businesses started to reopen in certain geographical areas of the U.S. and Europe. The decline at constant currency 1 reflected the following: • Entry - The decrease for the three months ended June 30, 2020, as compared to second quarter 2019, was primarily due to lower sales of devices through our indirect channels in EMEA, Latin America and the U.S. affected in part by the COVID-19 crisis and partially offset by higher sales of lower-end black-and-white devices associated with work-from-home promos and larger order deals from Eurasia. The decrease for the six months ended June 30, 2020, as compared to the prior year period, was primarily due to lower sales of devices through our indirect channels in EMEA, Latin America and the U.S. affected in part by the COVID-19 crisis and partially offset by the benefit of large order deals from Eurasia. • Mid-range - The decrease for the three months ended June 30, 2020, as compared to second quarter 2019, was driven by lower sales of devices partially as a result of the COVID-19 crisis and related office closures, which impacted this group of products more due to their prevalence in office-team settings; the decline was also more significant in our European operations due to a heavier mix of businesses through indirect channel partners, which, in response to lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. Higher sales to our government and healthcare customers in North America, as well as strong demand for our recently launched PrimeLink devices, provided a partial offset. The decrease for the six months ended June 30, 2020, as compared to the prior year period, was driven by lower sales of devices partially as a result of the COVID-19 crisis and related office closures, 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, which, in response to lower demand caused by the crisis, reduced their inventory purchases to manage liquidity. In North America, the majority of the decrease came from our XBS and indirect channel organizations, which primarily serve SMB customers, partially offset by strong demand for our recently launched PrimeLink devices. • High-end - The decrease for the three months ended June 30, 2020, as compared to second quarter 2019, primarily reflected lower installs of our Versant entry-production color devices and lower installs in EMEA of our Iridesse production presses. Sales of black and white presses for customers with transactional printing applications, and iGen systems grew during the quarter. The decrease in our equipment sales revenue from production color systems was partially impacted by the COVID-19 crisis, particularly in our European operations, where the distribution of our Versant and Iridesse devices through indirect channels was affected by furlough adoptions and lower inventory purchases as dealers managed their liquidity. The decrease for the six months ended June 30, 2020, as compared to the prior year period, primarily reflected lower installs of our Versant entry-production color devices, as well as lower installs of our Iridesse production presses in EMEA, which were partially offset by higher sales in EMEA of our iGen systems as well as demand for our recently launched Baltoro Inkjet press. The decrease in our equipment sales revenue from production color systems was partially impacted by the COVID-19 crisis, particularly in our European operations, where the distribution of our Xerox 2020 Form 10-Q 44 Versant and Iridesse devices through indirect channels was affected by furlough adoptions and lower inventory purchases as dealers managed their liquidity. 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. Installs for the second quarter 2019: Entry • 35% decrease in color multifunction devices reflecting lower installs of ConnectKey devices through our indirect channels in the U.S. and in EMEA. • 9% decrease in black-and-white multifunction devices reflecting lower activity from North and Latin America, partially offset by higher activity from EMEA. The declines are primarily driven by lower sales in the higher end of the portfolio partially offset by higher sales of low-end devices associated with large order deals from Eurasia and work-from-home promotions. Mid-Range (1) • 46% decrease in mid-range color installs primarily reflecting lower installs of multifunction color devices partially offset by strong demand for our recently launched PrimeLink entry-production color devices. • 42% decrease in mid-range black-and-white reflecting in part global market trends partially offset by strong demand for our recently launched PrimeLink light-production multi-function devices. High-End (1) • 58% decrease in high-end color installs reflecting primarily lower installs of our lower-end Versant devices and of our Iridesse production systems. • 2% increase in high-end black-and-white systems reflecting higher installs of our Nuvera offsetting market trends. Installs for the six months ended June 30, 2020: Entry • 27% decrease in color multifunction devices reflecting lower installs of ConnectKey devices through our indirect channels in the U.S. and in EMEA. • 4% decrease in black-and-white multifunction devices reflecting lower activity from North and Latin America, partially offset by higher activity from EMEA. The declines are primarily driven by lower sales in the higher end of the portfolio. Mid-Range (1) • 36% decrease in mid-range color installs primarily reflecting lower installs of multifunction color devices partially offset by strong demand for our recently launched PrimeLink entry-production color devices. • 30% decrease in mid-range black-and-white reflecting in part global market trends partially offset by strong demand for our recently launched PrimeLink light-production multi-function devices. High-End (1) • 55% decrease in high-end color installs reflecting primarily lower installs of our lower-end Versant devices, along with lower installs of our Iridesse production systems, partially offset by strong demand for our recently-launched Baltoro inkjet press. • 18% 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 for the three and six months ended June 30, 2020 Mid-range color devices decreased 46% and 36%, respectively, and High-end color systems decreased 57% and 55%, respectively. Xerox 2020 Form 10-Q 45 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. Xerox 2020 Form 10-Q 46 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 June 30, Six Months Ended June 30, (in millions) 2020 2019 B/(W) 2020 2019 B/(W) Gross Profit $ 564 $ 885 $ (321) $ 1,276 $ 1,762 $ (486) RD&E 76 88 12 160 180 20 SAG 426 517 91 967 1,063 96 Equipment Gross Margin 28.8 % 28.8 % — pts. 27.5 % 32.0 % (4.5) pts. Post sale Gross Margin 41.1 % 42.0 % (0.9) pts. 40.9 % 41.7 % (0.8) pts. Total Gross Margin 38.5 % 39.1 % (0.6) pts. 38.4 % 39.7 % (1.3) pts. RD&E as a % of Revenue 5.2 % 3.9 % (1.3) pts. 4.8 % 4.1 % (0.7) pts. SAG as a % of Revenue 29.1 % 22.8 % (6.3) pts. 29.1 % 23.9 % (5.2) pts. Pre-tax Income $ 35 $ 190 $ (155) $ 30 $ 263 $ (233) Pre-tax Income Margin 2.4 % 8.4 % (6.0) pts. 0.9 % 5.9 % (5.0) pts. Adjusted (1) Operating Profit $ 62 $ 280 $ (218) $ 149 $ 519 $ (370) Adjusted (1) Operating Margin 4.2 % 12.4 % (8.2) pts. 4.5 % 11.7 % (7.2) pts. ____________ _ (1) See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. Pre-tax Income Margin Second quarter 2020 pre-tax income margin of 2.4% decreased 6.0-percentage points as compared to second quarter 2019. The decrease primarily reflected the impact of lower adjusted 1 operating margin (see below), of 8.2-percentage points, partially offset by lower Restructuring and related, costs, and Other expenses, net. Pre-tax income margin for the six months ended June 30, 2020 of 0.9% decreased 5.0-percentage points as compared to the prior year period. The decrease primarily reflected the impact of lower adjusted 1 operating margin (see below), of 7.2-percentage points, partially offset by lower Restructuring and related costs and Other expenses, net. Adjusted 1 Operating Margin Second quarter 2020 adjusted 1 operating margin of 4.2% decreased 8.2-percentage points as compared to second quarter 2019 reflecting the impact of lower revenues, primarily as a result of the significant effect of the COVID-19 pandemic crisis on our business, partially offset by cost and expense reductions associated with our Project Own It transformation actions as well additional savings from various cost reduction actions to mitigate the impact of the crisis, including approximately $60 million from temporary government assistance measures and furlough programs (see the Government Assistance and Furlough Programs section for further details) and other reductions in discretionary spend such as near term targeted marketing programs and the use of contract employees as well as compensation incentives consistent with lower sales and operating results. Adjusted 1 operating margin for the six months ended June 30, 2020 of 4.5% decreased 7.2-percentage points as compared to prior year period reflecting the impact of lower revenues, primarily as a result of the significant effect of the COVID-19 pandemic crisis on our business and a 1.8-percentage point unfavorable impact due to an increase in bad debt expense of $61 million in the first quarter 2020, 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 crisis. These negative impacts were partially offset by cost and expense reductions associated with our Project Own It transformation actions as well as additional savings from various cost reduction actions to mitigate the impact of the crisis, including approximately $60 million from temporary government assistance measures and furlough programs in second quarter 2020 (see the Government Assistance and Furlough Programs section for further details) and other reductions in discretionary spend such as near term targeted marketing programs and the use of contract employees as well as compensation incentives consistent with lower sales and operating results. ______________ (1) Refer to the Operating Income and Margin reconciliation table in the "Non-GAAP Financial Measures" section. Xerox 2020 Form 10-Q 47 Gross Margin Second quarter 2020 gross margin of 38.5% decreased 0.6-percentage points as compared to second 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 crisis due to business closures, as well as the impact of price reductions, adverse transaction currency and tariffs. These headwinds were partially offset by the benefits from our Project Own It transformation actions, as well as additional cost reduction actions to mitigate the impact of the crisis, including savings of approximately $40 million from temporary government assistance measures and furlough programs. Gross margin for the six months ended June 30, 2020 of 38.4% decreased 1.3-percentage points as compared to the prior year period, 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 due to business closures, as well as the impact of price reductions, adverse transaction currency and tariffs. These headwinds were partially offset by the benefits from our Project Own It transformation actions, as well as additional cost reduction actions to mitigate the impact of the crisis, including savings of approximately $40 million from temporary government assistance measures and furlough programs. 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. Second quarter 2020 equipment gross margin of 28.8% was flat as compared to second quarter 2019, reflecting the benefit of cost reductions from our Project Own It, as well as a favorable mix of revenues due to the relatively smaller declines in our high-end category, which offset the pressure from lower revenues (primarily as a result of COVID-19 related business closures) and the adverse impact of transaction currency, incremental tariff costs and price incentives. Equipment gross margin for the six months ended June 30, 2020 of 27.5% decreased 4.5-percentage points as compared to the prior year period, reflecting the impact of lower revenues (primarily as a result of COVID-19 related business closures) as well as the impact of incremental tariff costs, price incentives and adverse transaction currency, partially offset by the benefits from our Project Own It transformation actions. Second quarter 2020 Post sale gross margin of 41.1% decreased 0.9-percentage points as compared to second 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, as well as savings from our additional cost reduction actions to mitigate the impact of the crisis, including approximately $40 million of savings from temporary government assistance measures and furlough programs. Post sale gross margin for the six months ended June 30, 2020 of 40.9% decreased 0.8-percentage points as compared to the prior year period, 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, as well as savings from our additional cost reduction actions to mitigate the impact of the crisis, including approximately $40 million of savings from temporary government assistance measures and furlough programs. Research, Development and Engineering Expenses (RD&E) Three Months Ended June 30, Six Months Ended June 30, (in millions) 2020 2019 Change 2020 2019 Change R&D $ 65 $ 73 $ (8) $ 133 $ 150 $ (17) Sustaining engineering 11 15 (4) 27 30 (3) Total RD&E Expenses $ 76 $ 88 $ (12) $ 160 $ 180 $ (20) Second quarter 2020 RD&E as a percentage of revenue of 5.2% increased by 1.3-percentage points as compared to second quarter 2019, primarily due to the impact of revenue declines that outpaced the benefits of cost reductions. RD&E of $76 million decreased $12 million as compared to second quarter 2019 reflecting savings from Project Own It and other temporary cost actions, as well as a favorable impact from the timing of investments, partially offset by higher spend in our innovation areas. Xerox 2020 Form 10-Q 48 RD&E as a percentage of revenue for the six months ended June 30, 2020 of 4.8% increased by 0.7-percentage points as compared to the prior year period, primarily due to the impact of revenue declines that outpaced the benefits of cost reductions. RD&E for the six months ended June 30, 2020 of $160 million decreased $20 million as compared to the prior year period, reflecting savings from Project Own It and other temporary cost actions, as well as a favorable impact from the timing of investments, partially offset by higher spend in our innovation areas. Selling, Administrative and General Expenses (SAG) Second quarter 2020 SAG as a percentage of revenue of 29.1% increased by 6.3-percentage points as compared to second quarter 2019, primarily due to the impact of lower revenues, partially offset by the benefits from productivity and restructuring associated with our Project Own It transformation actions, and savings from additional cost reduction actions to mitigate the impact of the crisis, including approximately $19 million from temporary government assistance measures and furlough programs, and other reductions in discretionary spend such as near term targeted marketing programs and the use of contract employees as well as compensation incentives consistent with lower sales and operating results. During first quarter 2020, our bad debt provision was $61 million higher than the prior year period 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 pandemic crisis. During second quarter 2020, write-offs were in line with expectations and the current bad debt reserves for our trade and finance receivables portfolios were determined to be adequate and consistent with future expectations regarding the impacts from the COVID-19 pandemic crisis. Accordingly, no incremental reserves were required and bad debt expense for second quarter 2020 of $13 million was effectively flat as compared to second quarter 2019. Second quarter 2020 SAG of $426 million decreased by $91 million as compared to second 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. SAG as a percentage of revenue for the six months ended June 30, 2020 of 29.1% increased by 5.2-percentage points as compared to the prior year period and included a 1.8-percentage point unfavorable impact due to the increase in bad debt expense of $61 million in the first quarter 2020, as compared to the prior year period. The increase also reflected the impact of lower revenues, partially offset by the benefits from productivity and restructuring associated with our Project Own It transformation actions and savings from additional cost reduction actions to mitigate the impact of the crisis, including approximately $19 million from temporary government assistance measures and furlough programs, and other reductions in discretionary spend such as near term targeted marketing programs and the use of contract employees as well as compensation incentives consistent with lower sales and operating results. Bad debt expense for the six months ended June 30, 2020 of $87 million was $62 million higher compared to the prior year period as a result of the increase in the bad debts provision recorded in first quarter 2020 as described above. SAG for the six months ended June 30, 2020 of $967 million decreased $96 million as compared to the prior year period, 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. The majority of the increased provision is related to finance receivables due to their larger balance and longer-term nature. We continue to monitor developments regarding this crisis, including expectations for lifting of business closures and mitigating government support actions and as a result our reserve estimates may need to be updated in future periods. Bad debt expense of approximately 2.7 percent of total gross receivables on a trailing-twelve-month basis (TTM) reflects the significant increase in first quarter 2020 and remained high as compared to the 2019 trend of less than one percent. Xerox 2020 Form 10-Q 49 Restructuring and Related Costs We incurred restructuring and related costs of $3 million for the second quarter 2020, as compared to $37 million for second quarter 2019, and $44 million for the six months ended June 30, 2020 as compared to $149 million in the prior year period . 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 June 30, Six Months Ended June 30, (in millions) 2020 2019 2020 2019 Restructuring and severance (1) $ 7 $ 13 $ 39 $ 25 Asset impairments (2) — 10 2 46 Other contractual termination costs (3) — 3 1 17 Net reversals (4) (9) (8) (15) (16) Restructuring and asset impairment costs (2) 18 27 72 Retention related severance/bonuses (5) 4 11 11 20 Contractual severance costs (6) — — 4 38 Consulting and other costs (7) 1 8 2 19 Total $ 3 $ 37 $ 44 $ 149 _____________ (1) Reflects headcount reductions of approximately 150 employees worldwide for the three months ended June 30, 2020 and 2019, respectively, and 450 and 300 employees worldwide for the six months ended June 30, 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 $0 million and $8 million f or the three months ended June 30, 2020 and 2019, respectively, and $1 million and $34 million f or the six months ended June 30, 2020 and 2019 , respectively, for leased right-of-use assets, as well as $0 million and $2 million f or the three months ended June 30, 2020 and 2019, respectively, and $1 million and $12 million for the six months ended June 30, 2020 and 2019 , respectively, for owned assets upon exit from the facilities, 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) 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. Second quarter 2020 actions impacted several functional areas, with approximately 10% focused on gross margin improvements and approximately 90% focused on SAG reductions. Second quarter 2019 actions impacted several functional areas, with approximately 15% focused on gross margin improvements, approximately 80% focused on SAG reductions and the remainder focused on RD&E optimization. The restructuring and related costs reserve balance as of June 30, 2020 for all programs was $94 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 $7 million and $24 million of Transaction and related costs, net for the three and six months ended June 30, 2020 primarily related to legal and other professional costs associated with certain strategic M&A projects including our 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 six months ended June 30, 2020 of $21 million decreased by $5 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 partially offset by intangible amortization associated with 2020 and 2019 acquisitions. Xerox 2020 Form 10-Q 50 Worldwide Employment Worldwide employment was approximately 26,100 as of June 30, 2020 and decreased by approximately 900 from December 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. Other Expenses, Net Three Months Ended June 30, Six Months Ended June 30, (in millions) 2020 2019 2020 2019 Non-financing interest expense $ 18 $ 26 $ 39 $ 54 Non-service retirement-related costs (8) 10 (7) 23 Interest income (3) (3) (11) (7) Gains on sales of businesses and assets — — (1) (1) Contract termination costs - IT services — — 3 — Currency losses, net 2 — 4 2 All other expenses, net (2) 5 3 6 Other expenses, net $ 7 $ 38 $ 30 $ 77 Non-Financing Interest Expense Second quarter 2020 non-financing interest expense of $18 million was $8 million lower than second quarter 2019. When combined with financing interest expense (Cost of financing), total interest expense decreased by $11 million from second quarter 2019 primarily due to a lower debt balance. For the six months ended June 30, 2020 non-financing interest expense of $39 million was $15 million lower than the prior year period. When combined with financing interest expense (Cost of financing), total interest expense decreased by $20 million from the prior year period 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 and six months ended June 30, 2020 decreased $18 million and $30 million, respectively, compared to the prior year periods, primarily driven by lower losses from pension settlements in the U.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 Interest income for the six months ended June 30, 2020 increased $4 million compared to the prior year period, primarily reflecting interest on a higher cash balance as a result of cash proceeds received from the sales of our indirect 25% equity interest in Fuji Xerox Co., Ltd. ("FX") and indirect 51% partnership interest in Xerox International Partners ("XIP") completed in fourth quarter 2019, partially offset by lower market interest rates. Income Taxes Second quarter 2020 effective tax rate was 22.9%. On an adjusted 1 basis, second quarter 2020 effective tax rate was 23.4%. This rate was higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits partially offset by the impact from various non-deductible and discrete items on lower pre-tax income. The adjusted 1 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. The effective tax rate for the six months ended June 30, 2020 was 23.3%. On an adjusted 1 basis, the effective tax rate for the six months ended June 30, 2020 was 27.0%. This rate was higher than the U.S. federal statutory tax rate of 21% primarily due to the impact of changes in our uncertain tax positions, state taxes, various non-deductible items partially offset by the impact of tax law changes and other discrete items. The adjusted 1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, Amortization of Xerox 2020 Form 10-Q 51 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. Second quarter 2019 effective tax rate was 26.3%. On an adjusted 1 basis, second quarter 2019 effective tax rate was 26.6%. These rates were higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits. The adjusted 1 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 and non-service retirement-related costs. The effective tax rate for the six months ended June 30, 2019 was 15.2% and included a benefit of $35 million related to the January 2019 finalization of regulations that govern the repatriation tax from the 2017 Tax Cuts and Jobs Act (the Tax Act). On an adjusted 1 basis, the effective tax rate for the six months ended June 30, 2019 was 26.5%. These rates were higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of profits. The adjusted 1 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 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. 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 June 30, 2020 largely consists of several minor investments in entities in the Middle East region. Three Months Ended June 30, Six Months Ended June 30, (in millions) 2020 2019 2020 2019 Equity in net income of unconsolidated affiliates - Fuji Xerox (1) $ — $ 32 $ — $ 75 Equity in net income of unconsolidated affiliates - continuing operations — 2 2 4 Total Equity in net income of unconsolidated affiliates $ — $ 34 $ 2 $ 79 Fuji Xerox after-tax restructuring and other charges $ — $ 7 $ — $ 19 _____________ (1) Equity in net income for Fuji Xerox for 2019 is reported in Income from discontinued operations, net of tax. Net Income from Continuing Operations Second quarter 2020 Net income from continuing operations attributable to Xerox Holdings was $27 million, or $0.11 per diluted share. On an adjusted 1 basis, Net income from continuing operations attributable to Xerox Holdings was $36 million, or $0.15 per diluted share. Second quarter 2020 adjustments to Net income from continuing operations included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net and non-service retirement-related costs. Net income from continuing operations attributable to Xerox Holdings for the six months ended June 30, 2020 was $25 million, or $0.08 per diluted share. On an adjusted 1 basis, Net income from continuing operations attributable to Xerox Holdings was $86 million, or $0.36 per diluted share and included the negative impact of a $61 million pre-tax increase in bad debt expense (approximately $43 million after-tax) as compared to the prior year period, 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 pandemic crisis. Adjustments to Net income from continuing operations for the six months ended June 30, 2020 included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net, non-service retirement-related costs, as well as other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. Xerox 2020 Form 10-Q 52 Second quarter 2019 Net income from continuing operations attributable to Xerox Holdings was $141 million, or $0.60 per diluted share. On an adjusted 1 basis, Net income from continuing operations attributable to Xerox Holdings was $186 million, or $0.79 per diluted share. Second quarter 2019 adjustments to Net income from continuing operations included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net and non-service retirement-related costs. Net income from continuing operations attributable to Xerox Holdings for the six months ended June 30, 2019 was $225 million, or $0.94 per diluted share. On an adjusted 1 basis, Net income from continuing operations attributable to Xerox Holdings was $344 million, or $1.45 per diluted share. Adjustments to Net income from continuing operations for the six months ended June 30, 2019 included Restructuring and related costs, Amortization of intangible assets, Transaction and related costs, net 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 - 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 Income and EPS reconciliation table in the "Non-GAAP Financial Measures" section. Discontinued Operations In November 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 in Fuji Xerox Co., Ltd. (FX) for approximately $2.2 billion as well as the sale of its indirect 51% partnership interest in Xerox 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 Income (Loss) Second quarter 2020 Other Comprehensive Income, Net Attributable to Xerox Holdings was $103 million and included the following: ii) $80 million of net gains from the changes in defined benefit plans primarily due to remeasurement; ii) net translation adjustment gains of $25 million reflecting the strengthening of our major foreign currencies against the U.S. Dollar; and iii) $2 million of net unrealized losses. This compares to Other Comprehensive Income, Net Attributable to Xerox Holdings of $5 million for the second quarter 2019, which reflected the following: iii) $9 million of net gains from the changes in defined benefit plans; ii) $4 million of net translation adjustment losses; and iii) no net unrealized gains or losses. Other Comprehensive Loss, Net Attributable to Xerox Holdings for the six months ended June 30, 2020 was $35 million and included the following: i) net translation adjustment losses of $172 million reflecting the significant weakening of our major foreign currencies against the U.S. Dollar; ii) $134 million of net gains from the changes in defined benefit plans primarily due to remeasurement in the second quarter; and iii) $3 million of net unrealized gains. This compares to Other Comprehensive Income, Net Attributable to Xerox Holdings of $45 million for the six months ended June 30, 2019, which reflected the following: i) $33 million of net translation adjustment gains, reflecting the strengthening of our major foreign currencies against the U.S. Dollar; ii) $10 million of net gains from the changes in defined benefit plans; and iii) $2 million of net unrealized gains. Refer to Note 19 - Other Comprehensive Income (Loss) in the Condensed Consolidated Financial Statements, for the components of Other Comprehensive Income (Loss), Note 14 - Financial Instruments in the Condensed Consolidated Financial Statements, for additional information regarding unrealized (losses) 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. Xerox 2020 Form 10-Q 53 Capital Resources and Liquidity Our financial results through June 30, 2020 were significantly impacted by COVID-19 related business closures and office building capacity restrictions 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 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 June 30, 2020, total cash, cash equivalents and restricted cash were $2,314 million and, apart from the restricted cash of $42 million, was readily accessible for use. • We have access to an undrawn $1.8 billion Credit Facility that matures in August 2022. • We expect to be able to utilize a combination of cash on hand, capital markets and securitization to manage debt maturities in 2020. Refer to Note 22 - Subsequent Event in the Condensed Consolidated Financial Statements for additional information regarding a recent secured borrowing transaction. • 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 near term targeted marketing programs, the use of contract employees and compensation incentives consistent with lower sales and operating results, as well as the use of available temporary government assistance measures and furlough programs. Cash Flow Analysis The following summarizes our cash, cash equivalents and restricted cash: Six Months Ended June 30, Change (in millions) 2020 2019 Net cash provided by operating activities of continuing operations $ 207 $ 498 $ (291) Net cash provided by operating activities of discontinued operations — 41 (41) Net cash provided by operating activities 207 539 (332) Net cash used in investing activities (232) (72) (160) Net cash used in financing activities (432) (846) 414 Effect of exchange rate changes on cash, cash equivalents and restricted cash (24) 7 (31) Decrease in cash, cash equivalents and restricted cash (481) (372) (109) 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 $ 2,314 $ 776 $ 1,538 Cash Flows from Operating Activities Net cash provided by operating activities of continuing operations was $207 million for the six months ended June 30, 2020. The $291 million decrease in operating cash from the prior year period was primarily due to the following: • $356 million decrease in pre-tax income before depreciation and amortization, provisions, restructuring and related costs and defined benefit pension costs. • $241 million decrease from higher levels of inventory primarily due to lower sales volume. • $113 million decrease from lower accounts payable primarily due to decreased spending and the year-over-year timing of supplier and vendor payments. • $112 million decrease in other current and long-term liabilities, reflecting lower accruals, particularly incentive-related payments associated with our indirect channel partners and decreases in deferred revenue reflecting lower sales activity. • $46 million decrease from accrued compensation primarily related to lower compensation costs and the year-over-year timing of payments. • $15 million decrease in transaction and related costs primarily due to insurance proceeds received in the prior year. • $419 million increase from accounts receivable primarily due to lower revenue. • $88 million increase primarily related to a higher level of run-off due to lower originations of finance receivables of $71 million and lower equipment on operating leases of $17 million. • $49 million increase due to the timing of payments associated with restructuring related costs of $9 million in the current year compared to $58 million in the prior year. Xerox 2020 Form 10-Q 54 • $47 million increase from net taxes primarily due to lower payments in 2020 as a result of lower pre-tax income and government programs, enacted as part of the COVID-19 relief actions, that allow for the deferral of income tax payments to 2021. Cash Flows from Investing Activities Net cash used in investing activities was $232 million for the six months ended June 30, 2020. The $160 million change from from the prior year period was primarily due to four acquisitions completed in the current year for $193 million compared to two acquisitions in the prior year for $42 million. Cash Flows from Financing Activities Net cash used in financing activities was $432 million for the six months ended June 30, 2020. The $414 million decrease in the use of cash from the prior year period was primarily due to the following: • $93 million decrease from net debt activity. 2020 reflects payment of $313 million on Senior Notes compared to prior year payments of $406 million on Senior Notes. • $300 million decrease due to share repurchases in prior year compared to no share repurchases in the current year. 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) June 30, 2020 December 31, 2019 Principal debt balance (1) $ 4,000 $ 4,313 Net unamortized discount (11) (16) Debt issuance costs (14) (17) Fair value adjustments (2) - terminated swaps 1 1 - current swaps 2 1 Total Debt $ 3,978 $ 4,282 _____________ (1) Includes no Notes Payable as of June 30, 2020 and December 31, 2019, respectively. (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. Finance Assets and Related Debt The following represents our total finance assets, net associated with our lease and finance operations: (in millions) June 30, 2020 December 31, 2019 Total finance receivables, net (1) $ 3,070 $ 3,351 Equipment on operating leases, net 312 364 Total Finance Assets, net (2) $ 3,382 $ 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 $33 million due to currency. Xerox 2020 Form 10-Q 55 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. Based on this leverage, the following represents the breakdown of total debt between financing debt and core debt: (in millions) June 30, 2020 December 31, 2019 Finance receivables debt (1) $ 2,686 $ 2,932 Equipment on operating leases debt 273 319 Financing debt 2,959 3,251 Core debt 1,019 1,031 Total Debt $ 3,978 $ 4,282 ____________________________ (1) Finance receivables debt is the basis for our calculation of "Cost of financing" expense in the Condensed Consolidated Statements of Income. Sales of Accounts Receivable Activity related to sales of accounts receivable is as follows: Three Months Ended June 30, Six Months Ended June 30, (in millions) 2020 2019 2020 2019 Estimated (decrease) increase to operating cash flows (1) $ (58) $ 5 $ (136) $ — _____________ (1) Represents the difference between current and prior period accounts receivable sales adjusted for the effects of currency. The respective decrease for the three and six months ended June 30, 2020 reflects decreased sales activity in the channel. Refer to Note 8 - Accounts Receivable, Net in the Condensed Consolidated Financial Statements for additional information regarding our accounts receivable sales arrangements. 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 spread over the next five years as follows: (in millions) Amount (1) 2020 Q3 $ 738 2020 Q4 — 2021 1,062 2022 300 2023 1,000 2024 300 2025 — 2026 and thereafter 600 Total $ 4,000 _____________ (1) Includes fair value adjustments. Treasury Stock No shares of our common stock were repurchased by Xerox Holdings during the six months ended June 30, 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 June 30, 2020. No additional shares of common stock have been repurchased since June 30, 2020, through our filing date, July 30, 2020. Xerox 2020 Form 10-Q 56 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 was expected to be completed during 2020, however, as a result of delays caused by the COVID-19 pandemic crisis, the transition is now expected to extend into 2021. 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. For the three and six months ended June 30, 2020, we incurred net charges of approximately $45 million and $90 million, respectively, associated with this arrangement. The cost has been allocated to the various functional expense lines in the Condensed Consolidated Statements of 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 pandemic 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 March 31, 2020 Xerox Holdings withdrew its tender offer to acquire HP and terminated its proxy solicitation 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. On March 31, 2020, following the withdrawal of Xerox Holdings' tender offer to acquire HP, notice was provided to the banks of the immediate termination of the financing commitment. No termination penalties 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 Xerox 2020 Form 10-Q 57 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. 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 second 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 costs and expenses primarily associated with certain strategic M&A projects including our announced proposal to acquire HP Inc., which was terminated in March 2020, and our planned transaction with Fujifilm/Fuji Xerox, which was terminated in May 2018. These 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 Xerox 2020 Form 10-Q 58 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. 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 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 Condensed 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: Xerox 2020 Form 10-Q 59 Net Income and EPS reconciliation: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in millions, except per share amounts) Net Income EPS Net Income EPS Net Income EPS Net Income EPS Reported (1) $ 27 $ 0.11 $ 141 $ 0.60 $ 25 $ 0.08 $ 225 $ 0.94 Adjustments: Restructuring and related costs 3 37 44 149 Amortization of intangible assets 10 11 21 26 Transaction and related costs, net 7 4 24 4 Non-service retirement-related costs (8) 10 (7) 23 Contract termination costs - IT services — — 3 — Income tax on adjustments (2) (3) (17) (24) (48) Tax Act — — — (35) Adjusted $ 36 $ 0.15 $ 186 $ 0.79 $ 86 $ 0.36 $ 344 $ 1.45 Dividends on preferred stock used in adjusted EPS calculation (3) $ 3 $ — $ 7 $ — Weighted average shares for adjusted EPS (3) 216 235 216 237 Fully diluted shares at June 30, 2020 (4) 216 ____________________________ (1) Net income and EPS from continuing operations attributable to Xerox 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. 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 at June 30, 2020 plus potential dilutive common shares as used for the calculation of adjusted diluted EPS for the second 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 June 30, 2020 2019 (in millions) Pre-Tax Income Income Tax Expense Effective Tax Rate Pre-Tax Income Income Tax Expense Effective Tax Rate Reported (1) $ 35 $ 8 22.9 % $ 190 $ 50 26.3 % Non-GAAP Adjustments (2) 12 3 62 17 Adjusted (3) $ 47 $ 11 23.4 % $ 252 $ 67 26.6 % Six Months Ended June 30, 2020 2019 (in millions) Pre-Tax Income Income Tax Expense Effective Tax Rate Pre-Tax Income Income Tax Expense Effective Tax Rate Reported (1) $ 30 $ 7 23.3 % $ 263 $ 40 15.2 % Non-GAAP Adjustments (2) 85 24 202 48 Tax Act — — — 35 Adjusted (3) $ 115 $ 31 27.0 % $ 465 $ 123 26.5 % ____________________________ (1) Pre-tax income and income tax expense from continuing operations. (2) Refer to Net Income and EPS reconciliation for details. (3) The tax impact on Adjusted Pre-Tax Income from continuing operations is calculated under the same accounting principles applied to the Reported Pre-Tax Income under ASC 740, which employs an annual effective tax rate method to the results. Xerox 2020 Form 10-Q 60 Operating Income and Margin reconciliation: Three Months Ended June 30, 2020 2019 (in millions) Profit Revenue Margin Profit Revenue Margin Reported (1) $ 35 $ 1,465 2.4 % $ 190 $ 2,263 8.4 % Adjustments: Restructuring and related costs 3 37 Amortization of intangible assets 10 11 Transaction and related costs, net 7 4 Other expenses, net 7 38 Adjusted $ 62 $ 1,465 4.2 % $ 280 $ 2,263 12.4 % Six Months Ended June 30, 2020 2019 (in millions) Profit Revenue Margin Profit Revenue Margin Reported (1) $ 30 $ 3,325 0.9 % $ 263 $ 4,443 5.9 % Adjustments: Restructuring and related costs 44 149 Amortization of intangible assets 21 26 Transaction and related costs, net 24 4 Other expenses, net 30 77 Adjusted $ 149 $ 3,325 4.5 % $ 519 $ 4,443 11.7 % ____________________________ (1) Pre-Tax Income and Revenue from continuing operations. Xerox 2020 Form 10-Q 61 ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information set forth under the “Financial Risk Management” section of this Quarterly Report on Form 10-Q is hereby incorporated by reference in answer to this Item.