全錄公司 (XRX) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Xerox Corporation second quarter 2003 earnings release conference hosted by Anne Mulcahy, Chairman and Chief Executive Officer. She's joined by Lawrence Zimmerman, Senior Vice President and Chief Financial Officer. During this call, Ms. Mulcahy and Mr. Zimmerman will refer to slides which are available on the Xerox investor website at www.Xerox.com/investor. At the request of Xerox Corporation, today's meeting will be tape-recorded. Taping and re-broadcasting of this call is prohibited without the express permission of Xerox. After the presentation, there will be a question and answer session.

During this meeting Ms. Mulcahy and Mr. Zimmerman will make comments that constitute forward-looking statements. Actual results could be different 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 first quarter 2003 report 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.

Thank you, and good morning, everyone, and thanks for joining us today. As you can see, we're using a new format now with slides we hope that you find them useful and informative. We're going to begin with slide four, which provides a summary of our Q2 results. And clearly, this quarter really was a breakthrough as we grew our equipment sales both pre-currency and as reported. And this is particularly significant because as we know, certainly the economy and the competitive environment are challenging, but as we've been communicating to you, we've been working hard to build the business model that delivers sustained bottom-line results, and our technology and services have given us a competitive advantage in this tough marketplace. As you can see, we delivered 9 cents of earnings, which included a 5 cent charge related to fees for the early repayment of the 2002 credit facility. So excluding this charge, we delivered earnings of 14 cents per share.

As usual, we've continued to focus on productivity and expense management. That's become a way of life for us here at Xerox. And our cash flow remained extremely strong with $682 million of operating cash generation. And as you know, we successfully completed the $3.6 billion recapitalization, which significantly strengthens the balance sheet. So Larry's going to walk you through that recapitalization as well as the income statement and cash throw in a minute. First I'd like to spend a little bit of time on revenue and installs. And then before we take your questions, I'll wrap up with a few thoughts on both Q3 and full-year guidance.

So if you turn to slide five. This slide really focuses on install rates. And as you know, install rates are a really important indicator of our future success and annuity growth. And I think our install performance shows that we're on the right track in all the right markets. Let me begin with production. Color installs were up 7% in the quarter. And of particular note, the mix was strong driven by DocuColor 6060 placements. And as you know, production color installs leverage our color page strategy which is particularly important to future growth and profitability. Also in the production space, black-and-white installs declined in the low single digits, which is an improvement from recent trends. And this is be driven by a mix of declines and production printing and older light lens products offsetting the digital light production growth we saw from the Xerox 1010 which we launched at the end of last year. I think most notably, DocuTech installs increased in North America, which is a really encouraging sign.

Now turning to the office. Color multifunction installs increased 64%. Black-and-white multifunction installs grew 8%. So we are beginning to see the benefits from the new suite of products that we've introduced, our copy center, work center, WorkCenter Pro offering. And as you know, our focus was to introduce them at very competitive prices in order to win in the marketplace. So considering these install growth rates, we're quite confident that Xerox is gaining year over year market share in key segments.

So let's turn to slide six. This slide shows six quarters of equipment sales trends which continue to show improvement. And it's important to remember that increasing equipment sales in key markets represents an important part of our revenue growth strategy. Improvement in equipment sales means more machines in the field and those machines pull Xerox supplies and service. These flow through most of our post sale revenue and have a sustaining benefit for our top-line results. So as we expected and have been communicating, post sales have declined due to business decisions we made earlier in 2000 through 2002, and this resulted in fewer equipment placements, but obviously a stronger profitable bottom line. But as committed, we got our business model right. So our leaner, faster business model now positions us to capture profitable revenue growth. The equipment sales growth we're experiencing is expected to flow through to post sale growth during the second half of 2004.

So if you turn to slide seven. This describes the portfolio of revenue and the impact of the growing segments that we've been focusing on from an investment standpoint. Like any business, some of our markets are growing, and a few are declining. And we are increasing the proportion of our revenues in growth areas while we are reducing the proportion of our revenues in businesses we've exited like Soho or markets that are in secular decline like light lens. So this all leads to future revenue increases as the investment areas are faster and declining areas become a smaller part of the total.

So let's look at Q2. The growth areas of our business which now represent 70% of our revenue, grew 10%, due to increasing customer demand for our innovative offerings in both the office digital and production digital markets. More frequently now integrated with content and document management services that add customer value and give Xerox the competitive edge. Just one quick example. We've recently signed a $50 million six-year contract with Well Choice, which is one of the country's largest health care insurers. And this is an integration of Xerox's hardware, software and services, and allows us to manage the production and distribution of more than 3.5 million customized documents each month.

We're also continuing to invest and bring to market advanced color technologies that serve customers small or large. In second quarter, total color revenue was up 19%, largely due to the success of our DocuColor series. And this is really an important indicator for future revenue growth. More placements means more pages printed in color. Xerox color. And more color supports our top line through equipment sales and post-sale revenue. And finally, developing markets, which represents about 10% of our revenues, was down 11%, which is a significant improvement over the past. And as we've been discussing, revenue declines in DMO are moderating, and we expect continued improvement in the second half of the year.

So let's turn to slide eight. This is kind of a graphic pictorial of what our revenue trends look like, and this trend will continue as we leverage our investments in key growth areas and we begin to see the flow-through on the revenue front, particularly by the changes we've made in our developing markets. So by 2005, we expect that approximately 90% of our revenue will be from our targeted growth areas, as well as our developing markets. So this quarter's results provide further evidence that our strategy to grow revenue is working, that our investments in technology are paying off, and that our business model is delivering sustainable benefits for Xerox to continue playing aggressively in our competitive market. So Larry's now going to spend time on the Q2 financials including a review of the recently completed recapitalization and then I'll return with comments on guidance and take your questions. Larry?

Thank you, Anne, and good morning, everyone. I'd like to start off by saying that this quarter demonstrates again the consistent improvement in our business. Our ability to compete and win and a continuation of delivering on commitments. The focus of our management team and all our employees is to execute and deliver quarter after quarter with consistent predictable returns. As you can tell from Anne's remarks, we are very pleased with this quarter's results. We believe we achieved improvements and delivered results in all major areas.

Slide 10 tries to summarize this point and covers all the points I want to make in this presentation. I will then quickly go through some additional slides that demonstrate the proof points I will make on this first chart. So slide 10. We start off with the point that Anne made, which is we have strong improvement in revenue trends any way you look at the trends, whether it's post-sale, whether it's equipment sales, whether it's total revenue, whether it's pre or post-currency. And I think the important point here is where we invest, we grow. And if you look at the digital world and the equipment sales for DMO, you can see we have significant growth. So where we invest, we grow. In addition to that, we know how to manage cost and expense. And so our gross profit margin of 42% was maintained, and we offset all the competitive pricing that we invested in for the last four quarters compared to last year, and we're able to manage the costs down to offset that and maintain gross profit margin.

In addition, our R & D and SAG productivity continues. We had a 2% improvement, our E to R was improved, and we were actually down 6% on a constant currency basis. So improving revenue and management of cost and expense leads to earnings expansion. And if you look at our 9 cents per share for the quarter plus the 5 cents associated with the write off of the credit facility from last June, you can see that we have expanded earnings significantly. In addition to that, we spent a considerable amount of time out on the road a month ago and successfully recapitalized our balance sheet. And I think the key points associated with that are number one, our access is significantly changed. We were able to access four different marketplaces at the same time. So that's the first big point. And the second big point is that investor confidence was shown by our ability to over-subscribe in each one of those areas. And I will take you through the detail of that.

But debt was reduced by $2.5 billion. We lowered interest expense which will offset the dilution of the share. So we think it's non-dilutive. We've extended our maturities, and we reduced our debt by about $11 billion from the year 2000. In addition to that, the last point on this chart is that we have $2.3 billion of cash on hand, and we had significant cash flow from operations of $682 million, all driven by operational kinds of improvements in the business.

If we go to slide 11, this is a simple P & L. And, again, just laying out the numbers, you can see 8% growth in equipment sales, 1% pre-currency, although we were slightly down in total revenue. Again, that's investing where we grow, and post-sale is coming down because of light lens. But other than that, we show very strong performance. If you look at gross margin, it's about the same as it was a year ago. E to R for both R & D and Sag have improved, and when you factor in the write off with our earnings, you can see expanded earnings year to year.

If we go to slide 12, this shows 6 straight quarters of gross profit margins maintaining from the 41% to the 43% range. And, again, I can't emphasize enough how much price was absorbed there to be competitive in the marketplace. In addition to that, there are higher pensions, as you know, this year in employee benefits, and every year, of course, there's something to absorb. But I think we've demonstrated our ability to manage this cost line and gross profit percent.

Turning to slide 13, a picture of selling administrative and general expenses, and again, down from 28.1 as a percent of revenue to 27.8 this year, again, we've absorbed currency in that, pensions, and other employee benefits and offset that with productivity improvements. So both those charts represent our ability to manage cost and expense and accelerate earnings.

If we go to slide 14, this is a picture of a point I just made, which is expanding margins. It's split between our three segments, production, office and DMO. You can see that the margin is expanding in all of those. The profit dollars are up year to year, and so we think we have a very balanced business where all parts of our business are contributing significantly.

If we go to slide 15, this is a summary of our recapitalization of going out to the market. And, again, I reinforce the two points, which is significant access to capital markets, which we proved that we have, and investor confidence. And we have a new credit facility that's $1 billion, $300 million is drawn, it's a term loan, so that's the bank market. Senior notes of $1.25 billion, we went out with $1 billion and we got $1.25 billion, and probably could have gotten more. So that's the bond market. Equity, we went out with 40 million shares and got 46 million shares, probably could have gotten more. That's the equity market. Equity linked, we went out with 800 million and got 920 and probably could have gotten more. And so, again, four markets accessed, and overachievement in all areas of it.

If we go to slide 16, it's our cash performance, and you can just look down every line, and they all relate to earnings and working capital improvements. So earnings, depreciation and amortization, accounts receivable got better by $100 million. I had told you last quarter that I was disappointed in some of the results. There may be other quarters I'm disappointed. This one I really think we had good performance and a lot of the process improvements that we're pushing are going through. And I think over the long pull of the next year, you're going to see other significant improvements there.

So cash from operations significantly improved, and $682 million is a really big quarter. If you look at cash from investing, the important point there is that we have $44 million of capital expenditures. That's consistent with our full-year plan which is around $220 million. Now, cash from finance receivable securitizations and repayments of debt secured by finance receivables, 329 versus 516. And this is just a function of timing of when we get the financing for new originations versus when we pay down the receivables that are coming in. And so what my expectation is that these are going to be in balance in most quarters, maybe up 100 one quarter, down 100 in another.

The important point here is that we really changed our point of view on securitizations. In the past, we were focused on funding, taking money and funding out of our portfolio to pay current debt. And then let the securitizations be paid down by the payment of customers. And with our recapitalization, we really have a new focus on that, which is to focus on new originations in the future. And as you know, we have that huge GE deal in the United States that represents a big portion of our new originations. We're working in Canada as we speak. We're working in U.K. and Germany. Those are all going to be on new originations. Our expectation is that 50% of our business will be securitized. 25% we will finance ourselves and 25% will be cash payments. So a really good story of how the securitization strategy worked in the past and how it’s going to work in the future.

If you look at the revolver, that change of $1.264 billion, underneath it you can see the three sets of numbers on the side, and it's really made up of those which is we got $1.340 billion from equity linked and equity in the marketplace. Our senior notes were $1.218 billion and our revolver term debt repayment was $3.816 billion. So we got the availability of $3.6 billion from the marketplace. We actually took $2.9 billion of that, added $200 million of our own cash and paid down the revolver, and in addition to that we had a $556 million bond that was due, or a convert, I'm sorry, that was due in April that we paid off. So significant, the net of those numbers are that we paid down debt $2.5 billion and ended up with ending cash of $2.3 billion with the ability to draw on $700 million of an unused revolver.

If we go to slide 17, this tries to address the point that we're really interested in our debt that is not associated with our receivables. Our receivable debt, we feel, is like any other finance company. We finance a good portion of that. It's all paid back by the customers. And you can see on the right side that it has a life of its own. It pays for itself. We have $7.7 billion of bond debt remaining, and you can see that's a significant reduction, the $2.5 billion. All our maturities are extended. We feel that our cash on hand and our $1.5 billion at least of cash flow a year is more than adequate to pay for that. And I've told you about our securitization focus shift to originations.

So in summary, I'm going to end where I began. An excellent quarter demonstrating our ability to grow where we invest and to manage cost and cash with consistent, predictable performance. Now I'll throw it back to Anne.

Thanks, Larry. And among slide 19, and I think just to reiterate what Larry said, without a lot of help from the economy, we delivered on all fronts. And these results are somewhat counter to what others in our segment are seeing that reinforces the fact that our technology investments integrated with our service and solutions are adding value for our customers. We're helping them improve productivity and reduce costs which is really important in these challenging economic times. Our business model is working. We've done a lot of heavy lifting and that continues to flow through to the bottom line giving us leverage and gives us room in the marketplace.

Our focus on targeted growth areas is delivering both install and share growth, contributing to future post-sale growth. And for the balance of the year, we expect to continue building marketplace momentum, delivering improved year over year equipment sale trends and increased revenue in targeted growth markets. And at the same time, we will remain focused on cost and expense management to help offset volatility in the marketplace.

So considering the strong performance we delivered the first half of this year and our confidence in continued improvements in equipment sales and operational performance, we remain committed to our full-year guidance of 50 to 55 cents per share, which, as you know, excludes the previously recognized litigation and credit facility related charges. We're confident that we're executing at the higher end of that range which reflects stronger second-half operational performance.

For Q3, our expectation is to deliver earnings in the range of 8 to 12 cents per share. We're giving you a broad range to account for the typical seasonal trends and continued uncertainty related to the economy. We are quite confident that the strength of our business model and new offerings will continue to deliver bottom and top-line improvements. In closing, we are really encouraged by our Q2 progress. The chapter is closed on our turnaround story. Through new digital technology, value-added services, lean operations and healthy financials, we've proven again that Xerox is a viable player, indeed a leader in the digital marketplace. So thanks for your time, and Larry and I would now be delighted to take your questions.

Thank you. If you have a question, please press star 1 on your touchtone phone. All participants are asked to limit themselves to one question. Once again, press star 1 on your touchtone phone. Our first question is from Ben Rietzes of UBS. Please state your question.

Morning, Ben.

I really appreciate the increased disclosure and the slides. I think it's very good

Great.

A couple things, just one clarification with regard to your outlook, the street is around 12 cents for the third quarter. You're saying 8 do 12. Is that because there's potentially a bigger write off in the third quarter given that you probably have a good chunk of your restructuring payments still coming maybe $70 million-plus coming in the second half?

Well, Ben, I think it's a few things. And we're obviously trying to be responsible, and I think the message would be as follows. We really do feel confident about operational improvement. But, you know, currency with June 30th spots rates will not be as strong or is not indicated to be as strong as it was in the first half of the year. Some change as it relates to tax rates potentially as well as, yes, the, pace of restructuring in terms of when it hits for the second half of the year, all give us some degree of a range on earnings that we think should be reflected. But I think the message I'd like to leave you with is that that operationally we're, you know, we continue to feel positive even though the third quarter is seasonally the weakest quarter for us as well.

Yeah, that's what I was going to follow up on. Is Europe particularly causing any of the outlook, or just some of your conservatism? Have you seen any deterioration there, or have you improved as well as the other geographies?

Yeah, I don't think there's anything that would be different about Europe and we've been pretty pleased with the progress in Europe and obviously currency has been a helper there, particularly. But as you know, August is not a terribly active time in Europe. And we do have the same trend here as other businesses do. So, you know, yes. Europe is weaker than other parts of the world in Q3, which does drive a little bit of that seasonality.

Anything with regard to product transitions in the outlook as well? There's been some talk about potentially some new light DocuTechs and what not, maybe that's coming in '04 now? Is there anything in there with regard to product transitions causing maybe some conservatism as well?

No, we're on schedule with all of our product time lines. If anything, I think the reason we feel optimistic about equipment sale trends is that our April 30th announcement really didn't have a large impact on Q2, whereas the availability in Q3 will be a better indication of the success of those products in the marketplace.

Okay. I know I'm breaking the one-question rule, but with regard to just on that note with regard to equipment sales, to make better sense of this trend, if we were to continue to have these kind of install numbers or something close to it with install growth, when would post-sale revenues start growing? Is there any way we can kind of -- I'm sure you have a better model than I do with regard to the tail on these sales. Does it pick up this year, or is that a next-year event?

Well, and we do watch this really closely. And, you know, there's lots of different factors that influence post-sale trends, color being one of them. Rates have declined in light lens. But overall what we've said is that post-sale will continue to be on a positive trend but will turn positive in the second half of 2004.

Okay. Second half 2004.

Yep.

Okay. Thanks. I'll get back in the queue.

Okay. Thanks, Ben.

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

Good morning. Very nice quarter.

Thanks, Jack.

Bad debt expense for the first time in probably three or four quarters turned up. I'm just wondering, Larry, if that was on a quarter over quarter basis, if you could just give us an idea of what's happening there and maybe a feel for the full year. Secondly, with regard to the agreement with GE, in terms of their approval rates of your transactions, how does it kind of compare to what you all were doing internally? I mean, is it a tougher filter to get through? And then just third, in terms of the production market segments 5 and 6, it seemed like the 1010 started off somewhat slowly. Can you give us a sense, are you doing better or worse than the market in 5 and 6 these days?

I'll take the first two and let Anne handle marketplace here. Bad debts, you know, I think there was a little bump of, like $6 million. But the trend on bad debts is exactly the same. I mean, we were experiencing something just under 2%. You know, when you take provisions, they're done for a lot of reasons. But we don't see any negative trends on bad debts. We think we're doing well on that. So I wouldn't perceive any change going out into the next few quarters or next year. I would think it's going to get better and better. So that's the first point.

Second point is, you know, we have a joint venture with XES which we started a year ago, and we obviously tightened up the credit terms associated with that just from a business standpoint to improve bad debts and the focus on bad debts. And so that's what we're practicing now. So the fact that we have a GE agreement hasn't changed that at all. It's just good practices on credit that we continue to follow. In production, Anne?

Yeah. In the production marketplace, I mean, just let me break it down into a few product areas within 5 and 6. There's two areas that are declining, not because of competition, but because of market trends. One is production printing, and the other is light lens in that market. So those are the ones that are kind of offsetting, you know, some of the growth areas. In departmental digital, which is product group 5 where we have, like, the 480, 490 we were pleased, departmental digital installs were up for the quarter, so that was a positive. We’re pleased with 1010 progress. I would agree with you that Q1 was slow. We launched it at the end of the year which we don't usually do. And it took us a while to get it going, but we were pretty pleased with Q2, and you'll see the results of that when share data's available which is not right now. And DocuTech growing in North America was a very good signal to us, and therefore a positive. So overall, when you add it all up, production trends got better and particularly in the areas that we care about.

Thank you.

Okay.

Our next question comes from Jay Vleeschhouwer of Merrill Lynch. Please state your question.

Morning.

Morning, Jay.

Part of your announcement on April 30th, of course, involved channel distribution, not just product. Can you update us, Anne, on how your progress is going thus far in terms of expanding or evolving your channel? Secondly, following up on some market questions, do you have any observations you could make about graphic arts, commercial or government markets?

In terms of economy?

Yes.

Okay. Yep. So let me talk a little bit about the April 30th announcement in terms of channels. I'd say we're really pleased with progress in tele-business. That's a channel that is playing more and more in the office, you know, touching now around 30% of our revenues and we think that's going up. So there's no question that tele-business is -- and that's equipment sales -- is definitely playing a part in terms of improved productivity and distribution. We've been more aggressive in Europe with regard to two-tiered distribution, and we're very pleased, particularly in the multifunction space and progress in Europe with regard to multifunction products that are distributed through two-tiered distribution. So that gives us an indication that that's both a healthy growth and profit strategy for us, and we are certainly looking to reflect some of those learnings in North America with regard to multifunction distribution through indirect channels. So I think we're pleased overall. We're cautious. But I think we're making good progress in terms of the new distribution strategy.

I don't think we're seeing any great progress in any segment of the economy. I will say that, you know, certainly in public sector, we've seen a lot more strength. I think that's reflective of the strength and competitiveness of our offerings in terms of getting on state and federal contracts. So our business is clearly doing better. Graphic arts, certainly I would characterize it as better than a year ago, but slow progress. And we still see consolidation in the graphic arts market, and one of the roles we're trying to play in graphic arts is to really help strengthen the graphic arts sector through creating new applications with, you know, and new growth opportunities with iGen3 and some of the digital color capabilities.

And in the commercial sector, I think we see it as kind of flat. We've not really seen anything that would indicate a significant uptick in capital spending. We're actually doing better because we're really focused on improving our customers' productivity through services like office document assessment and really helping them get a better bang for the bucks they're spending in the technology arena. But I can't say that I'm terribly bullish in terms of any major economic upturns that we saw in Q2.

All right. Just lastly, since you referred to customer productivity and lowering their costs, I'd like to reiterate a question we asked on the last call and get an update. And that is what you're seeing in terms of your relative profitability or customers' cost of usage of color versus black and white. You talked about there being a multiple difference there, and what's the update there in terms of trend and helping to drive the color market through, perhaps, you know, lower cost of ownership for its use.

Well, after you asked that question the last time, I have to tell thaw we did a lot more work on it as well to validate, you know, some of the leverage we get from both profit and revenue on the color side. And we do keep a very close eye on it quarter by quarter. So the leverage is still there at about a 5X kind of rate per page that really, you know, is so much a part of our growth strategy going forward and why we feel so excited about the success we're particularly having in production color where the lion's portion of pages go. So we are really pleased. I mean, overall, color grew 19% in the quarter, which is obviously indicative not just of success in production color, but in the midrange color area, and that's an install and revenue success in total. So yeah, we're staying very bullish on the implications for color in terms of forward looking both revenue and profit leverage for us.

Thank you.

Okay.

Our next question comes from Craig Ellis. Please state your question.

Thank you and good morning. A couple questions. First, on the equipment side of the business, it looks like you're getting some good help from nix and offsetting overall price declines. We're seeing a ramp up of the 1010. The iGen3 was mentioned in the release. Can you comment on the number of placements you saw in the quarter and related to that would you agree that you're getting some good help from mix? And then on the cost savings side, and this is probably more of a question for Larry, we had it looks like a staff reduction of 800 in the quarter. Was that kind of throughout the quarter, or more towards one or the other part of the quarter? And then what can be done going forward with staff reduction? Is there still the opportunity for one to two percent annual reductions through attrition, or have we really gone as far as we can go on that front? Thank you.

Craig, I'll begin and say, yeah, we were pleased with mix. Although we were -- I have to tell you, growing installs across most every segment. So it wasn't, you know, we were successful in all segments, but I'd say particularly in color. The production color mix is strong. And the most important part about mixing up to production in color is the page leverage that we get in the production segment. So yeah, we're pleased. There's no question about it. We also were pleased to see the growth in DocuTech in the production black-and-white segment which is obviously our strongest contributor in terms of page and mix much more so than light production area. Yeah, I think mix is really strong. And obviously helping us as well in terms of the very healthy gross margins we have delivered.

IGen3, you know, we're not disclosing a number of installs, but I will tell you that we're really pleased with iGen3. I think in two aspects. One is a lot of our initial installs have added second units already which certainly says that they're coming up the curve very, very quickly. Just about all of our placements and clearly all of the average of the placements are exceeding our expectations on page volumes. Which is really the key to what we wanted to see, which is making each and every install profitable and having a very sound foundation in the graphic arts market to grow in 2004 and beyond. We've been pretty consistent that, you know, it's not a significant impact to top our bottom line this year that we're going to do it right, and this is really a strategy for a decade. And we're really pleased with early results. We've also initiated our command center, which is kind of our remote technical center where we monitor all of our iGen3 installs, you know, from both a diagnostic and a support perspective centrally. Which really results in terrific uptime for the customer plus reduced costs to us in terms of our ability to tackle technical issues remotely. So getting that, you know, really strong as we roll out the installs, not only makes the iGen3 story a growth story, but it makes it a profit story as well. So we're going to stay focused on both those areas.

On the head count question, you know, I don't think it's particularly important what phase of the, you know, the quarter. It's kind of spread between the months. You should know, though, that actually the attrition is a much higher number. And we use that to hire back in places where we need. So if we lose some sales coverage or things of that nature, so there's also hires offsetting some of the attrition. To bring it down to a lower number. So that's the first point. Second point is, I think from the standpoint of infrastructure and productivity in some of our areas, our intent is to try to balance that between, you know, once we see revenue growth here, you know, putting it to coverage and I think where it's appropriate to take something down because that business needs a taking down, I think that's what we're planning on doing. So it's going to be, you know, sort of a rifle shot where appropriate.

Craig Ellis Okay. So just to clarify a couple of comments there, Anne, is there something new that you're doing this year on the DocuTech side? It seems that's been a more positive story the last couple quarters than the back half of last year and would we still perhaps be on track for around 200 units of iGen3 this year? And so Larry, just to summarize the takeaway there, it looks like there might be more investment on some of your growth opportunities so we wouldn't see the net reductions on staffing going forward.

Well, I think you may see some staff reductions in total coming down. But, again, it's going to be with hiring and the places we think are right to invest in. And so you might see some of it coming down, and it might flatten out. You know, it all depends on the business.

So I think on the DocuTech side, just, you know, this is really about basics. This is about, you know, stable coverage, you know, stable relationships with our customers, competitively priced and beating the competition. There's no question that the DocuTech via Heidelberger is winning, and we feel very confident that we'll continue to win in the marketplace with the DocuTech offering. On iGen3, we've stayed away from committing to any kind of specific numbers. I think what we've been talking about is to ensure that we've got, you know, the graphic arts, the first hundred customers in graphic arts. Profitable as the strongest possible reference channel we can develop this year as we go into 2004. And I'm sure we'll be able to update you more as we close the year out.

Craig Ellis Okay. Thanks so much. And then lastly, on the third quarter 2003 summary slide in the handout packet, on the improved year on over year equipment sales trends, were you referring to revenues or unit placements there?

Revenues.

Craig Ellis Okay. Thanks, Anne and Larry.

I think it's important to note, if revenue's improving, installs are improving a lot more than revenues.

Craig Ellis Great. Thank you.

Okay. Thanks, Craig.

Our next question comes from Shannon Cross (ph) of Cross Research. Please state your question.

Hi, guys.

Morning, Shannon.

Just a few questions. First of all, going back to, I guess, the April launch, there was some discussion about moving additional production to Flextronics, at least the questions were asked, I'm curious if there's an update there. And then where do you believe you're taking share? Do you think it's Canon and the big guys or second and third-tier players? Where do you really see the share shift occurring?

Okay. Let me just talk, you know, discussions on Flex. We're really pleased with the relationship, you know, we said we'll do what makes business sense across the board in terms of, you know, moving responsibilities, but I do think that we've moved, you know, the lion's portion of our office business to Flex. We continue to work with them on some design functions and other areas where they can add value. But, you know, I don't think there's anything significant that we would suggest in terms of a change in the Flex relationship. But I have to tell you, we're extraordinarily pleased with the results of the Flex relationship. It's really yielded the kind of productivity we had hoped for very quickly. And we'll continue to look for opportunities to grow that relationship.

And taking share, I think it's from both. You know, there's no question that if you look at the high end of the spectrum, we do believe that we're playing well against Heidelberger, playing well against HP indigo, you know, we're absolutely taking share in the production color part from, you know, Canon, and we're really facing off very well in the office against all the players. So we think we're successful in both the kind of second-tier players as well as the mainstream competitors.

Okay. And one of your competitors had indicated backlog. Just curious if you had had any backlog during the quarter.

Nothing that we would view as a problem. You know, healthy backlogs are a good thing. We're pleased with auto rates. But nothing that we would view as a, you know, problem as it relates to customer delivery.

Okay. And then finally, the sag was just the percent of revenue was slightly above where I had anticipated. But obviously down year over year. Where can we expect that line to go? Because I think your expectations are the low 20s by 2005? And how do you see about getting there. Obviously maybe currency hit you a little bit this quarter, but, you know, sort of a back row basis.

Well, I think there were some factors on sag even though it did decline, offset I think it was almost $50 million of a currency hit. There's also, Larry talked about just benefits and tensions as well which, you know, certainly year over year proved to be a negative. But despite all that, we've improved the ratios. We really are looking to continue the progress on sag. Some of that progress will come from revenue. And not just cost reduction. But we're looking to get more efficient. And one thing I think you'll see us do is that we're really looking at this play between gross margin and sag so we can maintain the integrity of the business model expectations that we've set for you. But I would look and say sag in the mid-20s will play very well against a gross margin that's actually delivering at a higher level than we had indicated in our business model. So all in all, I think the integrity of the bottom line will be kept intact.

Okay. Great. Thanks.

Thank you.

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

Yes. Good morning.

Hi, Steve.

A couple of questions. Can you size for us what at the bottom line the currency benefit is? You have both the transaction and all that stuff that goes on there. But you also have translation and clearly, since you weren't hedging as much as before, some of this must have leaked through to the bottom line. Can you help us there? Secondly, could you give us kind of some color on the sustainability of gross margins at the 42% level? Previously you had talked north of 40, and you're clearly north of 40. I'll stop there for a second.

Okay. I'll take gross margins, Larry can take currency.

Well, I think you had two questions in currency. One question was did we take currency to the bottom line? And the answer is no, we don't. I mean, that's a fruitless exercise, to be honest with you. Even doing constant currency on revenue doesn't recognize the fact that there are market events in play when currencies are that much different. And a lot of countries are based on U.S. prices. So it's not that simple. And when you try to take it to the bottom line, it is not a useful exercise. It's obvious when you had this much that it was help to the bottom line. I'm not denying that Steve. But we don't take it down to the bottom line, and I don't think it's a useful exercise. Secondly, you mentioned something about hedging, and I think the difference is that last year we weren't, you know, we weren't hedging in places like Brazil, and now we're not really hedging, we're buying forward contracts. And so, you know, protects your downside and sometimes you get an upside, and that's what we had in this quarter. So I think we're managing all of that prudently.

Okay. Gross margins. I think we've been indicating to you our goal of keeping gross margins above 40% and we've been consistently delivering higher than that. I believe that it's sustainable in that higher range, and that's not to be, you know, precise on the nose of 42%, but we believe that, you know, that's a better expectation than the 40%. And particularly in light of the discussion that we just had on kind of the sag gross margin dynamics, if we decide to invest a little bit more in sag or the impacts of currency and benefits you know, delay quite frankly a little bit of the sag ratio reductions, we do see the ability to sustain a higher gross margin than we originally anticipated.

Okay. One additional question. Can you describe -- I know there's geographic and product, et cetera. Can you talk to us about what page volumes are doing in the production space both color and black-and-white? And as well in the office side, is this -- if we look at the post-sales revenue, is that a good proxy for this or not?

Yeah, I think it is. I mean, I think we can get back to you with specifics. But overall, I think it would be fair to say pages are declining, but the mix of pages is changing substantially. So when we talked about the leverage on color pages and having color grow at the rates that it's growing, I think you won't see kind of an absolute flow through on pages on bottom or top line because of the leverage of color over time. So, you know, certainly all the color segments, pages are growing significantly, and the black-and-white segments particularly as it relates to, I think, production black-and-white, we've seen more significant declines. We are seeing increases in the pages for black-and-white multifunction, which is a good sign for us and gives us an ability to really manage, you know, the office pages piece. But overall, pages are declining and it's just a mix that's really driving, I think, a better story going forward as it relates to the leverage on earnings and revenue.

And lastly, Anne, when is your sales coverage look like right now, open territories, et cetera?

Sales coverage is pretty stable. We haven't really seen any major changes. We're in excess of usually 93, 94% still territories in all of our geographies, and that's stayed pretty consistent, Steve. No changes there. I'd say the bigger impact on coverage for us is the impact of tele-business. As it relates to providing additional productivity. But we've really kept our direct territories stable and filled now for a number of consecutive quarters.

Okay. Thank you.

Thank you.

Our next question comes from Carol Sabbagha (ph) of Lehman Brothers. Please state your question.

Good morning, Megan Talbott on behalf of Carol. I wondered if you could talk a little more on pricing. We've heard from a lot of your competitors about pricing pressure this quarter. I was wondering how much of the negative pricing you saw this quarter was planned as part of our office strategy and how much of it was competitive pricing pressure.

Okay, Megan. I think I would say, you know, our pricing investments are planned and coming through as expected. So, you know, we're in the 8 to 10% kind of range of price investments so there's no question that we've invested in being more competitive. We think it's been absolutely adequate to improve our win rate and share rate. But I can't say that it's coming through on more than a planned rate. So we're clearly driving a lot of the price pressure in the marketplace. We recognize that. But it's been intentional and planned for and an investment we've obviously offset with, you know, good cost and expense management.

Great. Thanks. And Larry, just one more quick question, I wondered if you could talk a little more about working capital. You obviously got a lot out this quarter. If you could just talk about what your plans ongoing forward where your focus is going to be and how much more room you think you have there.

Well, the focus, as I said before, is mainly on accounts receivable. This is one of those things you don't know how good you can be until you finally work through it. You know, we were able to do $100 million this quarter, which was a little bit catch up, but was really an excellent job by the operating units. And, you know, I don't know where it's going to end. I think we can do a lot better. I had said $200 million at one point. I don't know whether that will be at the end of year or go into next year. Once we get to that number, we'll regroup and think of another lower number.

Great. Thanks.

I think we have time for one more question.

Our last question today will come from Bill Shope of JP Morgan. Please state your question.

Quick question on your target for returning your revenue growth in ‘04. Are you basing that target on a constant currency assumption or do you think you can generate an overall through post-sales even if the dollar strengthens going into next year? And then the final question on the 1010, you're starting to see some more volume momentum. Now that that's happening, are you seeing any major response from the bill players in light production?

Well, I think our revenue projections are based on constant currency. So -- and on the 1010, you know, we are seeing success. I think that, you know, we've come in at, I think, a very competitive price with the 1010, so we're probably putting a little pressure on the segment. It's a new offering for us, a new play, so it's all gain for us in terms of share and bottom-line impact. But my guess is that it is putting a little bit of pressure on the competitive players, and we're seeing that. But we were pleased with Q2 results.

Excellent. Thank you.

Thank you very much. And thank you all for joining us today. We appreciate your continued interest and look forward to chatting with you next quarter. Take care. Thank you.

Ladies and gentlemen this does conclude today's teleconference. Thank you for participating. You may now disconnect.