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. References to "Xerox Holdings Corporation" refer to the stand-alone parent company and do not include its subsidiaries. References to "Xerox Corporation" refer to the stand-alone company and do not include subsidiaries. Currently, Xerox Holdings' primary direct operating subsidiary is Xerox and Xerox reflects nearly all of Xerox Holdings' operations. Accordingly, the following MD&A primarily focuses on the operations of Xerox and is intended to help the reader understand Xerox's business and its results of operations and financial condition. 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 this MD&A, references are made to various notes in the Condensed Consolidated Financial Statements which appear in Item 1 of this Quarterly Report on 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. Xerox Holdings' other direct operating subsidiary is CareAR, Inc. (CareAR), a small SaaS solutions provider, which was acquired in 2020. CareAR incurred approximately $1 million of Selling, administrative and general expenses and $1 million of Amortization of intangible assets, net in first quarter of 2021. Due to their immaterial nature, and for ease of discussion, CareAR's expenses are included in this discussion with Xerox's costs and expenses. Currency Impact To understand the trends in the 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 COVID-19 pandemic, we continue to prioritize the health and safety of our employees, customers and partners and support their needs so they can perform their work flawlessly, whether in the office or a remote location. During the first quarter 2021, our business was still experiencing the impact of the pandemic, and the recovery in the near-term may be uneven and affected by the emergence of new variants of the virus and the resurgence of elevated COVID-19 cases in various countries and regions. However, we saw a gradual recovery of our revenues as businesses gained confidence in the progress to control the pandemic and resumed investments in new printing technology and services, and we saw a positive correlation between the roll-out of vaccinations, the return of employees to the office, and the gradual recovery of our page-volume driven Post sale revenues. We expect that measures to control the pandemic and expand economic activity will result in a moderate economic improvement in 2021. We also expect to continue our actions to mitigate the effects of the pandemic on our business operations and financial performance, and we have a strong balance sheet and sufficient liquidity, including access to our undrawn $1.8 billion revolver. With our Project Own It transformation and cost savings, we have built a leaner and more flexible cost structure, but we also continue to focus our efforts on incremental actions to prioritize and preserve cash as we manage through the pandemic. These actions include the continued reduction of discretionary spend such as near-term targeted marketing programs, the use of contract employees, and the suspension of 401(k) matching contributions. In addition, in response to the COVID-19 pandemic, various governments continue to employ temporary measures to provide aid and economic stimulus directly to companies through cash grants and credits or indirectly through payments to temporarily furloughed employees. During first quarter 2021, we recognized savings of approximately $10 million from the use of such measures in the U.S., Canada and Europe. We continue to monitor government programs and actions being implemented or expected to be implemented to counter the economic impacts of the COVID-19 pandemic. Xerox 2021 Form 10-Q 39 Overview First Quarter 2021 Review Total revenue of $1.71 billion for first quarter 2021 declined 8.1% from first quarter 2020, including a 2.3-percentage point favorable impact from currency. The decrease in revenue reflected a decrease of 13.4% in Post sale revenue, including a 2.2-percentage point favorable impact from currency, offset by an increase of 17.2% in Equipment sales revenue, including a 3.0-percentage point favorable impact from currency. The COVID-19 pandemic impacted our first quarter 2021 revenues due to business closures and office building capacity restrictions that caused lower printing volumes on our devices. However, our revenues from equipment devices benefited from higher sales in the last month of the quarter corresponding with increased confidence in the progress of vaccinations and the gradual reopening of workplaces, compared to business shutdowns at the end of first quarter 2020. Net income (loss) attributable to Xerox Holdings and adjusted 1 Net income attributable to Xerox Holdings were as follows: Three Months Ended March 31, (in millions) 2021 2020 B/(W) Net income (loss) attributable to Xerox Holdings $ 39 $ (2) $ 41 Adjusted (1) Net income attributable to Xerox Holdings 47 50 (3) First quarter 2021 Net income attributable to Xerox Holdings increased $41 million as compared to first quarter 2020 primarily due to the prior year including a $60 million incremental provision to cover estimated write-offs on our trade and finance receivable portfolio from the economic disruption caused by the COVID-19 pandemic as well as lower Restructuring and related costs, net, Transaction and related costs, net and non-service retirement-related costs. These impacts were offset by lower Revenues that were only partially offset by lower operating costs and expenses. First quarter 2021 A djusted 1 net income attributable to Xerox Holdings decreased $3 million as compared to the prior year, reflecting lower revenues, which were only partially offset by lower operating costs and expenses and lower Income tax expense. Cash flows provided by operating activities for the three months ended March 31, 2021 were $117 million, as compared to $173 million in the prior year period primarily reflecting lower working capital, net 2 , as well as a lower run-off of finance receivables. Cash used in investing activities for the three months ended March 31, 2021 was $17 million for capital expenditures. Cash used in financing activities for the three months ended March 31, 2021 was $318 million reflecting payments of $95 million on secured borrowings, $162 million on repurchases of our Common Stock and dividend payments of $54 million. 2021 Outlook We continue to expect a modest recovery in 2021 and expect full year total revenues to increase to at least $7.2 billion, or approximately 2.5%, excluding the impact of currency. We are confident in our ability to generate cash and plan to continue our capital allocation policy of returning at least 50% of our annual free cash flow to shareholders, as disclosed in our 2020 Annual Report. We expect operating cash flows to be approximately $600 million, with capital expenditures of approximately $100 million and plan to opportunistically make share repurchases utilizing our remaining share repurchase authorization of approximately $338 million. ____________________________ (1) See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. (2) Working capital, net reflects Accounts receivable, net, Inventories and Accounts payable. Xerox 2021 Form 10-Q 40 Financial Review Revenues Three Months Ended March 31, % of Total Revenue (in millions) 2021 2020 % Change CC % Change 2021 2020 Equipment sales $ 381 $ 325 17.2 % 14.2 % 22 % 17 % Post sale revenue 1,329 1,535 (13.4) % (15.6) % 78 % 83 % Total Revenue $ 1,710 $ 1,860 (8.1) % (10.4) % 100 % 100 % Reconciliation to Condensed Consolidated Statements of Income (Loss): Sales $ 602 $ 565 6.5 % 4.2 % Less: Supplies, paper and other sales (221) (240) (7.9) % (9.3) % Equipment sales $ 381 $ 325 17.2 % 14.2 % Services, maintenance and rentals $ 1,053 $ 1,236 (14.8) % (18.0) % Add: Supplies, paper and other sales 221 240 (7.9) % (9.3) % Add: Financing 55 59 (6.8) % (8.6) % Post sale revenue $ 1,329 $ 1,535 (13.4) % (15.6) % Americas $ 1,076 $ 1,239 (13.2) % (13.4) % 63 % 67 % EMEA 587 575 2.1 % (4.6) % 34 % 31 % Other 47 46 2.2 % 2.2 % 3 % 2 % Total Revenue (1) $ 1,710 $ 1,860 (8.1) % (10.4) % 100 % 100 % _____________ 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 March 31, 2021 decreased 8.1% as compared to first quarter 2020, including a 2.3-percentage point favorable impact from currency and an approximate 1.0-percentage point favorable impact from 2020 partner dealer acquisitions. The COVID-19 pandemic impacted our first quarter 2021 revenues due to business closures and office building capacity restrictions that caused lower printing volumes on our devices. However, our revenues from equipment devices benefited from higher sales in the last month of the quarter corresponding with increased confidence in the progress of vaccinations and the gradual reopening of workplaces, compared to business shutdowns at the end of first quarter 2020. Sequentially, the rate of decline of our revenues moderated during first quarter 2021. Geographically, the rate of revenue decline moderated more significantly in our EMEA operations, partially due to the region's earlier and more expansive shutdown in the prior year, as well as its higher mix of SMB businesses which have recovered more rapidly with the progress of vaccinations and the control of the pandemic, while our North American operations include a higher proportion of Enterprise customers who are experiencing a slower pace of return to large office buildings. Our EMEA revenues were also favorably impacted by prior year acquisitions in the region Total revenue for the three months ended March 31, 2021 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 are 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 primarily from our XBS organization. For the three months ended March 31, 2021 Post sale revenue decreased 13.4% as compared to first quarter 2020, including a 2.2-percentage point favorable impact from currency. The COVID-19 pandemic impacted our Post sale revenue during the first quarter 2021 due to office closures. The decline in Post sale revenue 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. While these revenues are contractual in nature, our bundled services contracts generally include a Xerox 2021 Form 10-Q 41 minimum fixed charge and a significant variable component based on print volumes. The rate of decline of these revenues moderated as compared to fourth quarter 2020, benefiting from an easier compare (as the prior year was affected by shutdowns at the end of the quarter), but also corresponding with a modest sequential increase in page volumes as the quarter progressed consistent with the rollout of vaccinations, which allowed more employees to return to their offices. For the three months ended March 31, 2021, these revenues decreased 14.8% as compared to first quarter 2020, including a 3.2-percentage point favorable impact from currency. The decline at constant currency 1 reflected a lower population of devices (which is partially associated with lower installs in prior periods), an ongoing competitive price environment, and lower page volumes (including a higher mix of lower average-page-volume products). • Supplies, paper and other sales includes unbundled supplies and other sales. For the three months ended March 31, 2021, these revenues decreased 7.9% as compared to first quarter 2020, including a 1.4-percentage point favorable impact from currency and reflected primarily lower supplies revenues associated with lower page volume trends partially offset by higher IT revenues from IT dealers acquired in the prior year in the U.K. and Canada, and from our XBS sales unit The decrease in supplies was impacted by lower sales through indirect channels. The rate of decline of these revenues improved as compared to fourth quarter 2020, as resellers, moderately softened their cash control and inventory restrictions consistent with gradual indications of improvement in the control of the pandemic. • Financing revenue is generated from financed equipment sale transactions. For the three months ended March 31, 2021, these revenues declined 6.8%, reflecting a continued decline in the finance receivables balance due to lower equipment sales in prior periods and included a 1.8-percentage point favorable impact from currency. XFS lease originations increased in the quarter as compared to first quarter 2020, due to a higher level of lease originations for our XBS sales unit. ____________ (1) See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. Equipment sales revenue Three Months Ended March 31, % of Equipment Sales (in millions) 2021 2020 % Change CC % Change 2021 2020 Entry $ 68 $ 48 41.7% 35.9% 18% 15% Mid-range 238 206 15.5% 13.2% 63% 63% High-end 70 67 4.5% 2.0% 18% 21% Other 5 4 25.0% 25.0% 1% 1% Equipment sales $ 381 $ 325 17.2% 14.2% 100% 100% _____________ CC - See "Currency Impact" section for a description of Constant Currency. Note: During first quarter 2021, we revised the classification of equipment sales revenue by category for our XBS sales unit. Refer to the Equipment Sales Revenue - Classification Update section, for the revision of prior periods based on the new classification. Equipment sales revenue increased 17.2% for the three months ended March 31, 2021 as compared to first quarter 2020, including a 3.0-percentage point favorable impact from currency partially offset by the impact of price declines of less than 5%. The increase is partially the result of a favorable compare to the first quarter 2020, when the COVID-19 pandemic resulted in sudden business closures during the last month of the quarter when, historically, a significant portion of our equipment is sold. In addition, these revenues increased at a higher pace through our indirect channels in the U.S. and EMEA, in part due to resellers modestly rebuilding inventories as demand increased with business reopenings. We also continue to see higher sales to our government customers in the U.S., and a higher mix of our revenues coming from lower-end devices as a result of trends associated with the COVID-19 pandemic. The growth at constant currency 1 reflected the following: • Entry - The increase was driven primarily by higher demand for our lower-end printers and MFPs through our indirect channels in the U.S. and in EMEA, including higher installs related to government deals in the developing regions of EMEA. • Mid-range - The increase was driven primarily by higher demand as a result of business reopenings as compared to business shutdowns that reduced purchases of office devices in the prior year. In addition, through the quarter, we saw a gradual narrowing of the gap to pre-pandemic levels consistent with the progress of vaccinations and office and school reopenings. Xerox 2021 Form 10-Q 42 • High-end - The increase reflected primarily improvement in sales of devices in the lower-end of the range, to SMB customers, while sales of larger production engines continued to be depressed as a result of our clients' delayed capital investment decisions. 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 and non-Xerox branded products installed by our XBS sales unit. Detail by product group (see Geographic Sales Channels and Product and Offerings Definitions ) is shown below. Installs for the first quarter 2021: Entry • 9% increase in color multifunction devices reflecting higher installs of ConnectKey devices through our indirect channels in EMEA, partially offset by lower installs through our U.S. resellers. • 97% increase in black-and-white multifunction devices reflecting higher activity primarily from indirect channels in the U.S and from developing regions in EMEA. The increase is primarily driven by higher sales of low-end devices including large order government deals from developing markets in EMEA. Mid-Range (1) • 11% increase in mid-range color installs primarily reflecting higher installs of our recently launched PrimeLink entry-production color devices and our new-generation of ConnectKey multi-function printers. • 13% increase in mid-range black-and-white installs reflecting higher installs of our recently launched PrimeLink light-production devices and our new-generation of ConnectKey multi-function devices. High-End (1) • 46% increase in high-end color installs reflecting primarily growth from our lower-end Versant devices and our Iridesse systems partially offset by lower installs of our higher-end production presses. • 18% increase in high-end black-and-white systems reflecting higher installs of our Nuvera devices related to cyclical account refreshes in the U.S. _____________ (1) Mid-range and High-end color installations exclude Fuji Xerox (now known as FUJIFILM Business Innovation Corp. (Fuji Xerox)) digital front-end sales; including Fuji Xerox digital front-end sales Mid-range color devices increased 12% and High-end color systems increased 44%. Xerox 2021 Form 10-Q 43 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. Equipment Sales Revenue - Classification Update During first quarter 2021, we revised the classification of equipment sales revenue by category for our XBS sales unit to conform the classification of devices across Xerox sales channels. The revision had no impact on reported total equipment sales revenue. 2020 Equipment Sales Revenue As Reported (in millions) Q1 Q2 Q3 Q4 FY Entry $ 40 $ 34 $ 55 $ 59 $ 188 Mid-range 218 209 291 325 1,043 High-end 64 64 69 115 312 Other 3 3 4 11 21 Equipment Sales Revenue $ 325 $ 310 $ 419 $ 510 $ 1,564 Change (in millions) Q1 Q2 Q3 Q4 FY Entry $ 8 $ 10 $ 11 $ 11 $ 40 Mid-range (12) (14) (15) (16) (57) High-end 3 3 3 4 13 Other 1 1 1 1 4 Equipment Sales Revenue $ — $ — $ — $ — $ — 2020 Equipment Sales Revenue As Revised (in millions) Q1 Q2 Q3 Q4 FY Entry $ 48 $ 44 $ 66 $ 70 $ 228 Mid-range 206 195 276 309 986 High-end 67 67 72 119 325 Other 4 4 5 12 25 Equipment Sales Revenue $ 325 $ 310 $ 419 $ 510 $ 1,564 Xerox 2021 Form 10-Q 44 Costs, Expenses and Other Income Summary of Key Financial Ratios The following is a summary of key financial ratios used to assess our performance: Three Months Ended March 31, (in millions) 2021 2020 B/(W) Gross Profit $ 611 $ 712 $ (101) RD&E 74 84 10 SAG 448 541 93 Equipment Gross Margin 27.9 % 26.3 % 1.6 pts. Post sale Gross Margin 38.0 % 40.8 % (2.8) pts. Total Gross Margin 35.7 % 38.3 % (2.6) pts. RD&E as a % of Revenue 4.3 % 4.5 % 0.2 pts. SAG as a % of Revenue 26.2 % 29.1 % 2.9 pts. Pre-tax Income (Loss) $ 53 $ (5) $ 58 Pre-tax Income (Loss) Margin 3.1 % (0.3) % 3.4 pts. Adjusted (1) Operating Profit $ 89 $ 87 $ 2 Adjusted (1) Operating Margin 5.2 % 4.7 % 0.5 pts. ____________ _ (1) See the “Non-GAAP Financial Measures” section for an explanation of the non-GAAP financial measure. Pre-tax Income Margin First quarter 2021 pre-tax income margin of 3.1% increased by 3.4-percentage points as compared to first quarter 2020. The increase primarily reflected the impact of higher adjusted 1 operating margin (see below) as well as lower Restructuring and related costs, net, Transaction and related costs, net and lower Other expenses, net, partially offset by higher Amortization of intangible assets. Adjusted 1 Operating Margin First quarter 2021 adjusted 1 operating margin of 5.2% increased by 0.5-percentage points as compared to first quarter 2020 reflecting an approximate 3.7-percentage point favorable impact from lower bad debt expense due to a higher provision in the prior year to reflect the expected impact to our trade and finance receivable portfolio as a result of the economic disruption caused by the COVID-19 pandemic. This benefit was partially offset by the impact of lower revenues, primarily due to the effect of the COVID-19 pandemic on our business. The impact of these lower revenues was in turn partially mitigated by cost and expense reductions associated with our Project Own It transformation actions, and additional savings from various other cost reductions to mitigate the impact of the pandemic. These actions include savings of approximately $10 million from temporary government assistance measures and reductions in discretionary spend such as the use of contract employees and the suspension of 401(k) matching contributions. ______________ (1) Refer to the Operating Income and Margin reconciliation table in the "Non-GAAP Financial Measures" section. Gross Margin First quarter 2021 gross margin of 35.7% decreased by 2.6-percentage points as compared to first quarter 2020, reflecting the impact of lower revenues, primarily as a result of the effect of the COVID-19 pandemic, including a lower mix of our higher-margin post sale stream (which is most affected by business closures and the associated lower print volumes), as well as the impact of the ongoing competitive price environment. These headwinds were partially offset by the cost savings from our Project Own It transformation actions as well as the additional cost reduction actions to mitigate the impact of the pandemic, including savings of approximately $7 million from temporary government assistance measures and reductions in discretionary spend such as the use of contract employees and the suspension of 401(k) matching contributions. Xerox 2021 Form 10-Q 45 First quarter 2021 Equipment gross margin of 27.9% increased by 1.6-percentage points as compared to first quarter 2020, reflecting higher sales in the last month of the quarter, as well as the benefit of cost reductions from Project Own It and favorable transaction currency partially offset by an unfavorable mix of growth in low-end devices and the impact of targeted price promotions. First quarter 2021 Post sale gross margin of 38.0% decreased by 2.8-percentage points as compared to first quarter 2020, reflecting the impact of lower revenues (primarily as a result of COVID-19 related business closures impacting page volumes) and price erosion on contract renewals, partially offset by productivity and cost savings and restructuring savings associated with Project Own It transformation actions, as well as savings from additional cost reduction actions to mitigate the impact of the pandemic. Research, Development and Engineering Expenses (RD&E) Three Months Ended March 31, (in millions) 2021 2020 Change R&D $ 59 $ 68 $ (9) Sustaining engineering 15 16 (1) Total RD&E Expenses $ 74 $ 84 $ (10) First quarter 2021 RD&E as a percentage of revenue of 4.3% decreased by 0.2-percentage points as compared to first quarter 2020, as a result of cost reductions that outpaced the rate of revenue declines. RD&E of $74 million decreased $10 million as compared to first quarter 2020 reflecting savings from simplification and rationalization in our core technology, as well as a favorable impact from the program cycle of recent launches and the timing of projects. Selling, Administrative and General Expenses (SAG) First quarter 2021 SAG as a percentage of revenue of 26.2% decreased by 2.9-percentage points as compared to first quarter 2020, primarily as a result of an approximate 3.7-percentage point favorable impact from lower bad debt expense due to a higher provision in the prior year to reflect the expected impact to our trade and finance receivable portfolio as a result of the economic disruption caused by the COVID-19 pandemic. The remaining increase was primarily due to the impact of lower revenues, which was only partially offset by lower expenses as a result of cost savings and restructuring associated with our Project Own It transformation actions, and savings from additional cost reduction actions to mitigate the impact of the pandemic. These actions include savings from temporary government assistance measures and reductions in discretionary spend such as near-term targeted marketing programs, and the suspension of 401(k) matching contributions. First quarter 2021 SAG of $448 million decreased by $93 million as compared to first quarter 2020, reflecting primarily lower bad debt expenses, as well as cost savings and restructuring savings associated with our Project Own It transformation actions and from additional cost reduction actions to mitigate the impact of the pandemic, as described above, partially offset by higher compensation related accrual expenses (consistent with higher expected operating results), an approximate $10 million impact from translation currency, and higher expenses from prior year acquisitions. Our bad debt provision of $10 million decreased by $64 million as compared to first quarter 2020, primarily due to the prior year reflecting an approximate $60 million incremental provision to cover estimated write-offs on our trade and finance receivable portfolio from the economic disruption caused by the COVID-19 pandemic. Subsequent to first quarter 2020 and through first quarter 2021, actual write-offs incurred to date have lagged expectations but remain in line with our original projections over the life of the lease portfolio and consistent with future expectations regarding our estimated impacts from the COVID-19 pandemic. Accordingly, our reserves as a percent of receivables have remained fairly consistent subsequent to the first quarter 2020 charge. We continue to monitor developments regarding the pandemic, including business closures and mitigating government support actions and as a result our reserves may need to be updated in future periods. On a trailing twelve-month basis (TTM), bad debt expense was approximately 1.3% of total receivables, which is nearly back to the pre-pandemic trend of approximately 1.0% and reflects the consistent level of reserves subsequent to the first quarter 2020 charge. Xerox 2021 Form 10-Q 46 Restructuring and Related Costs, Net We incurred Restructuring and related costs, net of $17 million for the first quarter 2021 , as compared to $41 million for first quarter 2020. These costs were primarily related to the implementation of initiatives under our business transformation projects including Project Own It. The following is a breakdown of those costs: Three Months Ended March 31, (in millions) 2021 2020 Severance (1) $ 14 $ 32 Asset impairments (2) 10 2 Other contractual termination costs (3) 1 1 Net reversals (4) (4) (6) Restructuring and asset impairment costs 21 29 Retention related severance/bonuses (5) (4) 7 Contractual severance costs (6) — 4 Consulting and other costs (7) — 1 Total $ 17 $ 41 _____________ (1) Reflects headcount reductions of approximately 350 and 300 employees worldwide in first quarter 2021 and 2020, respectively. (2) Primarily related to the exit and abandonment of leased and owned facilities. The charge includes the accelerated write-off of $1 million and $1 million for leased right-of-use assets and $9 million and $1 million for owned assets upon exit from the facilities, net of any potential sublease income and other recoveries, including potential sales, in the first quarter of 2021 and 2020, respectively. (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. The $4 million credit in first quarter 2021 reflects a change in estimate. (6) Amounts primarily reflect estimated severance and other related costs we were contractually required to pay in connection with employees transferred as part of the shared service arrangement entered into with HCL Technologies in the first quarter 2019. (7) Represents professional support services associated with our business transformation initiatives. First quarter 2021 actions impacted several functional areas, with approximately 25% focused on gross margin improvements, approximately 65% focused on SAG reductions and the remainder focused on RD&E optimization. First quarter 2020 actions impacted several functional areas, with approximately 40% focused on gross margin improvements, approximately 50% focused on SAG reductions and the remainder focused on RD&E optimization. The Restructuring and related costs, net reserve balance as of March 31, 2021 for all programs was $76 million, which is expected to be paid over the next twelve months. Refer to Note 10 - Restructuring Programs in the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs. Transaction and Related Costs, Net Transaction and related costs, net primarily reflect costs from third party providers for professional services associated with certain strategic M&A projects. There were no Transaction and related costs, net incurred during first quarter 2021 as compared to $17 million of Transaction and related costs, net, during the first quarter of 2020 primarily related to legal and other professional costs associated with the terminated proposal to acquire HP Inc. Amortization of Intangible Assets Amortization of intangible assets for the three months ended March 31, 2021 of $15 million increased by $4 million as compared to the prior year period primarily related to intangible assets associated with our 2020 partner dealer acquisitions in the U.K. and Canada. Worldwide Employment Worldwide employment was approximately 24,600 as of March 31, 2021 and decreased by approximately 500 1 from December 31, 2020. The reduction resulted from net attrition (attrition net of gross hires), of which a large portion is not expected to be back filled, as well as the impact of organizational changes. _____________ (1) Decrease based on revised headcount at December 31, 2020 of 25,100 from 24,700 due to the change in definition of full-time equivalent employee. Xerox 2021 Form 10-Q 47 Other Expenses, Net Three Months Ended March 31, (in millions) 2021 2020 Non-financing interest expense $ 24 $ 21 Interest income (1) (8) Non-service retirement-related costs (20) 1 Gains on sales of businesses and assets — (1) Currency losses, net 2 2 Contract termination costs - IT services — 3 All other expenses, net (1) 5 Other expenses, net $ 4 $ 23 Non-Financing Interest Expense First quarter 2021 non-financing interest expense of $24 million was $3 million higher than first quarter 2020. When combined with financing interest expense (Cost of financing), total interest expense increased by $1 million from first quarter 2020 primarily reflecting a lower average debt balance. Refer to Note 11 - Debt in the Condensed Consolidated Financial Statements, for additional information regarding debt activity and the interest expense. Interest Income Interest income for the three months ended March 31, 2021 was $7 million lower than first quarter 2020, primarily due to lower interest rates. Non-Service Retirement-Related Costs Non-service retirement-related costs for the three months ended March 31, 2021 were $21 million lower than first quarter 2020, primarily driven by lower discount rates, as well as higher expected returns on plan assets due to higher asset balances, and lower losses from pension settlements in the U.S. Refer to Note 14 - Employee Benefit Plans in the Condensed Consolidated Financial Statements, for additional information regarding non-service retirement-related costs. Income Taxes First quarter 2021 effective tax rate was 26.4%. On an adjusted 1 basis, first quarter 2021 effective tax rate was 27.7%. This rate was higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of earnings. The adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, net, Amortization of intangible assets, non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. First quarter 2020 effective tax rate was 20.0%. On an adjusted 1 basis, first quarter 2020 effective tax rate was 29.4%. This rate was higher than the U.S. federal statutory tax rate of 21% primarily due to state taxes and the geographical mix of earnings as well as the increased impact from various non-deductible and discrete items on lower pre-tax income. The adjusted1 effective tax rate excludes the tax impacts associated with the following charges: Restructuring and related costs, net, Amortization of intangible assets, Transaction and related costs, net, non-service retirement-related costs and other discrete, unusual or infrequent items as described in our Non-GAAP Financial Measures section. 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 Investment in Affiliates, at Equity largely consists of several minor investments in entities in the Middle East region. There was no Equity in net income of unconsolidated affiliates for the three months ended March 31, 2021, as compared to $2 million of Equity income of unconsolidated affiliates for the three months ended March 31, 2020. Xerox 2021 Form 10-Q 48 Net Income (Loss) First quarter 2021 Net income attributable to Xerox Holdings was $39 million, or $0.18 per diluted share. On an adjusted 1 basis, Net income attributable to Xerox Holdings was $47 million, or $0.22 per diluted share. First quarter 2021 adjustments to Net income included Restructuring and related costs, net, Amortization of intangible assets, and non-service retirement-related costs (see Non-GAAP Financial Measures). First quarter 2020 Net loss attributable to Xerox Holdings was $2 million, or $(0.03) per diluted share. On an adjusted 1 basis, Net income attributable to Xerox Holdings was $50 million, or $0.21 per diluted share. Both amounts included the impact of the approximately $60 million pre-tax increase in bad debt expense (approximately $43 million after-tax) as compared to first quarter 2019, primarily reflecting the expected impact to our customer base and related outstanding receivable portfolio as a result of the economic disruption caused by the COVID-19 pandemic. First quarter 2020 adjustments to Net loss included Restructuring and related costs, net, Amortization of intangible assets, Transaction and related costs, net as well as non-service retirement-related costs and other discrete, unusual or infrequent items (see Non-GAAP Financial Measures). Refer to Note 18 - Earnings (Loss) per Share in the Condensed Consolidated Financial Statements, for additional information regarding the calculation of basic and diluted earnings (loss) per share. _____________ (1) Refer to the Net Income (Loss) and EPS reconciliation table in the "Non-GAAP Financial Measures" section. Other Comprehensive Loss First quarter 2021 Other Comprehensive Loss, Net Attributable to Xerox was $3 million and included the following: i) net translation adjustment losses of $51 million reflecting the weakening of the Euro against the U.S. Dollar that was only partially offset by the strengthening of the GBP and CAD dollar; ii) $7 million of net unrealized losses; and iii) $55 million of net gains from the changes in defined benefit plans primarily due to net actuarial gains as a result of higher discount rates in the U.S. This compares to Other Comprehensive Loss, Net Attributable to Xerox of $138 million for the first quarter 2020, which reflected the following: i) net translation adjustment losses of $197 million reflecting the significant weakening of our major foreign currencies against the U.S. Dollar; ii) $54 million of net gains from the changes in defined benefit plans; and iii) $5 million net unrealized gains. Refer to Note 17 - Other Comprehensive Income (Loss) in the Condensed Consolidated Financial Statements, for the components of Other Comprehensive Loss, Note 12 - Financial Instruments in the Condensed Consolidated Financial Statements, for additional information regarding unrealized (losses) gains, net, and Note 14 - Employee Benefit Plans in the Condensed Consolidated Financial Statements, for additional information regarding net changes in our defined benefit plans. _____________ (1) AOCL - Accumulated other comprehensive loss. New Business Strategy As disclosed in our 2020 Annual Report, in January 2021 we announced our intention to stand up our Software, Financing and Innovation businesses as separate units by 2022. At this stage, the operations and financial results for these units continue to be managed by and reported in our “go-to-market” (GTM) sales channels. We have begun the process of reorganizing these new units from the GTM units but we have not progressed to the point where we have discrete and complete financial information for these new businesses. Accordingly, the chief operating decision maker (CODM) and management continue to manage the Company’s operations, including the products and services from these units, through the GTM sales channels and as result, we continue to have one operating and reportable segment. We expect that the business and financial information for these new units, as well as the operational management of these businesses, will continue to be refined and improved during 2021. Accordingly, a reassessment of our operating segments may be required later in 2021. Xerox 2021 Form 10-Q 49 Capital Resources and Liquidity Our first quarter financial results were impacted by COVID-19 related business closures and office building capacity restrictions. However, we believe we have sufficient liquidity to manage the business through the economic disruption caused by this pandemic: • A majority of our business is contractually based and most of our bundled services contracts include not only a variable component linked to print volumes, but also a fixed minimum, which provides us with a continuing stream of operating cash flow. • As of March 31, 2021, total cash, cash equivalents and restricted cash were $2,461 million and, apart from the restricted cash of $82 million, was readily accessible for use. We have access to an undrawn $1.8 billion Credit Facility that matures in August 2022. • We have utilized a combination of capital markets financing and securitization to refinance all of our 2021 debt maturities, significantly reducing our near-term debt commitments and improving our liquidity. • We continue to focus our efforts on incremental actions to prioritize and preserve cash as we manage through the pandemic. These actions include the use of available temporary government assistance measures and furlough programs and the reduction of discretionary spend such as near-term targeted marketing programs and the suspension of 401(k) matching contributions. Cash Flow Analysis The following summarizes our cash, cash equivalents and restricted cash: Three Months Ended March 31, Change (in millions) 2021 2020 Net cash provided by operating activities $ 117 $ 173 $ (56) Net cash used in investing activities (17) (214) 197 Net cash used in financing activities (318) (60) (258) Effect of exchange rate changes on cash, cash equivalents and restricted cash (12) (29) 17 Decrease in cash, cash equivalents and restricted cash (230) (130) (100) Cash, cash equivalents and restricted cash at beginning of period 2,691 2,795 (104) Cash, Cash Equivalents and Restricted Cash at End of Period $ 2,461 $ 2,665 $ (204) Cash Flows from Operating Activities Net cash provided by operating activities was $117 million in first quarter 2021. The $56 million decrease in operating cash from the prior year period was primarily due to the following: • $82 million decrease from lower accounts payable primarily due to decreased spending and the year-over-year timing of supplier and vendor payments. • $74 million decrease from accounts receivable primarily due to a lower sequential revenue decrease as compared to the prior year partially offset by timing of collections. • $56 million decrease from a lower net run-off of finance receivables due to an increased level of XFS lease originations for our XBS sales unit. • $38 million decrease from derivatives primarily related to settlements of EUR/GBP derivative contracts reflecting the significant movements in rates year-over-year. • $108 million increase from inventory primarily due to significant usage in 2020 as inventory levels increased with the onset of the COVID-19 pandemic. • $72 million increase from accrued compensation primarily related to the year-over-year timing of employee incentive payments. Cash Flows from Investing Activities Net cash used in investing activities was $17 million in first quarter 2021. The $197 million change from the prior year period was primarily due to acquisitions of $193 million in the prior year compared to no acquisitions in the current year. Xerox 2021 Form 10-Q 50 Cash Flows from Financing Activities Net cash used in financing activities was $318 million in first quarter 2021. The $258 million increase in the use of cash from the prior year period was primarily due to the following: • $162 million increase due to share repurchases in the current year compared to no share repurchases in the prior year. • $97 million increase from net debt activity primarily due to payments of $94 million on secured financing arrangements in the current year compared to no payments in the prior year. Cash, Cash Equivalents and Restricted Cash Refer to Note 5 - 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 and 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 twelve years and a variety of renewal and/or termination options. As of March 31, 2021 and December 31, 2020, total operating liabilities were $310 million and $333 million, respectively. Refer to Note 9 - Lessee in the Condensed Consolidated Financial Statements for additional information regarding our leases accounted under lessee accounting. Debt and Customer Financing Activities The following summarizes our debt: (in millions) March 31, 2021 December 31, 2020 Xerox Holdings Corporation $ 1,500 $ 1,500 Xerox Corporation 2,200 2,200 Xerox - Other Subsidiaries (1) 673 767 Subtotal - Principal debt balance 4,373 4,467 Debt issuance costs Xerox Holdings Corporation (12) (13) Xerox Corporation (10) (11) Xerox - Other Subsidiaries (1) (3) (3) Subtotal - Debt issuance costs (25) (27) Net unamortized premium 3 3 Fair value adjustments (2) - terminated swaps 1 1 Total Debt $ 4,352 $ 4,444 _____________ (1) Represents secured debt issued by subsidiaries of Xerox Corporation as part of the securitization of Finance Receivables - Refer to Note 11 - Debt in the Condensed Consolidated Financial Statements for additional information. (2) Fair value adjustments normally 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. Refer to Note 11 - Debt in the Condensed Consolidated Financial Statements for additional information regarding debt. Xerox 2021 Form 10-Q 51 Finance Assets and Related Debt The following represents our total finance assets, net associated with our lease and finance operations: (in millions) March 31, 2021 December 31, 2020 Total finance receivables, net (1) $ 3,077 $ 3,165 Equipment on operating leases, net 277 296 Total Finance Assets, net (2) $ 3,354 $ 3,461 _____________ (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, 2020 includes a decrease of $43 million due to currency. Our lease contracts permit customers to pay for equipment over time rather than at the date of installation; therefore, we maintain a certain level of debt (that we refer to as financing debt) to support our investment in these lease contracts, which are reflected in total finance assets, net. For this financing aspect of our business, we maintain an assumed 7:1 leverage ratio of debt to equity as compared to our finance assets. Based on this leverage, the following represents the breakdown of total debt between financing debt and core debt: (in millions) March 31, 2021 December 31, 2020 Finance receivables debt (1) $ 2,692 $ 2,769 Equipment on operating leases debt 243 259 Financing debt 2,935 3,028 Core debt 1,417 1,416 Total Debt $ 4,352 $ 4,444 ____________________________ (1) Finance receivables debt is the basis for our calculation of "Cost of financing" expense in the Condensed Consolidated Statements of Income (Loss). Sales of Accounts Receivable Activity related to sales of accounts receivable is as follows: Three Months Ended March 31, (in millions) 2021 2020 Estimated decrease to operating cash flows (1) $ (27) $ (77) _____________ (1) Represents the difference between current and prior period accounts receivable sales adjusted for the effects of currency. Refer to Note 6 - Accounts Receivable, Net in the Condensed Consolidated Financial Statements for additional information regarding our accounts receivable sales arrangements. Xerox 2021 Form 10-Q 52 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) Xerox Holdings Corporation Xerox Corporation Xerox - Other Subsidiaries (1) Total 2021 Q2 $ — $ — $ 107 $ 107 2021 Q3 — — 101 101 2021 Q4 — — 93 93 2022 — 300 289 589 2023 — 1,000 83 1,083 2024 — 300 — 300 2025 750 — — 750 2026 and thereafter 750 600 — 1,350 Total (2) $ 1,500 $ 2,200 $ 673 $ 4,373 _____________ (1) Represents secured debt issued by subsidiaries of Xerox Corporation as part of securitization of Finance Receivables - Refer to Note 11 - Debt in the Condensed Consolidated Financial Statements for additional information. (2) Includes fair value adjustments. Treasury Stock In the first quarter 2021 Xerox Holdings repurchased 6.7 million shares of our common stock for an aggregate cost of $162 million, including fees. The cumulative total of shares repurchased by Xerox Holdings under the current share repurchase program is 31.4 million shares for an aggregate cost of $762 million, including fees. As of March 31, 2021, the remaining share repurchase authorization is approximately $338 million. 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, from Xerox to HCL. This transition was expected to be completed during 2020, however, it sustained some delays caused by the COVID-19 pandemic, and it is now expected to be finalized by the end of 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 billion over the next 5 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. We incurred net charges of approximately $50 million and $45 million during first quarter 2021 and 2020, respectively. The increase of approximately $5 million was primarily due to scope changes and currency. The cost has been allocated to the various functional expense lines in the Condensed Consolidated Statements of Income (Loss) based on an assessment of the nature and amount of the costs incurred for the various transferred functions prior to their transfer to HCL. Xerox 2021 Form 10-Q 53 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, interest rate caps, foreign currency spot, forward and swap contracts and net purchased foreign currency options to manage interest rate and foreign currency exposures. Our primary foreign currency market exposures include the Japanese Yen, Euro and U.K. Pound Sterling. The fair market values of all our derivative contracts change with fluctuations in interest rates and/or currency exchange rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial instruments are held solely as risk management tools and not for trading or speculative purposes. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities. We are required to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. As permitted, certain of these derivative contracts have been designated for hedge accounting treatment. Certain of our derivatives that do not qualify for hedge accounting are effective as economic hedges. These derivative contracts are likewise required to be recognized each period at fair value and therefore do result in some level of volatility. The level of volatility will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the currency and interest rate markets during the period. The related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities. By their nature, all derivative instruments involve, to varying degrees, elements of market and credit risk. The market risk associated with these instruments resulting from currency exchange and interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. We do not believe there is significant risk of loss in the event of non-performance by the counterparties associated with these instruments because these transactions are executed with a diversified group of major financial institutions. Further, our policy is to deal with counterparties having a minimum investment grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties. The current market events have not required us to materially modify or change our financial risk management strategies with respect to our exposures to interest rate and foreign currency risk. Refer to Note 12 – Financial Instruments in the Condensed Consolidated Financial Statements for further discussion and information on our financial risk management strategies. Xerox 2021 Form 10-Q 54 Non-GAAP Financial Measures We have reported our financial results in accordance with generally accepted accounting principles (GAAP). In addition, we have discussed our financial results using the non-GAAP measures described below. We believe these non-GAAP measures allow investors to better understand the trends in our business and to better understand and compare our results. Accordingly, we believe it is necessary to adjust several reported amounts, determined in accordance with GAAP, to exclude the effects of certain items as well as their related income tax effects. A reconciliation of these non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are set forth below as well as in the first quarter 2021 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 (Loss) and EPS • Effective Tax Rate The above measures were adjusted for the following items: Restructuring and related costs, net: Restructuring and related costs, net 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. These costs are primarily for third-party legal, accounting, consulting and other similar type professional services as well as potential legal settlements that may arise in connection with those M&A transactions. These costs are considered incremental to our normal operating charges and were incurred or are expected to be incurred solely as a result of the planned transactions. Accordingly, we are excluding these expenses from our Adjusted Earnings Measures in order to evaluate our performance on a comparable basis. Non-service retirement-related costs: Our defined benefit pension and retiree health costs include several elements impacted by changes in plan assets and obligations that are primarily driven by changes in the debt and equity markets as well as those that are predominantly legacy in nature and related to employees who are no longer providing current service to the company (e.g. retirees and ex-employees). These elements include (i) interest cost, (ii) expected return on plan assets, (iii) amortization of prior plan amendments, (iv) amortized actuarial gains/losses and (v) the impacts of any plan settlements/curtailments. Accordingly, we consider these elements of our periodic retirement plan costs to be outside the operational performance of the business or legacy costs and not necessarily indicative of current or future cash flow requirements. This approach is consistent with the classification of these costs as non-operating in other expenses, net. Adjusted earnings will continue to include the service cost elements of our retirement costs, which is related to current employee service as well as the cost of our defined contribution plans. Other discrete, unusual or infrequent items: We excluded the following item given its discrete, unusual or infrequent nature and its impact on our results for the period: • Contract termination costs - IT services Xerox 2021 Form 10-Q 55 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: Net Income (Loss) and EPS reconciliation: Three Months Ended March 31, 2021 2020 (in millions, except per share amounts) Net Income EPS Net (Loss) Income EPS Reported (1) $ 39 $ 0.18 $ (2) $ (0.03) Adjustments: Restructuring and related costs, net 17 41 Amortization of intangible assets 15 11 Transaction and related costs, net — 17 Non-service retirement-related costs (20) 1 Contract termination costs - IT services — 3 Income tax on adjustments (2) (4) (21) Adjusted $ 47 $ 0.22 $ 50 $ 0.21 Dividends on preferred stock used in adjusted EPS calculation (3) $ 4 $ 4 Weighted average shares for adjusted EPS (3) 198 216 Fully diluted shares at March 31, 2021 (4) 194 ____________________________ (1) Net income (loss) and EPS attributable to Xerox Holdings. (2) Refer to Effective Tax Rate reconciliation. (3) Average shares for the calculation of adjusted diluted EPS for the three months ended March 31, 2021 and 2020 excludes 7 million shares associated with our Series A convertible preferred stock and therefore earnings include the preferred stock dividend. In addition, adjusted diluted EPS shares for 2020 include 4 million shares for potential dilutive common shares, which are not included in the GAAP EPS calculation since it was a loss. (4) Represents common shares outstanding at March 31, 2021 plus potential dilutive common shares as used for the calculation of adjusted diluted EPS for the first quarter 2021. The amount excludes shares associated with our Series A convertible preferred stock as they were anti-dilutive for the first quarter 2021. Xerox 2021 Form 10-Q 56 Effective Tax Rate reconciliation: Three Months Ended March 31, 2021 2020 (in millions) Pre-Tax Income Income Tax Expense Effective Tax Rate Pre-Tax (Loss) Income Income Tax (Benefit) Expense Effective Tax Rate Reported (1) $ 53 $ 14 26.4 % $ (5) $ (1) 20.0 % Non-GAAP Adjustments (2) 12 4 73 21 Adjusted (3) $ 65 $ 18 27.7 % $ 68 $ 20 29.4 % ____________________________ (1) Pre-tax income (loss) and income tax expense (benefit). (2) Refer to Net Income (Loss) and EPS reconciliation for details. (3) The tax impact on Adjusted Pre-Tax Income (Loss) is calculated under the same accounting principles applied to the Reported Pre-Tax Income (Loss) under ASC 740, which employs an annual effective tax rate method to the results. Operating Income and Margin reconciliation: Three Months Ended March 31, 2021 2020 (in millions) Profit Revenue Margin (Loss) Profit Revenue Margin Reported (1) $ 53 $ 1,710 3.1 % $ (5) $ 1,860 (0.3) % Adjustments: Restructuring and related costs, net 17 41 Amortization of intangible assets 15 11 Transaction and related costs, net — 17 Other expenses, net 4 23 Adjusted $ 89 $ 1,710 5.2 % $ 87 $ 1,860 4.7 % ____________________________ (1) Pre-Tax Income (Loss) Xerox 2021 Form 10-Q 57 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.