ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Xerox Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes. Throughout the MD&A, we refer to various notes to our Consolidated Financial Statements which appear in Item 8 of this 2015 Form 10-K, and the information contained in such notes is incorporated by reference into the MD&A in the places where such references are made.

Throughout this document, references to “we,” “our,” the “Company,” and “Xerox” refer to Xerox Corporation and its subsidiaries. References to “Xerox Corporation” refer to the stand-alone parent company and do not include its subsidiaries.

Executive Overview

With revenues of $18.0 billion we are a leader across large, diverse and growing markets estimated at nearly $365 billion. The global business process outsourcing market is very broad, encompassing multi-industry business processes as well as industry-specific business processes, and our addressable market is estimated at almost $275 billion. The document management market is estimated at about $90 billion and is comprised of the document systems, software, solutions and services that our customers have relied upon for years to help run their businesses and reduce their costs. Xerox led the establishment of the managed print services market, and continues today as the industry leader in this expanding market segment.

Headquartered in Norwalk, Connecticut, the 143,600 people of Xerox serve customers in more than 180 countries providing business services, printing equipment and software for commercial and government organizations. In 2015 , 30% of our revenue was generated outside the U.S.

We organize our business around two main reportable segments: Services and Document Technology .

Annuity-Based Business Model

In 2015 , 85% of our total revenue was annuity-based, which includes contracted outsourcing services, equipment maintenance services, consumable supplies and financing, among other elements. Our annuity revenue significantly benefits from growth in Services . Some of the key indicators of annuity revenue growth include:

Planned Company Separation

On January 29, 2016, we announced that our Board of Directors had approved management’s plan to separate

the Company's Business Process Outsourcing business from its Document Technology and Document Outsourcing

businesses. Each of the businesses will operate as an independent, publicly-traded company. Leadership and the names of the two companies will be determined as the process progresses. The transaction is intended to be

tax-free for Xerox shareholders for federal income tax purposes.

Xerox will begin the process to separate while we finalize the transaction structure. Our objective is to complete the

separation by year-end 2016, subject to customary regulatory approvals, the effectiveness of a Form 10 filing with the U.S. Securities and Exchange Commission, tax considerations, securing any necessary financing and final approval of the Xerox Board of Directors. Until the separation is complete, we will continue to operate and report as a single company, and it will continue to be business as usual for our customers and employees.

As part of the planned separation, Xerox also announced that we will implement a three-year strategic transformation program targeting incremental savings of $600 million across all segments for a cumulative cost reduction of $2.4 billion over the three years when combined with savings from on-going programs.

Acquisitions and Divestitures

Consistent with our strategy to enhance our Services offerings and global presence and to expand our distribution capabilities in Document Technology, we completed several acquisitions during 2015 . Refer to Acquisitions and Divestitures section in Item 1. Business in this Form 10-K as well as Note 3 - Acquisitions in our Consolidated Financial Statements for additional information regarding our 2015 acquisitions.

In December 2014 , we announced an agreement to sell our Information Technology Outsourcing (ITO) business to Atos and began reporting it as a Discontinued Operation. The sale was completed on June 30, 2015. Refer to Note 4 - Divestitures in our Consolidated Financial Statements for additional information.

Significant 2015 Charges

During 2015, we announced several changes regarding the strategic direction of our Government Healthcare Solutions (GHS) business, specifically with respect to the implementation of our Health Enterprise (HE) Medicaid platform. In October 2015, we determined that we would not fully complete the implementation of the platform in California and Montana. This determination resulted in recording a pre-tax charge (HE charge) of $389 million ($241 million after-tax) in the third quarter 2015. $116 million of the charge was recorded as a reduction to revenues and the remaining $273 million was recorded to Cost of outsourcing, maintenance and rentals. This development followed the GHS strategy change announced in July 2015, regarding our decision to focus our future HE implementations on current Medicaid customers and to discontinue investment in and sales of the Xerox Integrated Eligibility System. This change in strategy resulted in pre-tax non-cash software platform impairment charges of $146 million in the second quarter 2015. Refer to the " Government Healthcare Strategy Change" section of the " Services Segment " review for further details of these decisions and charges.

As a result of the significant impact of the HE charge and the software impairment charges on our reported revenues, earnings and key metrics for the period, we are also discussing our results excluding the impact of these charges. These adjusted results are noted as “adjusted ¹ ” in the discussion below. Refer to the "Non-GAAP Financial Measures" section for an explanation of these non-GAAP financial measures.

Financial Overview

Total revenue of $18.0 billion in 2015 declined 8% from the prior year, with a 4-percentage point negative impact from currency. On an adjusted ¹ basis, excluding the HE charge, total revenues decreased 7%, with a 4-percentage point negative impact from currency. Services segment revenues decreased 4%, with a 3-percentage point negative impact from currency. On an adjusted ¹ basis Services segment revenues decreased 3%, with a 3-percentage point negative impact from currency, reflecting a 1% constant currency decrease in BPO revenues offset by a 3% increase in DO revenues . Services segment margin of 4.4% decreased 4.6-percentage points. On an adjusted ¹ basis segment margin was 8.1% and decreased 0.9-percentage points primarily due to targeted resource and other investments and increased expenses associated with our GHS HE platform implementations prior to the change in strategy. Document Technology segment revenues declined 12%, with a 4-percentage point negative impact from currency reflecting lower sales of entry products particularly in developing markets and to OEM customers and

lower supplies demand as well as continued price and page declines. Document Technology segment margin of 11.9% decreased 1.8-percentage points from 2014 , reflecting unfavorable product mix and price declines, within our historical range, and an increase in pension expense partially offset by restructuring and productivity benefits.

2015 Net income from continuing operations attributable to Xerox was $552 million and included the $241 million after-tax HE charge and $90 million after-tax GHS software impairment charges as well as $193 million of after-tax amortization of intangible assets. Net income from continuing operations attributable to Xerox for 2014 was $1,128 million and included $196 million of after-tax amortization of intangible assets. The decrease in net income, after consideration of the noted charges, is primarily due to the profit decline in both the Services and Document Technology segments.

Cash flow from operations was $1.6 billion in 2015 as compared to $2.1 billion in 2014 . The decrease in operating cash flow was primarily due to lower earnings and the elimination of cash flows from the divested ITO business. Cash provided by investing activities of $508 million primarily reflects net proceeds from the sale of the ITO business of approximately $930 million partially offset by capital expenditures of $342 million and acquisitions of $210 million. Cash used in financing activities was $2.1 billion, reflecting $1.3 billion for share repurchases, $370 million of net payments on debt and $326 million for dividends.

2016 Outlook

We expect total revenues to decline 2 to 4% in 2016 , excluding the impact of currency. At mid January 2016 exchange rates, we expect currency to have about a 1 to 2 percentage point negative impact on total revenues in 2016 , reflecting the continued weakening of our major foreign currencies against the U.S. dollar as compared to prior year. Earnings in 2016 are expected to reflect margin improvements in the Services segment and a Document Technology margin generally consistent with 2015. Refer to the " 2016 Segment Reporting Change " section for a discussion of planned changes in the measurement of segment revenues and profits in 2016. The discussion below reflects those changes and the " 2016 Segment Reporting Change " section includes a summary of revised segment results for 2015 on the new basis for comparison purposes.

In our Services business, we expect flat to 3% revenue growth, excluding the impact of currency, with revenue growth improving through the year driven by continued growth in signings. Services margins are expected to improve and be in the range of 8 to 9.5% in 2016 as we continue to focus on productivity and cost improvements, capturing additional efficiencies, including streamlining and automating more of our service delivery capabilities, and continued improvements to our business mix with a greater proportion of revenue from higher value offerings.

In our Document Technology business, we expect revenue to decline 5 to 7%, excluding the impact of currency, as we continue to face secular declines in these markets. We expect to offset these expected declines through continued cost management as well as the benefits from productivity and restructuring actions. 2016 margins in Document Technology are expected to be in the range of 12 to 14%, in line with 2015.

We expect 2016 cash flows from operations to be between $1.3 and $1.5 billion in 2016 and capital expenditures to be approximately $300 million.

Our capital allocation plan for 2016 includes the following:

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 “currency impact” or “the impact from currency” or "constant currency". In 2015 and 2014, 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. Our calculation of this impact currently excludes the exchange impact from our developing market countries (Latin America, Brazil, the Middle East, India, Eurasia and Central-Eastern Europe). Revenues and expenses for these countries are analyzed at actual exchange rates for all periods presented, since these countries generally had unpredictable currency and inflationary environments, and our operations in these countries have historically been able to implement pricing actions to recover the impact of inflation and devaluation.

Approximately 30% of our consolidated revenues are derived from operations outside of the United States where the U.S. Dollar is normally not the functional currency. When compared with the average of the major European currencies and Canadian Dollar on a revenue-weighted basis, the U.S. Dollar was 16% stronger in 2015 and flat in 2014 , each compared to the prior year. As a result, the foreign currency translation had a 4-percentage point negative impact on revenue in 2015 and no impact on revenue in 2014 . We do not hedge the translation effect of revenues or expenses denominated in currencies where the local currency is the functional currency.

The weakness of our major currencies against the U.S. Dollar is expected to remain an unfavorable revenue impact in 2016. At mid January 2016 exchange rates, we expect currency to have about a 1 to 2 percentage point negative impact on full-year 2016 revenues with a higher impact in the first half of the year than the second half.

In 2016 we plan to revise our calculation of the currency impact on revenue growth to include the currency impacts from the developing market countries (Latin America, Brazil, Middle East, India, Eurasia and Central-Eastern Europe), which, as noted above, are currently excluded from the calculation. Over the past few years, the exchange markets for the currencies of all countries - developed countries and developing market countries - have experienced significant volatility and unpredictability. Additionally, due to the changing nature of the global economy and the increased economic dependencies among all countries, the currency exchange markets in the developing market countries are no longer materially different from those in the developed countries. As a result of these market dynamics and economic changes, we currently manage our exchange risk in our developing market countries in a similar manner to the exchange risk in our developed market countries; therefore, the exclusion of the developing market countries from the calculation of the currency effect is no longer warranted. Applying this revised methodology in 2015 would have increased the negative impact from currency by about 1% for both the Total Company and the Document Technology segment revenues. The impact of this change was not material for 2014.

 

Application of Critical Accounting Policies

In preparing our Consolidated Financial Statements and accounting for the underlying transactions and balances, we apply various accounting policies. Senior management has discussed the development and selection of the critical accounting policies, estimates and related disclosures included herein with the Audit Committee of the Board of Directors. We consider the policies discussed below as critical to understanding our Consolidated Financial Statements, as their application places the most significant demands on management's judgment, since financial reporting results rely on estimates of the effects of matters that are inherently uncertain. In instances where different estimates could have reasonably been used, we disclosed the impact of these different estimates on our operations. In certain instances, like revenue recognition for leases, the accounting rules are prescriptive; therefore, it would not have been possible to reasonably use different estimates. Changes in assumptions and estimates are reflected in the period in which they occur. The impact of such changes could be material to our results of operations and financial condition in any quarterly or annual period.

Specific risks associated with these critical accounting policies are discussed throughout the MD&A, where such policies affect our reported and expected financial results. For a detailed discussion of the application of these and other accounting policies, refer to Note 1 - Basis of Presentation and Summary of Significant Accounting Policies in the Consolidated Financial Statements.

Revenue Recognition

Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Refer to Note 1 - Basis of Presentation and Summary of Significant Accounting Policies - Revenue Recognition in the Consolidated Financial Statements for additional information regarding our revenue recognition policies . Specifically, the revenue related to the following areas involves significant judgments and estimates:

Bundled Lease Arrangements : We sell our equipment under bundled lease arrangements, which typically include the equipment, service, supplies and a financing component for which the customer pays a single negotiated monthly fixed price for all elements over the contractual lease term. Approximately 38% of our equipment sales revenue is related to sales made under bundled lease arrangements. Recognizing revenues under these arrangements requires us to allocate the total consideration received to the lease and non-lease deliverables included in the bundled arrangement, based upon the estimated fair values of each element.

Sales to Distributors and Resellers : We utilize distributors and resellers to sell many of our technology products, supplies and services to end-user customers. Sales to distributors and resellers are generally recognized as revenue when products are sold to such distributors and resellers. Distributors and resellers participate in various rebate, price-protection, cooperative marketing and other programs, and we record provisions and allowances for these programs as a reduction to revenue when the sales occur. Similarly, we also record estimates for sales returns and other discounts and allowances when the sales occur. We consider various factors, including a review of specific transactions and programs, historical experience and market and economic conditions when calculating these provisions and allowances. Approximately 11% of our revenues includes sales to distributors and resellers, and provisions and allowances recorded on these sales are approximately 23% of the associated gross revenues.

Revenue Recognition for Services - Percentage-of-Completion : A portion of our Services revenue is recognized using the percentage-of-completion (POC) accounting method. This method requires the use of estimates and judgment. Approximately 2% of our Services revenues were recognized using the POC accounting method. Although not significant to total Services revenue, the POC methodology is normally applied to certain of our larger and longer term outsourcing contracts involving system development and implementation services, primarily in government healthcare and certain government transportation contracts. In addition, we had unbilled receivables totaling $229 million and $360 million at December 31, 2015 and 2014 , respectively, representing revenues recognized but not yet billable under the terms of our POC contracts. The decrease in unbilled revenues in 2015 is primarily due to developments in certain implementations of our Health Enterprise (HE) Medicaid platform - see below.

The POC accounting methodology involves recognizing probable and reasonably estimable revenue using the percentage of services completed based on a current cumulative cost incurred to estimated total cost basis and a reasonably consistent profit margin over the period. Due to the long-term nature of these arrangements, developing the estimates of cost often requires significant judgment. Factors that must be considered in estimating the progress of work completed and ultimate cost of the projects include, but are not limited to, the availability of labor and labor productivity, the nature and complexity of the work to be performed and the impact of delayed performance. If changes occur in delivery, productivity or other factors used in developing the estimates of costs or revenues, we revise our cost and revenue estimates, which may result in increases or decreases in revenues and costs. Such revisions are reflected in income in the period in which the facts that give rise to that revision become known. We perform ongoing profitability analysis of our POC services contracts in order to determine whether the latest estimates require updating. Key factors reviewed by the company to estimate the future costs to complete each contract are future labor costs, future product costs, expected productivity efficiencies, achievement of contracted milestones and performance goals as well as potential penalties for milestone and system implementation delays.

If at any time our estimates indicate the POC contract will be unprofitable, the entire estimated loss for the remainder of the contract is recorded immediately in cost of services and results in the contract being recorded at a zero profit margin with recognition of an equal amount of revenues and costs.

As noted previously, we apply the POC accounting method for arrangements in our government healthcare business. This includes the implementation of our HE Medicaid platform for various states in the U.S. Changes in the healthcare market, including evolving regulations, have continued to impact our development work and project scope for these arrangements including the development work required by our clients and their providers. This has contributed to delays in meeting client delivery dates as well as increased delivery costs for these contracts. In addition, the POC estimation process is particularly complex and challenging for these arrangements due to their significant scope and duration and the highly technical nature of the implementations. As a result, throughout the respective development and implementation periods, there is the potential for additional changes in contract costs, productivity, performance penalties and other factors, all of which may result in material increases or decreases in future revenues and costs. 

As an example, during 2015 it was determined that we would not fully complete the HE Medicaid platform implementation projects in California and Montana. Revenues associated with these implementations were being recognized using the POC accounting method. As a result of the determination that we will not fully complete these implementations, we recorded a $116 million write-off of unbilled POC receivables associated with these projects and additional charges of $273 million. Based on the significance of these projects, we continually monitor the progress on our remaining HE Medicaid platform implementations and consider the potential for increased costs as well as risks and uncertainties in our estimates of revenues and costs under the POC accounting methodology. To the extent possible, we attempt to mitigate these risks through operational changes, project oversight and process improvements. Total unbilled receivables associated with our current HE Medicaid implementation projects were $51 million at December 31, 2015.

Allowance for Doubtful Accounts and Credit Losses

We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience adjusted for current conditions. We recorded bad debt provisions of $53 million, $53 million and $120 million in Selling, Administrative and General Expenses (SAG) expenses in our Consolidated Statements of Income for the years ended December 31, 2015 , 2014 and 2013 , respectively.

Bad debt provisions remained fairly flat in 2015 reflecting a consistent trend in write-offs throughout the year as well as a continued disciplined credit process. Reserves, as a percentage of trade and finance receivables, were 3.0% at December 31, 2015 , as compared to 3.1% and 3.4% at December 31, 2014 and 2013 . We continue to assess our receivable portfolio in light of the current economic environment and its impact on our estimation of the adequacy of the allowance for doubtful accounts.

As discussed above, we estimated our provision for doubtful accounts based on historical experience and customer-specific collection issues. This methodology was consistently applied for all periods presented. During the five year period ended December 31, 2015 , our reserve for doubtful accounts ranged from 3.0% to 3.4% of gross receivables. Holding all assumptions constant, a 0.5-percentage point increase or decrease in the reserve from the December 31, 2015 rate of 3.0% would change the 2015 provision by approximately $33 million.

Refer to Note 5 - Accounts Receivables, Net and Note 6 - Finance Receivables, Net in the Consolidated Financial Statements for additional information regarding our allowance for doubtful accounts.

Pension Plan Assumptions

We sponsor defined benefit pension plans in various forms in several countries covering employees who meet eligibility requirements. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense, liability and asset values related to our defined benefit pension plans. These factors include assumptions we make about the expected return on plan assets, discount rate, lump-sum settlement rates, the rate of future compensation increases and mortality. Differences between these assumptions and actual experiences are reported as net actuarial gains and losses and are subject to amortization to net periodic benefit cost over future periods. Over the past several years, we have amended several of our major defined benefit pension plans to freeze current benefits and eliminate benefit accruals for future service. The freeze of current benefits is the primary driver of the reduction in pension service costs since 2013. In certain plans we are required by law or statute to continue to reflect salary increases and inflation in determining the benefit obligation related to prior service.

Cumulative net actuarial losses for our defined benefit pension plans of $3.1 billion as of December 31, 2015 decreased by $223 million from December 31, 2014 , reflecting the decrease in our benefit obligations as a result of higher discount rates and the recognition of actuarial losses through amortization and U.S. settlement losses. These impacts were partially offset by losses as a result of actual plan asset returns being less than expected returns in

2015. The total actuarial loss at December 31, 2015 is subject to offsetting gains or losses in the future due to changes in actuarial assumptions and will be recognized in future periods through amortization or settlement losses.

We used a consolidated weighted average expected rate of return on plan assets of 6.0% for 2015 , 6.7% for 2014 and 6.7% for 2013 , on a worldwide basis. During 2015 , the actual return on plan assets was $(89) million as compared to an expected return of $376 million, with the difference largely due to negative returns in the equity markets in 2015. When estimating the 2016 expected rate of return, in addition to assessing recent performance, we considered the historical returns earned on plan assets, the rates of return expected in the future, particularly in light of current economic conditions, and our investment strategy and asset mix with respect to the plans' funds. The weighted average expected rate of return on plan assets we will use in 2016 is 5.8%. The decline in the 2016 rate primarily reflects the increased investment in fixed income securities as we reposition our investment portfolios in light of the freeze of plan benefits.

Another significant assumption affecting our defined benefit pension obligations and the net periodic benefit cost is the rate that we use to discount our future anticipated benefit obligations. In the U.S. and the U.K., which comprise approximately 77% of our projected benefit obligation, we consider the Moody's Aa Corporate Bond Index and the International Index Company's iBoxx Sterling Corporate AA Cash Bond Index, respectively, in the determination of the appropriate discount rate assumptions. The consolidated weighted average discount rate we used to measure our pension obligations as of December 31, 2015 and to calculate our 2016 expense was 3.7%; the rate used to calculate our obligations as of December 31, 2014 and our 2015 expense was 3.4%. The weighted average discount rate we used to measure our retiree health obligation as of December 31, 2015 and to calculate our 2016 expense was 4.1%; the rate used to calculate our obligation at December 31, 2014 and our 2015 expense was 3.8%.

Holding all other assumptions constant, a 0.25% increase or decrease in the discount rate would change the 2016 projected net periodic pension cost by approximately $30 million. Likewise, a 0.25% increase or decrease in the expected return on plan assets would change the 2016 projected net periodic pension cost by $19 million.

One of the most significant and volatile elements of our net periodic defined benefit pension plan expense is settlement losses. Our primary domestic plans allow participants the option of settling their vested benefits through the receipt of a lump-sum payment. We recognize the losses associated with these settlements immediately upon the settlement of the vested benefits. Settlement accounting requires us to recognize a pro rata portion of the aggregate unamortized net actuarial losses upon settlement. As noted above, cumulative unamortized net actuarial losses were $3.1 billion at December 31, 2015 , of which the U.S. primary domestic plans represented approximately $1,101 million. The pro rata factor is computed as the percentage reduction in the projected benefit obligation due to the settlement of a participant ' s vested benefit. Settlement accounting is only applied when the event of settlement occurs - i.e. the lump-sum payment is made. Since settlement is dependent on an employee's decision and election, the level of settlements and the associated losses can fluctuate significantly from period to period. During the three years ended December 31, 2015 , U.S. plan settlements were $340 million, $250 million and $838 million, respectively, and the associated settlement losses on those plan settlements were $88 million, $51 million and $162 million, respectively. In 2016, on average, approximately $100 million of plan settlements will result in settlement losses of approximately $25 million.

The following is a summary of our benefit plan costs for the three years ended December 31, 2015 as well as estimated amounts for 2016 :

Our estimated 2016 defined benefit pension plan cost is expected to be approximately $38 million higher than 2015 , primarily driven by higher projected U.S. settlement losses. The increase in expense associated with Retiree health

 

The decrease in contributions to our worldwide defined benefit pension plans in 2016 is largely due to not including any planned contribution for our domestic tax-qualified defined benefit plans because none are required to meet the minimum funding requirements. However, once the January 1, 2016 actuarial valuations and projected results as of the end of the 2016 measurement year are available, the desirability of additional contributions will be reassessed. Based on these results, we may voluntarily decide to contribute to these plans.

Refer to Note 16 - Employee Benefit Plans in the Consolidated Financial Statements for additional information regarding defined benefit pension plan assumptions, expense and funding.

Income Taxes

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments are required in determining the consolidated provision for income taxes. Our provision is based on nonrecurring events as well as recurring factors, including the taxation of foreign income. In addition, our provision will change based on discrete or other nonrecurring events such as audit settlements, tax law changes, changes in valuation allowances, etc., that may not be predictable.

We record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in our Consolidated Balance Sheets, as well as operating loss and tax credit carryforwards. We follow very specific and detailed guidelines in each tax jurisdiction regarding the recoverability of any tax assets recorded in our Consolidated Balance Sheets and provide valuation allowances as required. We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. Adjustments to our valuation allowance, through (credits)/charges to income tax expense, were $(3) million, $(20) million and $2 million for the years ended December 31, 2015 , 2014 and 2013 , respectively. There were other decreases to our valuation allowance, including the effects of currency, of $125 million, $56 million and $42 million for the years ended December 31, 2015 , 2014 and 2013 , respectively. These did not affect income tax expense in total as there was a corresponding adjustment to deferred tax assets or other comprehensive income. Gross deferred tax assets of $3.1 billion and $3.4 billion had valuation allowances of $410 million and $538 million at December 31, 2015 and 2014 , respectively.

We are subject to ongoing tax examinations and assessments in various jurisdictions. Accordingly, we may incur additional tax expense based upon our assessment of the more-likely-than-not outcomes of such matters. In addition, when applicable, we adjust the previously recorded tax expense to reflect examination results. Our ongoing assessments of the more-likely-than-not outcomes of the examinations and related tax positions require judgment and can materially increase or decrease our effective tax rate, as well as impact our operating results. Unrecognized tax benefits were $247 million, $240 million and $267 million at December 31, 2015 , 2014 and 2013 , respectively.

Refer to Note 17 - Income and Other Taxes in the Consolidated Financial Statements for additional information regarding deferred income taxes and unrecognized tax benefits.

Business Combinations and Goodwill

The accounting for business combinations requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are depreciated and amortized from goodwill. Our estimates of the fair values of assets and liabilities acquired are based upon assumptions believed to be reasonable, and when appropriate, include assistance from independent third-party valuation firms. Refer to Note 3 - Acquisitions in the Consolidated Financial Statements for additional information regarding the allocation of the purchase price consideration for our acquisitions.

As a result of our acquisition of Affiliated Computer Services, Inc. (ACS) in 2010, as well as other acquisitions including GIS, we have a significant amount of goodwill. Goodwill at December 31, 2015 was $8.8 billion. Goodwill is not amortized but rather is tested for impairment annually or more frequently if an event or circumstance indicates that an impairment may have been incurred. Events or circumstances that might indicate an interim evaluation is warranted include, among other things, unexpected adverse business conditions, macro and reporting unit specific economic factors, supply costs, unanticipated competitive activities and acts by governments and courts.

Application of the annual goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and the assessment- qualitatively or quantitatively - of the fair value of each reporting unit against its carrying value. At December 31, 2015 , $6.5 billion and $2.3 billion of goodwill was allocated to reporting units within our Services and Document Technology segments, respectively. Our Services segment is comprised of five reporting units while our Document Technology segment is comprised of one reporting unit for a total of six reporting units with goodwill balances.

Our annual impairment test of goodwill was performed in the fourth quarter of 2015 . Consistent with 2014 , we elected to utilize a quantitative assessment of the recoverability of our goodwill balances for each of our reporting units.

In our quantitative test, we estimate the fair value of each reporting unit by weighting the results from the income approach (discounted cash flow methodology) and market approach. These valuation approaches require significant judgment and consider a number of factors that include, but are not limited to, expected future cash flows, growth rates and discount rates, and comparable multiples from publicly traded companies in our industry and require us to make certain assumptions and estimates regarding the current economic environment, industry factors and the future profitability of our businesses.

When performing our discounted cash flow analysis for each reporting unit, we incorporate the use of projected financial information and discount rates that are developed using market participant-based assumptions. The cash-flow projections are based on three-year financial forecasts developed by management that include revenue and expense projections, capital spending trends and investment in working capital to support anticipated revenue growth or other changes in the business. The selected discount rates consider the risk and nature of the respective reporting units' cash flows and an appropriate capital structure and rates of return that market participants would require to invest their capital in our reporting units.     

In performing our 2015 impairment test, the following were the 3-year compounded assumptions for Document Technology and the five reporting units within our Services segment with respect to revenue, operating income and margins, which formed the basis for estimating future cash flows used in the discounted cash flow model:

We believe these assumptions are appropriate and reflect our forecasted long-term business model, giving appropriate consideration to our historical results as well as the current economic environment and markets that we serve. The average discount rate applied to our projected cash flows was approximately 9.0%, which we considered reasonable based on the estimated capital costs of applicable market participants. Although the sum of the fair values of our reporting units was in excess of our market capitalization, we believe the difference is reasonable when market-based control premiums and other factors are taken into consideration, including the evolution of our

business to be predominantly services-based.

Our impairment assessment methodology includes the use of outside valuation experts and the inclusion of factors and assumptions related to third-party market participants. When performing our market approach for each reporting unit, we rely specifically on the guideline public company method. Our guideline public company method incorporates revenues and earnings multiples from publicly traded companies with operations and other characteristics similar to each reporting unit. The selected multiples consider each reporting unit’s relative growth, profitability, size and risk relative to the selected publicly traded companies.

After completing our annual impairment reviews for each reporting unit in the fourth quarter of 2015 and 2014 , we concluded that goodwill was not impaired in either of these years. Although we experienced a decline in the fair values of our reporting units in 2015 as compared to 2014, with the exception of the Commercial Services and the Commercial Healthcare Services reporting units, no reporting unit had an excess of fair value over carrying value of less than 20%.

The excess of reporting unit fair values over carrying values for our Commercial Services reporting unit (which has approximately $2.0 billion of goodwill) was significantly less than in prior years with an excess of fair value over carrying value of approximately 17%. Although we experienced a similar 2015 decline in fair value in our Commercial Healthcare Services reporting unit (which has approximately $900 million of goodwill), that decline is expected to be mitigated by synergies and operational improvements resulting from the combination of this reporting unit with the Government Healthcare Services reporting unit in 2016. We will continue to monitor the impact of economic, market and industry factors impacting these reporting units in 2016. The decrease in fair values for these reporting units was largely due to the mix of services and pricing pressures not being matched with cost reductions from productivity and restructuring actions. However, both of these reporting units operate in key growth segments of the business process outsourcing market, and the 2016 expectation is that through an increased focus on revenue and cost management both businesses will reflect improved performance and a corresponding increase in fair value.

Subsequent to our fourth quarter impairment test, we did not identify any indicators of potential impairment that required an update to the annual impairment test.

Refer to Note 10 - Goodwill and Intangible Assets, Net in the Consolidated Financial Statements for additional information regarding goodwill by reportable segment.