全錄公司 (XRX) 2002 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Xerox Corporation fourth quarter 2002 earnings release conference, hosted by Ann Mulcahy, Chairman and Chief Executive Officer. She is joined by Lawrence Zimmerman, Senior Vice-President and Chief Financial Officer.

At the request of Xerox Corporation, today's meeting will be tape recorded. Taping and re-broadcasting of this call are prohibited without express permission so Xerox. After the presentation, there will a question-and-answer session.

During this meeting, Ms. Mulcahy and Mr. Zimmerman will make comments that constitute forward-looking statements. Actual results could differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause actual results to differ materially is included in the company's third quarter 10-Q filed with the SEC. The company does not intend to update any forward-looking statement made during this meeting.

At this time, I would like to turn the meeting over to Ms. Mulcahy. Ms. Mulcahy, you may begin.

Good morning and thanks for joining us today.

By now you've seen our fourth quarter results, which include another strong quarter of earnings and cash flow, as well as improving trends in revenue, especially in equipment sales. Our Q4 performance is further evidence that we are building momentum in the marketplace and that the benefits from our substantially strengthened operations continue to flow through to the bottom line.

Our fourth quarter results also contributed to Xerox's commitment of returning to full-year profitability. Income for the full year was 91 million, a profit of two cents per share, which includes full-year after-tax restructuring charges of 470 million or 58 cents per share.

So this is indeed a significant milestone for the company, reflecting the determination of Xerox people, who've executed with precision to transform our company into a leaner, faster and market-focused global enterprise.

We reported fourth quarter net income of 19 million, a profit of one-cent per share. Our results include restructuring charges of 34 cents per share, as well as a one-time tax benefit of 11 cents per share, so excluding restructuring and the tax gain, our Q4 results reflect earnings of 24 cents per share.

In a moment, our CFO, Larry Zimmerman will walk you through the details of the restructuring and the tax impact. He's also going to provide more information on the strength of our operating cash flow. In the quarter we generated operating cash of 634 million. For the full year operating cash flow was 1.9 billion. And Larry's going to give you an update on Xerox's finance receivable securitization strategy, which is helping to insure our financial flexibly and a steady cash flow. This strategy is working with our year-end worldwide cash position increasing to 2.9 billion.

You'll also be hearing from us this morning about customer's demand for the new technology we introduced in 2002. Our investments and innovative products and services are driving improved revenue and increased market share in our key growth markets.

So we got a lot of ground to cover today; good news on earnings, operations, financing and market demands. So let's get started.

Larry's going to provide a quick review of our Q4 operational metrics and our balance sheet. I'll then return to discuss revenue performance and share our expectations for the first quarter and full-year 2003.

Larry?

Thank you Ann, and good morning everyone.

Our results today continue to underscore the solid progress Xerox has made as well as our consistent performance in delivering on commitments. We're profitable for the quarter and the year. We're generating strong operating cash flow. We continue to make progress, strengthening the balance sheet to operating cash generation, as well as our finance receivables securitization strategy.

Before I review highlights of the quarter, I want to discuss restructuring, the tax benefit we recognized in the fourth quarter and pensions.

As we reported on November 19th, we accelerated restructuring actions into the 2002 fourth quarter. As a result, our fourth quarter results include a pre-tax restructuring charge of 408 million. As we begin the new year we believe our restructuring actions are largely complete and anticipate 2003 pre-tax charges of about 115 million, primarily related to pension settlements for employees who have left the business.

The 90 million or 11 cent benefit we recorded in the fourth quarter is non-cash, and relates to the completion of a tax audit. This represents a tax liability that was on the balance sheet. Upon successful completion of the audit, this reserve is no longer required. For full-year 2003, we expect our tax rate will be about 40 percent.

Regarding pensions, we told you last quarter that we expected a charge of several hundred million dollars due to the market's performance over the last two years, which reduced the value of the assets held by our pension plans.

In the fourth quarter we reported a 265 million non-cash, non-P&L charge to shareholders' equity. As we've also previously said, we decided to reduce both the expected return on plan assets and discount rate by three quarters of a point each. The expected combination of these actions will increase our 2003 pension expenses by about 175 million from 2002 and cash contributions will increase by about 50 million from 120 million to 170 million.

We have already factored these increases into our 2003 expectations.

Next, I'll quickly review the P&L, then spend a few moments discussing operating cash flow and provide an update on our financial receivables securitization strategy.

As Anne noted, we reported fourth quarter earnings of one cent per share, including restructuring charges of 34 cents in the 11-cent tax benefit that I just discussed. Fourth quarter revenues of 4.25 billion declined three percent from the 2001 fourth quarter, and included 50 million for a previously announced third party cross-licensing agreement, consistent with our technology commercialization strategy.

Further evidence of the stabilization in our business, equipment sales declines moderated to two percent in the fourth quarter, reflecting the success of recent production and office product launches. Anne will provide more detail on this in a moment.

Our operational improvements and streamlined cost structure continue to significantly benefit the bottom line results. Gross margins improved by two and a half percentage points to 43.9 percent. About half the increase is due to the lower cost design of our new products, as well as improvements in overall manufacturing and service productivity -- all of which more than offset planned lower new product pricing and other marketplace market pressures. Improved gross margins in also contributed about half a point, demonstrating our successful focus on prioritizing profitable returns in this challenging business area.

Finally, the third party cross-licensing revenues I just mentioned contributed about a half a point to our fourth quarter gross margin. We expect 2003 gross margins will be 40 percent, although not at fourth quarter 2002 levels.

Fourth quarter selling, administrative and general expenses decreased 49 million, or four percent from last year. Factoring into SAG is the steady progress we've been making improving our cost base and reducing bad debt expense. Bad debt reductions reflect lower provisions and reduced write-off trends due to tighter credit policies. For the year, SAG was down six percent, demonstrating the sustainable cost reductions that we've achieved.

So, let's move to the balance sheet. As Anne mentioned, Xerox generated operating cash flow of 634 million in the fourth quarter. For the full year, we generated approximately 1.9 billion of operating cash flow, and ended the year with 2.9 billion of worldwide cash on our balance sheet.

Considering this cash balance, as well as cash flow from operations, and our securitization strategy, we are confident that the strength of our balance sheet continues to yield excellent results and provides financial flexibility. In fact, during the fourth quarter we terminated a $230 million U.S. accounts receivable securitization that was no longer attractive, and this month we took the opportunity to reduce two million dollars in 2003 first quarter interest expense by retaining the 200 million of the new credit facility debt ahead of the scheduled March requirement.

Operating cash flow and finance receivable runoff were partially offset by accounts receivable usage of 250 million due to the termination of this U.S. accounts receivable securitization, as well as inventory investments of 60 million, which included new product launches.

As you know, our strategy is to securitize an increasing proportion of our finance receivables. Funding received from third parties, like GE, supports these secured loans. As we collect cash from our finance receivables, we pay down the secured loans. It becomes a self-sustaining model that provides Xerox with the financial flexibility to effectively support our financing business and manage our other debt obligations.

In the fourth quarter, we completed new securitizations of over one billion dollars, including 557 million in the U.S., and 474 million in Europe. The U.S. securitizations included 304 million of new lease originations, and 253 million for existing U.S. state and local receivables that had not previously been securitized. The European securitizations included 362 million from Merrill Lynch in France. Merrill intends to make this a public offering later this year. We also repaid 414 million for previously secured finance receivables debt.

As a result of these activities, we've increased the proportion of our securitized finance receivables from 41 percent at the end of the third quarter to 49 percent at the end of the fourth quarter, 2002.

We have about 4.6 billion available for future securitizations out of our current nine billion finance receivables portfolio, and we are actively pursuing opportunities to securitize portions of this through agreements similar to the ones we completed in the fourth quarter. As you know, our objective is to securitize 60 percent of our finance receivables by the end of 2004, and I am committed to accelerating achievement of that goal well ahead of that timeframe.

Also consistent with our objectives, an increasing proportion of our debt is securitized. Finance receivables secured-type debt increased from 23 percent at the end of the third quarter to 3.9 billion, or 28 percent at the end of the fourth quarter, 2002.

It is clear that Xerox is on firm financial ground. We are well-positioned to meet our debt obligations and the related interest payments.

In closing, let me again reiterate the key highlights of the quarter from a financial perspective. Consistent profitability -- our third sequential quarter of profitability driven by moderating revenue declines, increased margins and lower costs, significant operating cash flow of about 634 million and a steady flow of good new related to our effective management of the balance sheet.

Once again, it was a powerful quarter, reflecting our disciplined execution and intense focus on strengthening every area of our business.

I'll now turn it over to Anne to further discuss revenue and our 2003 expectations.

Thanks, Larry.

I think it'd be fair to say that 2002 certainly presented a number of challenges and opportunities for Xerox. And our focus has always been clear; create a sustainable business model that leverages our core competencies, exploit the growth opportunities in the market, and add value for shareholders by delivering solid profitable returns. And through precise execution, we have consistently delivered results in line with these objectives. This focus and resolve have clearly become part of the Xerox culture and a fundamental attribute of our management style, so with the same determination we are executing on a well-defined plan to play aggressively and competitively in winning market share and growing revenue.

As you know, our turnaround was designed to strengthen Xerox' operations while investing in new technology so that we could build customer value with the industry's leading products and services. And throughout 2002, we did just that. As Larry addressed, our operations are sound, with margins up and costs down, further evidence of the sustaining power of Xerox' strength in business. And we launched 17 new products supported by an integrated set of services and solutions that are not only winning industry awards, but more important, increasing customers' confidence in Xerox as a strategic partner. At the same time we invested in sales channels and marketing activities, our operations, which along with our direct sales force and network of agents and distributors, gives us a significant competitive advantage in extending sales capacity. It's clear that our technology investments and expanded sales outreach are generating revenue results we expect in key markets. While total revenue declined year over year, we are making progress in the areas of the business with greatest growth opportunity.

As Larry stated, we reported Q4 revenue of $4.25 billion -- a decline of three percent from Q4 2001, yet a positive sequential trend from last quarter.

So, while the majority of our revenue decline is due to lower sales in our developing markets operations, it's important to note that our major restructuring of the DMO business model continues to deliver bottom line improvements. For the fourth quarter, DMO's profit was 39 million -- a year-over-year increase of 87 million. DMO segment margins improved by 18.2 percentage points to nine percent. This Q4 profit improvement is clearly a result of this margin improvement, as well as significantly lower SAG spending and lower bad debt provisions. And our improved financial status has allowed us to better hedge currency exposures in developing countries.

North America and Europe delivered another quarter of operational improvement with solid performance in the key segments of our business, which brings me to the big picture on revenue -- where we were in the quarter and what we expect as new products lift equipment sales.

So, let me begin with color revenue, which truly is a highlight in our Q4 revenue results. Our investments in advanced color technology led to a 10 percent year-over-year increase in total color revenue, driven by the success of our DocuColor 1632, 2240 and 6060 Production Color Series.

Xerox offers the industry's broadest portfolio of color technology and integrated solutions, and these results are evidence that we are continuing to build on our leadership in this important market.

In the overall production business, revenue grew three percent, reflecting the gains in production color sales, as well as the strength of the DocuTech family -- Xerox's flagship black and white production publishing system. Despite a Q4 launch of a competitive offering in this base, customers continue to demand the technological leadership and unmatched service that Xerox offers through the DocuTech line.

As you know, we added a new offering in Xerox's rich production portfolio with the DocuColor iGen3 Digital Production Press, which is now available six major markets. Fourth quarter 2002 iGen3 installs went as planned, and we continue to closely monitor the success of these placements.

For the beginning of this year, our focus remains on ensuring that the first 100 installs are with satisfied customers who are delivering profitable results from their iGen3 applications. We'll gradually accelerate placements throughout the year.

Q4 operating margins in production continue to trend in the right direction, up year-over-year by 4.2 points to 15.8 percent, despite competitive price pressures. The operating profits for the production business improved $73 million from Q4 last year to $253 million.

Xerox's Office Business delivered 154 million in profit for Q4. Modest margin improvement led to a 9.1 percent operating margin in the Office, reflecting the continued flow-through from our cost savings actions, as well as manufacturing and service productivity.

The headline in the Office is the Document Centre 500 Series, which led to strong growth in Xerox's monochrome networked multi-function business. The 500 Series is attacking this sweet spot in the office industry -- an area that continues to grow as customers recognize the value of transitioning to a digital networked . And Xerox's big wins in this space are typically bad news for competitors, like HP and Canon, as we knock out standalone printers and copiers, replacing them with Xerox's advanced Document Centre products and services.

Total Office revenue declined six percent in the quarter, primarily due to declines in light lens copiers, planned lower pricing in Office Digital, and declines in Office Color, which reflected softer demand in competitive pricing pressure in Office Color printing.

Despite the impact for weakened economies, as we look at revenue and market share, we're comfortable that the picture is as we expected -- even better in certain key growth markets. We've effectively managed costs to ensure our pricing is competitive, without sacrificing margins. In fact, in the Office, we've reduced prices while increasing margins. Plus, as customers expect from Xerox, our technology, our quality and our service continues to be leading-edge.

Just recently, customers, like Fidelity Investments, Traveler's Property Casualty, Airborne Express, Butler Manufacturing, Lloyds TSB, UnitedHealth Group, and many, many more have responded. Several of these wins represent knockouts of products from competitors, including Ricoh, Canon, and HP as our customers recognize the opportunity to capture productivity improvement through Xerox's innovative products, solutions and services.

For the first quarter, we expect that our expanded products, solutions and services portfolio will continue to drive modest improvement in year-over-year equipment sales trends. The flow-through from our accelerated cost reductions in the fourth quarter will further strengthen our bottom line, delivering Q1 earnings in the range of six to nine cents per share after restructuring charges.

For the full year, we remain comfortable with our prior expectations of 50 to 55 cents per share, reflecting our confidence that the combination of strong operations and full-year equipment sales growth will contribute to continued year-over-year improvements.

So, as we bring closure to 2002 -- a year where we returned to profitability, accelerated demand for Xerox technology and services through new offerings, won customer confidence, and made the right decisions that will serve Xerox best in the long term -- I have to say that Xerox people are motivated by what we have achieved, and the great opportunities in front of us.

We remain focused on continuing to execute with precision on our key priorities, including: growth and share, where we're building customer value through the industry's best technology and services. Productivity; the benefits of recent employment reductions and other initiatives will continue to strengthen our bottom line. At the same time, we're deploying across the corporation, identifying opportunities to further drive productivity and customer satisfaction. Leveraging cash flow with a focus on increasing finance receivable securitization, investing in our people through training and professional development, and as always, building shareholder value by meeting our commitments, sustaining profitability, driving growth in equipment sales, and strengthening our balance sheet.

So, we've been tested and continue to prove that we have the right people, the best technology, a sound strategy, and an intense focus on implementation to deliver performance that speaks to the strength of our new business.

So, it is the new year, and we are ready to do it again. I thank you for your time, and now Larry and I would be pleased to take your questions.

Thank you.

If you have a question, please press the one on your touchtone phone. All participants are asked to limit themselves to one question. Once again, please press the one on your touchtone phone.

Our first question comes from Ben Reitzes of UBS Warburg. Please state your question.

Yeah, good morning and nice progress, guys.

OK, Ben. Thank you.

Thank you.

A couple of things for clarification, and then my question, so I can break the rules officially. Just with regard to your outlook for the year -- the 50 to 55 cents, Anne -- there's about nine cents, if I calculate it right, of restructuring with the 125 million in restructuring charges. Is that 50 to 55 cents including, and is that the reported figure? Or is that excluding the restructuring charges?

That's inclusive of restructuring, so bottom-line results.

So, the operating figure gets you almost 60-plus, depending on the math?

Yes.

OK. Thank you. And also, just with regard to your revenues, the production revenues were a little better than anticipated. We were hearing from some of our sources that perhaps pricing went down a little bit, and that you had, you know, held your share. I was wondering, A, if you could comment on what your pricing initiatives were in production. Also, I was surprised your gross margins were able to be so strong with the competitive environment. And if you can comment on, you know, the potential inflection point that's been hit there and production margins as we head into this year. Thank you.

OK. Well, the good news in production really was a mix of strong Color Production performance, which grew significantly due to the new product introductions, Ben. And we believe that when share results are available, which they're not now, that we've done well with our DocuTech Production Publishing Systems. So, that we continue to win the market place with DocuTech and get stronger, and there was actually 22 percent in Production Color alone, so, you know, very, very strong performance there.

So, we believe that, you know, overall, you know, the Production business did strengthen quite a bit. And I have to tell you I do not believe that it's primarily due to pricing pressures. This one really is, I think, due to volume placement and the strength of Production Color. We did earlier in the year, Ben, take some reductions in the Production Color business, and that clearly has helped us, I think, in terms of placement. But, our strategy in the color market place is really to gain pages, and you'll see that if you split and look at the post-sale performance in Production Color. It's really driving a very nice performance overall in the Production business.

Where we've made pricing investments is really in the Office business. We've definitely gotten more aggressive in terms of our pricing in the Office business, but we've been able to offset those as it relates to, you know, service and productivity.

On the gross margin side, you know, as Larry stated, you know, there is some part of that gross margin performance - about a half a point to a point - that, you know, is due to the licensing revenue and some, you know, probably non-recurring kinds of events. And our intent is - has always been to stay north of 40 percent in margins, and having such strong performance certainly gives us an opportunity going forward to be a little bit more aggressive in the marketplace from a marketing perspective and really drive our goals for revenue growth and share gain.

Did you agree with my comment that perhaps you hit an inflection point in some of these areas of production or is it too early to tell?

Well, I think we do believe we've turned a corner. There's no question about it. And part of that is due to, you know, the sales force productivity. You know, that had been certainly a challenge for us in past quarters. We think that, you know, the performance from the sales force is indicative of the growing tenure and stability of the sales force, so we don't expect to reverse that by any means. We expect to continue with the progress there.

Well, thanks. And just, Larry, as a housekeeping, what kind of share count should we use for '03?

Again, it depends - you know how that's done with the shares and the ...

No, I don't. It's the most confusing thing. But ...

You can - I'll make a house call or you make a house call on me and I'll show you the arithmetic - how it's done.

Thanks a lot. You can just answer if you can. Otherwise we'll take it offline.

Yes, it's - there are accounting rules that guide exactly how you do shares from the standpoint as converted, so if you have some sort of a convert and it's more dilutive with share than it is with interest, then you have to take it. And every time you do that calculation in every quarter and you actually don't know it until you do it. So, ...

All right. We'll take it offline. I usually come out with a stab that's in the ballpark, but - thanks a lot.

OK.

Our next question come from Caroline Sabbagha with Lehman Brothers. Please state your question.

Good morning. Thanks very much. Just a quick follow-up on your earnings guidance - I wanted to know behind that guidance what are you assuming for the economy.

And then the follow-up to that is we are looking for improvements in equipment sales or you're looking for improvements in equipment sales as the year progresses. Given the compares you have - the year-over-year compares, in what - should we - should we look for equipment sales to be up year-over-year excluding in the first half or is it more of a second half event?

OK. So, Carol, on the economy, I think, you know, we probably are fairly consistent in our view, which is we're really not planning on any significant upturn in the economy as we do our planning for 2003 - so, a fairly consistent set of economic conditions, which certainly are not terribly strong. We certainly are prepared to take advantage of an upswing in the economy the - if it had - if it should happen. But I think we've been really thoughtful and prudent. And one of the reasons we certainly accelerated our restructuring into Q4 we could be well positioned despite what happens in the economy.

On the equipment sales side, we said, you know, modest improvement year-over-year. I think we see that, you know, certainly throughout the year but stronger in the second half than in the first half.

OK. And that's excluding also, right?

Yes.

OK. Thank you.

You're welcome.

Our next question comes from Stephen Weber of SG Cowen. Please state your question.

Yes, good morning. Could you - you emphasized earlier, Anne, that the post-sales revenue in Color was doing particularly well. Can you give us some metrics and I - particularly if you could break it between Production and Office on what is happening to those post-sales revenues the kind of growth that you've had ...

Yes.

... in 2002 or in the fourth quarter if you wanted - if you wanted to ...

Yes.

... separate that? And do you think that those numbers will accelerate or is this the kind of pace that you'll be on?

And if I can throw one other question in, which would be could Larry or you comment on what currency will - might or might not do to you at the bottom line.

OK. So, I'll take the first part, Steve, and talk a little bit about post-sale revenue. And Production - you asked me to kind of talk about in the context of Production and Office.

Right.

So, earlier I mentioned that 10 percent growth overall in Color revenues, which includes Production and Office. Those markets are a little bit difficult to separate as cleanly as they have been in the past, so I think 10 percent is a good indication of the fact that it's a 22 percent growth in Production and a slight decline in Office, but overall very strong growth in Color.

The strategy that's really working for us is is that our placements are generating the majority of pages in the Color marketplace. So, whereas you can see Canon certainly having some success in what I'll call the lower end of the Office market with placements with the 3000 and 5000, the fact is is that the majority of the pages are going to Xerox devices - certainly the 2000 series, as well as the new 1632 and 2240.

The name of the post-sale game is pages, and that's really how you generate, you know, the profits per page. So, we do see that as a real strength and advantage for us as the proportion of our Color placements continues to grow. So, will those numbers accelerate? You know, as the market moves from Black & White to Color, and obviously this is a huge part of our strategy, then there's no question that the momentum we'll get from the Color post-sale will have a big influence on our bottom line.

So, Larry, do you want to chat on currency?

On currency, I think, you know, if you look at where currency was in 2002 and where it ended the year and if you just look and straight line that out, you would say there'd be a slight improvement compared to Europe - probably still a lot of volatility in - down in Latin America. So, I would say overall you would expect to get a slight plus in 2003 and then just see where it goes.

If I could come back, Anne, ...

Yes?

... my question particularly within Production when you had a 22 percent increase in revenue, what was the post-sales increase? And did you get a post-sales - I assume you got a post-sales increase in Office. And how big would that have been?

OK. So, on post-sale for Production Color, it actually was almost 30 percent in terms of growth - so, driven by the post-sale piece of it. Office was down, and as I said, it's kind of really due to the mix of equipment and how we're drawing the line between Production and Color. Overall, there would have been a nice post-sale improvement for Color in total.

OK, but Office post-sales was down, as well?

Single digits.

Single digits.

Yes.

OK. And why would that have been mix? I'm ...

It is because, you know, the R1632 and 2240 devices are actually reflected in the production line, although we do believe it's taking a lot of the, you know, the volume from the office market, so. But we can certainly get you some more detail on that, Steve, and break it down for you.

Well, I would--and--I'd appreciate that and do you--that was--that was one of my questions. Do you think that, as you see the placements, does that--does that increase in post-sales? Do you think that's going to of course, do you think that's going to accelerate in '03?

We do believe that it will accelerate in '03 and actually someone just gave me some information, Steve, that says that the post-sale in--for office color is up significantly. So I was talking office total when it was actually office color is up double-digits. So the entire office line, both color and production, is up and we do expect that those placements increase and pages increase that that will accelerate in 2003.

OK, thank you very much.

OK.

Our next question comes from Solin Cho of Morgan Stanley. Please state your question.

Hi, thank you. Just a quick follow-up on the post-sale question. Is there a typical lag time that we can look to in terms of when the install base starts to grow again and between that time and when post-sale starts to pick up? I've been under the impression that it was about a 12 to 18 months time period, but if you could just comment on that?

Yes, Solin, I think you're roughly right. We actually have commented that the post-sale will decline in 2003 despite improvements in equipment sale and that as a result, then 2004 will be back to, you know, growth in post-sales. So it is about a 12 to 18 month lag time, so that we would expect, you know, a nice rebounding in 2004 around the post-sales.

OK, great. And then, just in terms of the incremental pension expense you're going to record for the P&L, how does that get recorded? Is that hit recorded on a consistent basis throughout the year or is it weighted to a particular quarter?

Yes, it's spread between the full year. I mean, it's not exactly evenly because it's based on people and where people are, but it's basically spread throughout the year. It shouldn't be--you won't see it in one quarter...

OK.

... if that's the question.

But just roughly evenly...

Right.

... so we're not going to get like some one quarter that's particularly loaded. And then finally, just on the changes in cash flow, I noticed a pretty big contribution from accounts payable. It was up pretty substantially during the fourth quarter. Can you talk about that?

Well, I think, you know, I don't think there's any, you know, policy change or anything like that. I think it's just a function of, you know, some quarters it goes down and some quarters it goes up and this one it was a little more than the average, you know, that we would expect. But there were no policy changes, there was no intent to, you know, change any of that, so I think it's just where the ball landed here.

OK. Alright, thank you.

OK.

Your next question is from Peter Ausnit of Deutsche Banc. Please state your question.

Thanks. Can you tell us a little bit about the R&D trend? It seems to have ticked down a bit. Is that a trend or just a one-time event?

Peter, I wouldn't necessarily call it a trend, although I have to tell you we are focused on efficiency and productivity on every line in the business and R&D's no exception to that. You will see, from an R&D perspective, some movement throughout the year,so the quarter is not necessarily the best example of going rate on R&D. I think we had a ratio of about 5.1 percent in the quarter and a full year ratio of about 5.8 percent of revenues for R&D. We've consistently said that R&D will be between five and six percent of revenues. We expect it to stay there, but we are absolutely going after productivity in R&D. As a matter of fact, it's one of the areas that we're focused on with the deployment of to really reduce time-to-market, get rid of as much indirect expense and infrastructure out of the R&D environment, so we believe there's opportunity there.

OK, great.

But it won't come at the expense of cutting, you know, technology investments and programs. It'll really be about efficiency.

Can you give us a little more commentary on the licensing deal? The $50 million? And are there other opportunities to your IT or is this sort of, you know, something that's a one-time event that we shouldn't look to be repeated?

Well, we can't disclose the details, particularly to that licensing deal, but, you know, we've been talking about our strategy as it relates to our research and our ability to commercialize some of our technology investment, particularly on the research end. So I'd put it in the category of things like licensing, you know, some of the spin-offs we've done like with and Content Guard, you know, certainly opportunities that we have to continue to some of those, so I would not call this a one-off. It think it's very consistent with what we've been talking about in terms of really, you know, getting a better bang, quite frankly, for our research investments.

OK, thanks very much.

OK.

Our next question is from Bill Shope with JP Morgan. Please state your question.

Great. Nice progress on the quarter.

Thanks, Bill.

Two quick questions. Could you give us some qualitative discussion of your progress on the value-added services front, moving into document outsourcing consulting? And then the second question would be should we expect, given the strength in the production space, should we expect a less than normal seasonal drop-off in the operating margins going into the first quarter or is it pretty much the standard volume-based drop-off?

OK, let me talk a little bit about our services business and maybe I'll take it in--we have really two kinds of services businesses, if you will, our services, which is our outsourcing business, and then also we have our kind of innovative services, our consulting services and if--the outsourcing is somewhat of a mixed story. It actually grew quite nicely in Europe, but we had some slight declines in North America where the market's been a little bit sluggish in outsourcing. And we've also been focused on really ensuring the strength of our business model in outsourcing in terms of profitable returns and that's yielding with improved margins and better profitability from our outsourcing business. So we're kind of pleased with the progress.

We're still certainly very focused on outsourcing and services as a source of growth going forward and we've done a lot of the housekeeping, if you will, on the outsourcing business model that we think will serve us well going forward. On our consulting services, we actually saw some positive momentum in Q4 with some growth and we actually spent--and during the investor conference we talked about it--but we've really refined and launched our service practices in a very defined way in terms of our go-to-market strategy. And we actually saw some good benefit in Q4, which we hope to continue during 2003 - so, overall good progress in Services.

Oh, seasonal - I think you asked about, you know, the margins are typically kind of seasonally strongest in Q4 and what our expectations are in Q1. So, I think we wouldn't - we would maybe see, you know, the kind of seasonal decline that would be associated with a lower activity of a Q1, but nothing indicative of more than just lower activity levels.

OK, great. Thank you.

OK.

Our next question comes from Jack Kelly of Goldman Sachs. Please state your question.

Good morning.

Hi, Jack.

Just maybe a little color, Anne.

Yes?

One of your - and maybe this is all definitional - one of your competitors, when they reported their December quarter, indicated that their sales of five and - segment five and six were up high-single digit and expected 10 to 20 percent growth for the year in five and six. And then, secondly, just focusing in on segment six, mentioned that they might have been up - sales might have been up 14 percent worldwide. And so I guess the - you know, the question is to the - to the extent you can share with us, you know, did you see those kinds of numbers in your areas - your respective areas it's kind of getting to this market share question.

Yes, absolutely. So, let me just talk about Production, and particularly the light Production area, which is segment six, which, as you know, Jack, we just actually for the first time in that segment in actually the very end of the year in December, so just launched the 1010 in that space.

But there's no question that, you know, competitors have grown in that space, and that's why, you know, when we look at our overall growth in the Production market, that's embracing fact that we really haven't had the benefit of an offering in the segment six space.

If we look at, you know, share outside of segment six, we believe we've really done quite well. As a matter of fact, you know, we believe that our digital placements in the Office are up 13 percent year-over-year - that's activity, that, you know, certainly in the 20 to 90 category that we had gained I think a point-and-a-half a share in the first half. We think our performance in the second half has been stronger.

So, clearly we won't see the benefits of the new product introduction in segment six until full-year 2003, but in the other segments, we feel very strongly that we've made good progress.

Good. Just a question for Larry - the cash restructuring charge this year - how do you see that running? You gave us what the actual charge would be, but just in cash restructuring.

Well, we have about $400 million of restructuring on our balance sheet, and, you know, all of that will be paid out in 2003 and, you know, will be skewed towards the front of the year.

OK, thank you.

You're welcome.

Our next question comes from Craig Ellis with Salomon Smith Barney. Please state your question.

Thanks and good morning, Anne. Good morning ...

Good morning, Craig.

Just a few clarifications, really - first, on the outlook, is there any benefit from licensing deals included in your 2003 outlook?

The answer's really, "No." It's, you know - this is not one that we outlook and clearly is an event type of approach, so we would have to, you know - and clearly would those out as being outside the fundamental trends in the business.

OK. And then, on expenses, looking at SAG, excluding the bad debt, it looks like it's down 1% year over year despite the aggressive staff reductions and a little greater reduction in the top line. Is there anything unusual in the numbers that would raise the fourth quarter number? I expected it to be a little bit lower?

Well, I mean, I'd look at it and say that for the full year, absolute SAG expenses went down 6%, which certainly was a very credible decline based upon the actions that we have taken and a little bit less in fourth quarter. We did have a couple of things. We happened to have a software write off that hit in Q4 that clearly was a one time event and increased the SAG level in Q4, but despite all that it came down 4% in absolute terms. So, we look at 2003 continuing to focus on absolute cost reductions in SAG that we have laid the ground work for and will continue with a point or two in overall ratio throughout the year.

Okay. And then, lastly, on revenues. Revenues and services, even backing out the licensing deal, were pretty nice and I was surprised with the robustness. I think usually you are flatter sequentially. You were up about 100 million, excluding the license deal. Are you still looking for post sale revenue to decline going into 2004 and late into 2004 or were your comments earlier that you would see increases in 2004 really on a full year basis for that year?

Yeah. I think our, my comments were full year 2004 and the you know, the trend that we know post sale will take as it -- we see the benefits from the improving both services as well as equipment sale annuity over time. So, it was a comment about full year 2004 revenues. This is a case where it builds momentum over time and therefore the strongest performance will come as we get more and more quarters of sequential revenue improvement.

Okay. And maybe I can indulge one last question. In the press release, three things were cited with respect to the office sales declines. Channel inventory reductions, price differentials, which you talked about a little bit and then light lens run off. Can you just give us some order of magnitude on how much each of those might have contributed to the decline?

Okay. So, on the channel inventory side, we're specifically talking to the performance of office color printing, which goes through the distributor channels and we believe we saw a fairly significant reduction in inventories in the channels at the end of the year based upon the financial status of those distribution channels. So, that was strictly a statement as it related to office color printing. And it had a significant impact although full year our office color printing business grew in double digits quite nicely.

On price, we look at the office as we made investments certainly in the range of 10 to 12% in our office business so that is why we had activity increases of 13% in the office, in terms of installs while we saw some slight revenue decline. So, we have more than offset the pricing investments with the productivity and the margins that we have been delivering in the office business. And light lines as you know, is a declining business and that gets to be less and less of an issue every quarter that passes because of diminishing returns in light lens, so our focus really is on ensuring that we can continue to make the kinds of price investments we need to win in the market place and offset it with the kind of productivity we have and certainly we hope that we'll benefit from the fact that there is very low inventories in the channel as it relates to office color printing going into 2003.

And did those things contribute about equally to the decline that we saw, or was one factor significantly greater than the other two factors?

I think that probably the number one factor is light lens declines. It has been over time and I don't think Q4 would be any exception, although less so than in the past and then the other two were probably relatively equal in the weight they played in the fourth quarter.

Okay. Thank you very much.

Okay. I think we have time for one more question.

Our last question will come from Matt Zolen of Lehman Brothers. Please state your question.

Yes. Good morning. This is for Larry. I was curious to know if you were still standing by the 2.4 in '03 and 2.6 in '04 in these secured financings from the analyst meeting and then my second question was the debt amortization for '03 is now 3.9 billion versus the analyst meeting expectation of 4.8. just curious to know what has changed here in the 2004 amortization assumptions?

I think to answer your second question first, you know, the debt without securitization payoffs for 2003 is 2 ½ billion and then on top of that we would pay off securitizations as customers pay us. So, I'm not sure exactly what you are looking at there.

I was looking at the -- in the analyst meeting there was -- this is for '04 by the way, the guidance is now 3.9 and in one of the schedules in the analyst meeting you showed expectation of 4.8 so it's actually less debt amortizing performance in '04 versus the previous meeting.

I'm not sure. I can handle that offline with you.

Okay.

We'll go back through it, Matt, and see, I don't think there is anything that has changed dramatically in terms of the expectations we set there so we'll have to come back and revisit it with you.

Do you still expect 2.4 and 2.6 in new financings in '03 and '04.

Yes.

Very good. Thank you.

Okay. Thank you and let me just reiterate that we do appreciate your time this morning. It was a very busy quarter at Xerox Q4 and I'm pleased to say it resulted in the positive performance we announced today and we really do look forward of staying on this trend of sharing good news with you in the future. So, thanks for your participation and enjoy the day.

Ladies and gentlemen, this does conclude today's teleconference. T hank you for participating. You may now disconnect.