全錄公司 (XRX) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Xerox Corporation Third Quarter 2003 Earnings Release Conference hosted by Anne Mulcahy, Chairman and Chief Executive Officer.

She is 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 Web site at www.xerox.com/investor at the request of Xerox Corporation today's meeting will be tape-recorded. Taping and rebroadcasting of this call are 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 differ materially from those projected in such forward-looking statements. Information concerning certain factor that is could cause actual results to differ materially is included in the company's second quarter 2003 report 10Q filed with the SEC. The company does not intend to update any forward-looking statements made during this meeting.

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

Well, thanks, everyone for joining us today. We're going to begin with slide 4, which provides a summary of our Q3 results. As you all know, it's been a tough marketplace with very little economic predictability, but a whole lot of earnings volatility, and I think we're pleased to say that quarter after quarter, we remain consistent in delivering on expectations and making progress on our key metrics.

Equipment sales are up in key markets, leading to share gains, and we continue to focus on productivity and expense management. Cash flow has remained quite strong, in fact, our healthy cash position enabled us to accelerate funding into our pension funds this quarter, and excluding that pension funding, we generated about $671 million in Q3 operating cash. Larry is going to walk you through the income statement and cash flow in a moment, and first I'd like to spend a few minutes on revenue and installs, and before we take your questions, I'll wrap up with a few thoughts on Q4 and full-year expectations.

So if you turn to slide 5, you'll see that equipment sale trends continue to show improvement, and that is both pre and post currency. Currency was less of a benefit in Q3. It was seven points in Q2 and three points in Q3. And we have increased equipment sales in key markets, which is really an important step of our revenue growth strategy. More machines in the field that depend on Xerox supplies and service create business that flows through to our post-sale revenue and has a sustaining benefit for our top-line results. Or in other words, a dollar of install revenue generates $3 of post sale.

As expected, post sale has declined due to business decisions made that prioritize profitability over revenue growth in 2001 and 2002, and as a result, we stabilized our business model. The revenue decline in Q3 is due to significant decline in light lens and our exit from Soho. Bottom line, 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 6, you'll see that in Q3, the growth areas of our business, which now represent about 70% of our revenue, grew 6%. Declining areas were obviously making no investment, light lens and Soho, represent 10% of our revenues and were down 33% in the quarter.

DMO is improving significantly, which I'll discuss in a moment. There's no question that growth is being driven by increasing customer demand for Xerox's office digital and production digital systems integrated with services that add customer value and give Xerox a competitive advantage. Services like our office document assessment digital imaging and repository offerings and Workflow solutions are enabling big wins as Xerox helps customers improve productivity. A quick example. Honeywell aerospace engaged Xerox to streamline its publications process. They signed a five-year out sourcing contract where we consolidate a number of Honeywell's in-house re pro graphic services and then apply Xerox's customized web fulfillment solution, our technology and our professional services to save Honeywell $17 million over five years in the document management cost area.

And of course color continued to be a highlight with total color revenue up 15%, largely due to the success of our DocuColor series. Color now represents about 20% of Xerox's total revenue. And this is an important indicator for future revenue growth. More placements, more pages printed in color, Xerox color. If you turn to page 7 or slide 7, we'll focus on production for a moment. We continue to build on strength in digital color with production color installs up 8%. We've also had install growth in production black and white due to the strength, continuing strength, by the way, the DocuTech family, and headway we're making in the light production space with the launch of the 1010 and most recently the 2101. We've maintained market share leadership positions in black and white publishing, printing and color in both Europe and the United States. I'd like to share a little bit of specific detail with you on market share, and this will be first half 2003 market share compared to second half 2002.

In black and white publishing, our U.S. share was up five points, Europe was down two points, but that left us at absolute shares in the U.S. at 66% and Europe at 53%. In segment 6, U.S. share was up four points, Europe share was sustained with Xerox share at 20% in the U.S. and 24% in Europe, and as you know, this is a segment we really didn't participate in until we launched the 1010 and 2101, and in color, our U.S. share was maintained and Europe was up two points, bringing us to a share in the U.S. of 51% and 62% in Europe. Making us clearly the worldwide leader.

We announced at graph expo that we had crossed the 100 million-page mark printed on iGen 3. We also announced that we're adding new markets, which means by the end of the year, we'll have iGen 3 available in 30 markets, and customers like copy Cub in Boston have been quite articulate about the fact that they expect iGen 3 will increase their overall revenue by at least 15%. We're really pleased with the pages per install for iGen 3 installations, which is critical for the movement of applications to iGen 3 and the profitability of our customers. So the strong -- of Xerox services continues to give Xerox advantage over hardware-only competitors.

For example, in Europe, Siemens extended it's $120 million contract for Xerox to man manage the production of its telephone user guide, and that's through a combination of our production systems, our variable information software and services, that allows us now to produce Siemens user guides for four global markets. So Xerox production systems integrated with our variable information database management software continues to enable new applications for customization or one to one marketing and we're really excite the about this revenue opportunity and think it has great potential for growth, particularly as the do not call registry forces marketers to rely on more creative direct mail approaches. So if you turn to slide 8, move to the office for a moment, all of the products we announced on April 30th are now fully launched, and we're seeing strong demand from small and medium-sized businesses driving growth in office digital.

Lower priced offerings in the office is impacting total revenue growth, but accelerated activity remains a strong indicator of future post sale revenue. Xerox's office services offer incomparable customer value, especially compared with competitors who simply sell the box. For example, Monsanto recently engaged Xerox to complete an office document assessment, which resulted in a contract to network their enterprise with more than 100 Xerox WorkCentre Pro multifunction devices. Then through a managed services agreement, we have an on-site Xerox team, which allowed Monsanto to reduce monthly costs and increase office productivity. A few specifics on office market share from the first half 2003, which I may remind you is prior to the impact of our April 30th announcement, but as compared to the second half of 2002, so if we look at black and white digital copiers and multifunction devices, we maintained our share in Europe, U.S. share was down one point, but our overall share in the U.S. was at 13% and Europe at 14%, and we do expect certainly that our April 30th announcement will bring good news as it relates to the overall black and white market share.

Color digital copiers and multifunction devices, U.S. share up 4 points, Europe's share was down from an absolute record high, it was down 6 points, but it brought our Xerox share in the U.S. to 30%, Europe 33%, so the first half of 2003, we maintained both in U.S. and Europe leadership positions in a key growth area. And in addition, we expanded our office portfolio last month through the launch of two new laser printers and two additional WorkCentre multifunction systems. So if you turn to slide 9, just a moment on DMO.

Business clearly continues to improve, especially in Latin America in our developing markets, equipment sales were up 33%. Post sale declines of 11% are a 10 point improvement from last quarter, and total revenue improved nine points from last quarter. We expect the trend to continue in Q4 with equipment sales growing and post sale declines moderating. Due to the strength of our operations in developing markets in much leaner and flexible business model, we believe our developing markets are well positioned to capture profitable revenue growth by year-end.

So now I'm going to turn it over to Larry who's going to review the financials, and then I'll return to discuss Q4 and join Larry to take your questions. Larry?

Thank you, Anne and good morning, everyone. Thanks for being here. I will start by saying that we are pleased with third quarter results in all areas. First and foremost, we delivered on our commitments, which is truly important to us. Second, our revenue results are consistent with our expectations, and on track as we transition to total revenue growth. We installed significant volumes in all areas as Anne talked about. We grew equipment sales, we grew in total on our digital sales, which is where we invest, and as Anne said also, our developing markets now is close to becoming a growth area where it should be. Third, in our operating performance, we are on track with margins and ratios. We see increased productivity, and we think this drives earnings in this quarter and will in future quarters. And fourth, we're driving operational cash flow significantly. So again all areas' goals accomplished in the quarter. If we move to slide 11, I'll start off by again saying 11 cents continuing on our commitments with earnings, and we revenue in transition to growth.

And what I mean by that is equipment sales is growing, units is growing, and if you look at our growth businesses, we grew that total revenue 6%. That's the digital world. Our gross profit margin was 41%, and it's on track. We've consistently said our model is 40 to 42. This is a seasonally low quarter, but again, it's a consistent track record here. Sales productivity is up, R&D productivity is up bad debts are down. Again, another strong indication of operational performance in our sag area. A very important point for the future is focusing on our cost-competitiveness. And what I mean by that is that we want to be cost-competitive in every area of the business. So whether it's product cost or it's SG&A or it's R&D, we want to be able to compare to our competitors and be the best. And in order to do that, the enabling tool is lean Six Sigma, which we've talked about before, and this is going to drive costs down in all portions of the business, and at the moment, we have 300 people in our company dedicated to this responsibility. We've already touched about 9,000 people that have been involved out of our 60,000 people, and we have 258 projects in place that we're working on, and that is growing day by day and more and more people are getting educated. So this tool is working and will work in the future.

Operating cash flow was up $67 million. That included $604 million of pension payments, and we still had $2.3 billion of cash on hand, which is what we started the quarter with. If you go to slide 12, I wanted to reinforce the point on our transition to growth. Again, we grow where we invest, so if you look at the growth areas of $2.5 billion, it grew at 6%, and that represents a 4% bottom line plus in that area, and as light lends get smaller, it's gone from 15% of the total to 10% of the total. Year to year, that declining at 33% took away 5%, so as that gets smaller, and by the latter part of next year, we will see total growth for the company, and can you see in the right-hand corner, the arrow driving from 70% from 59% to 70% from the growth areas, and we expect this to be 90% by 2005. So the transition to growth is on track. If you go to slide 13, this is a picture of the P&L from 2002 third quarter to 2003, and unfortunately, every line has a story here from a year-to-year basis of comparison. And in the next two slides, I'm going to take you through gross profit and sag, but the overall comment that I would make is that when you get underneath the year-to-year anomalies, all our ratios are on track and are getting better, and our gross profit margin is where we expected and wanted it to be in that bandwidth of 40 to 42.

In addition to that, there's a line called "other net" here that includes interest expense, and because of accounting requirements of FASB 150 and 133, it obscures the fact that we have a $30 million benefit year to year in interest expense and quarter to quarter. This was the commitment we made when we recapitalized and issued equity that we could save significant interest expense, which would offset the dilution and the stock, and we see this in this quarter, and because of these accounting changes year to year, it is not easy to see, but it is in there.

In addition to that, this accounting FASB 133, which is mark to market for swaps on interest swaps cost us $10 million in 2003 just because of the volatility of the interest. It's not a cash payment, it's an unrealized swap loss, and so that also hides some of the benefits, and that offsets some of the tax gain that we had. If you look at 28.3% of our effective tax rate, that was underneath -- underlying that was the 39% tax rate, and we had favorable audits and a favorable refund in California that brought it down to 28%. All of this drives our 11% earnings and our growth in earnings year to year.

If we go to slide 14, without making any adjustments year to year, you can see that the 41.1 is in line with what we've done for the last seven or eight quarters. Again, it's in our sites of where we want to be. There was an anomaly last year. We had this ESOP, which is an employee stock ownership plan, and there was an accounting adjustment to move some of that expense back down to the dividend line. That was worth 28 million. So if you look at that, we're about flat on gross profit margin.

In addition to that, we are now moving some of our manufacturing engineering, production engineering is moving over to our gross profit or cost line from R&D as eye iGen3 gets into major production here. I think the important point is really the first top point, which is that manufacturing and service productivity more than offset price declines in every quarter that we have on this chart. If we go to slide 15, the same story holds true for sag, selling, administrative and general. If you look at third quarter to third quarter and you adjust again for this anomaly of ESOP, we are down year to year if you adjust for currency, we're down 3% on pure selling and G & A.

In addition to that, we're down three% year to year on bad debts, $34 million. We had a high water mark of bad debts as a percent of revenue of 3.7% in 2001, and right now we're at 1.4%, so there's a spectacular improvement here, and again, the ratios are better and year-to-year productivity is better in SAG. If we go to slide 16, again, we have an outstanding story here. $67 million plus in cash flow we were 682 prior quarter, 159 in the first quarter. We paid down or put $604 million into our pension fund to get ourselves to be on a cash basis fully funded worldwide, and I think the real telling story here is if you look at year-to-date, and you looked at the cash contribution of pensions of 649, restructuring of payments of 299, that's over a billion dollars that went out for those two items, and we still have cash flow of $1 billion after that, and we still have a cash balance of $2.3 billion, which we've had for the last two quarters prior to that. So a really well done cash flow.

In addition to that, we've had improvements in accounts receivable, and our securitizations here are just about balanced from what we're borrowing and what customers are paying back. If we go to slide 17, what I'd like to cover really here is that, again, the second point on the chart, we had committed to do all the major countries by the end of the year. We've done U.S., U.K., France and Canada on a securitization strategy for new originations. Those are all complete. We've done a lot of smaller countries. We have $11.8 billion of debt, $7.7 billion is non-securitized, which is the debt we pay ourselves. You can see the debt ladder there, $1.5 billion of annual cash flow in the cash we have. We see that debt ladder as a totally manageable position for us. So just in summary, I'd like to just reiterate equipment sales growth pre and post currency, installation growth and share gains up significantly, disciplined cost and expense management, improving earnings, very strong operating cash flow on hand, and this makes us optimistic on the future from both an earnings standpoint and a competitive standpoint.

So with that, I'll turn it back to Anne.

Thanks, Larry, and I'll just build on Larry's summary and if you'd look at slide 19, I think it's clear that we could characterize this as a quarter of consistent and solid delivery on key metrics. Our business model is definitely working. We have good news on the revenue side driven by activity in share, good news on the profitability side driven by our cost base discipline, and we're delivering both strong and consistent operating cash flow. I think what we feel best about at the marketplace momentum, this company is now on offense, our wins are at the expense of our competitors, and we're seeing that certainly in install and share growth, and that we are delivering value and differentiating our self to our customers through our services, which are driving our enterprise wins with key accounts.

So if we'd now kind of wrap up with some guidance on slide 20, I think that you'll recall that our 2002 investor conference last November, we established an expectation of full year 2003 earnings in the range of 50 to 55 cents. During the last three quarters, we've been quite consistent in delivering on all fronts and have clearly laid the foundation for meeting those full-year expectations excluding the previously recognized litigation and credit facility charges.

Considering the strong performance we've delivered to date and our confidence in continued equipment sale growth and operational improvements, we believe that our full year operational results will be above this range. However, the best position the company for further improvement in 2004, we expect to increase our Q4 restructuring investments by about 30 to 40 million. And including this incremental restructuring, we expect to deliver full-year earnings within the middle of the 50 to 55-cent range.

So in closing, despite a tough business climate, we remained quite encouraged by our progress this year, confident in the business decisions we've made to transform Xerox into an aggressive competitor and a global technology leader, so we want to thank you for your time and now Larry and I will be most pleased to take your questions.

Thank you. [operator instructions]

And our first question comes from Ben Rietzes from UBS. Please go ahead with your question.

Hello. Thanks a lot. Good morning.

Good morning, Ben.

Good morning. Couple of -- well, clarification just on your outlook. What does that imply for revenue growth for the fourth quarter? I think you're getting close to turning the corner into growth, but do we have a comparable decline, and what are the puts and takes there? And then with regard to margins, if you could just provide a little more clarity on some of the pressures that could be -- could have been faced other than seasonality in the quarter? Looks like you've seen an acceleration of lower end comp years. I'm wondering how that's impacting the mix with the strong segment 1 and 2, or maybe I read that slide wrong. But also just how that is impacting maybe also in the margins, how currency and you're dealing with suppliers and components is impacting the gross margins at this time. Thanks.

Ok, Ben. Let me start with revenue growth, and I think we would characterize our outlook on revenue as more of the same, which is equipment in sales, equipment revenue driven by continued momentum on the technology we've brought to market so that, you know, we would look at that as increasing momentum. We talked about post sale as certainly stabilizing and turning that corner in the second half of 2004, so we would still see declines in post sale, but once again, moderating and modest improvement is where we believe we will be on the post sale side, so, you know, the strength of the revenue picture in Q4 will be driven by the equipment sale revenue once again.

So a comparable type of decline figure? Probably?

I think it would be. I mean, I think there's, you know, modest improvement potential, but once again, it will driven by equipment sales.

Got it.

Ok? On the margin side in terms of pressures, I think we've been really doing a pretty good job of balancing our pricing investments with all the productivity we've seen from both UMC and service, so that continues, I think, to be a strength of being able to offset the pricing investments we're making, which are pretty stable, and delivering the kind of productivity that's required to ensure that margins aren't impacted. The good news is, I think as it relates to activity, although we're seeing a lot of low end activity growth, it was 50%-plus, I think, in the quarter in segments 1 and 2.

We also saw growth in segments 3 and 4, so, you know, the message being that, yeah, there will be some pressure based upon that from a activity standpoint, but in the long term, it makes for a really healthy post sales stream in terms of the amount of post sale revenue those installs will generate downstream, so we believe we can live within the expectations we've set for our margin range and still drive activity in the lower end of the market aggressively, so we're pretty pleased with that. And certainly on the currency side, we continue to look at, you know, precurrency improvement in every aspect of the business from a productivity perspective, so I think we can manage this one, deliver consistency in margin expectations, make price investments, and drive activity and gain share.

All right. Well, the end of the fourth quarter, you usually get a pretty nice seasonal pop in gross margins. Is that kind of the norm you're expecting right now?

I think the one thing I'd probably note on the year-over-year comparison is last year we had some licensing revenues, about $50 million that drove I think about -- almost -- a little bit less than a point of gross margin, so, you know, I think minus that, you could expect kind of comparable gross margins.

Thank you.

Thank you. Our next question comes from Stephen Weber from S.G. Cowan. Please go ahead with your question.

First of all, could I get -- we get a clarification on the restructuring? Originally at the beginning of the year or I can't remember, but you said you were going to have $115 million of restructuring. Is this $40 million incremental to that?

Yes. And it's 30 to 40. You know, we've got a range there, but it is incremental to the 115.

Ok. Could you -- one of the big parts of this story all along, Anne, has been that you were driving down your SAG as a percentage of revenue. SAG was down on a constant currency basis about two percentage points in the third quarter, which was a moderation of the improvement. What do you think -- were there extra investments? Do you see that -- the kind of trend we're going to see in Q4, or does it get a little better than that, and if you could even think about how you're positioning going into 2004?

So just as a reminder, I know it's a complicated discussion year-over-year, but the ESOP benefit we saw in Q3 was not repeatable this quarter, so actually the improvement was understated, so that's where I think you heard Larry say we had 3% improvement on SAG in just the actual selling and general and administrative expense, and another 3% on bad debt representing a $34 million improvement, so we think the SAG performance was pretty good when you really create a level playing field, and that's going to continue both in absolute dollars as well as in ratios where we will see improvement in Q4.

Now seasonally, you know Q4 is higher than Q3, but year-over-year, I think you'll see good news flow through on SAG, and, you know, we are very comfortable that as we look at our business model, that we'll be able to deliver the kind of committed returns with gross margins probably a little higher than we initially anticipated, and SAG ratios a little higher, but we're balancing the enabling of equipment sale growth with the declines in post sale, and I think we've been walking a delicate balance there and doing it pretty well.

Ok. If I could come back just for one second to the restructuring, does that entail incremental people? Is there something else that you're doing in the business? And does it have any cash flow implications in Q4 or next year?

Let me begin with I think the cash flow implications are pretty minimal and not something that we would highlight for you to be concerned about. You know, I think if you look at what's happening during 2001 and 2002, we probably did $1.6 billion of restructuring, which we refer to as kind of the heavy lifting part of getting the business model in order. This is really kind of business as usual. We are ticking up the 115, but modestly, not by huge amounts, that are really playing and adapting to as Larry indicated every single part of our business is at benchmark cost, so that we can be aggressive and competitive in the marketplace.

So we're not going to let these problems build. We're going to identify them, we're going to act on them as quickly as we can and make sure that we enter 2004 with a really clean business approach in terms of our ability to be aggressive in the marketplace. You know, clearly we're working that business by business and making sure, I think digital economics have a lot to do with it in terms of making sure that our capacity is appropriate for the business that we're running, but, you know, we're not going to provide specifics at this point. We always do that internally before we do it externally, and I think we'll leave it there.

Thank you.

Ok.

Thank you. Our next question comes from Jay Vleeschhouwer from Merrill Lynch.

First, your color revenues while growing year-over-year declined sequentially as they did last year, but they seem to have declined more sequentially this year from the second quarter and last year's third quarter did, so the question is, do you view that as a normal seasonal decline from the June quarter? And secondly, your production-operating margin was cut in half sequentially. I know there might have been some small reallocations going on there, but is that mid single digit operating number for production you think more the norm for that business or could you see it getting back to high single digits or double digit?

Ok. Let me begin with color revenues, and, you know, talk about by the way, we're actually pretty pleased with the strength of color revenues. If you look back at the third quarter last year, the fact is, is that we had introduced new color multifunction products which clearly did drive, and printers as well, which drove a spike in revenue in Q3 that probably makes for a little bit of a difficult compare. Sequentially, third quarter always comes down from second quarter just due to seasonality, so I'm very pleased with the growth that we had in total color revenues. I think the portfolio is stronger than it's ever been both in the office and production in color, so I would not be concerned about any third quarter compares that I think were driven probably by product launch anomalies more than anything else. The production-operating margin did come down and you identified a piece of it. You'll notice that our office margins went up, and there was some reallocation of cost between office and production that did sway that.

One of the things that I think we would suggest is that if you look at year-to-date operating margins, you get a much more rationalized balanced view of, you know, clearly what we think the business is delivering in terms of operating margins, and we're pretty comfortable that our production operating margins will be strong going forward and actually improve quarter-over-quarter if you take out some of those anomalies if in terms of the operating profit, but, you know, this is certainly a business in third quarter that makes for a difficult compare, but year-to-date, if you look at the operating margin compares, I think you'll see that we continue to make progress.

Ok. Larry, with respect to the comment you made about strategic cost competitiveness, can you bring us up to date on any thoughts with respect to additional outsourcing or some other kind of manufacturing leverage you can look to gain from that program or perhaps on the product design side, could you be a bit more specific as to how you can, in fact, get that leverage?

Well, I think in total, we're not excluding any idea to look at anything, and right now we have a huge effort going on at looking at our total cost, which include service, manufacturing, everything else. It's $9 billion, and we're going to look at everything there. We have a consultant in helping us, we have our Six Sigma people on it, and so we're going to focus on whatever is the right idea. I mean, other things to outsource are things like, you know, software, some things with supplies maybe, but again, you know, we'll look at it, and we rule nothing out on that.

Your next question comes from Carol Sabbagha from Lehman Brothers.

Thanks. Good morning. Just a very broad question. In your comments in the press release and you sort of implied that the economy remains remained weak, stabilized but weak. We're starting to hear from some other players in the industry that they are seeing a little bit of a pickup in market demand that's not product-driven and maybe a little bit of freeing up of corporate budgets. Are you seeing any of that? And can you talk about -- and market demand, really what you're seeing across the world in the major regions?

Well, I think, you know, I've probably been more hesitant to declare victory in terms of, you know, a systemic economic recovery, because I do think it's been somewhat volatile in its nature, so I think, you know, our perspective has been not to plan on it, to continue doing what we're doing and make sure that we create the kind of contingencies that allow us to deliver to expectations regardless of economic recovery.

We certainly are seeing growth, in particularly, I'd say, our small and medium-sized businesses. A little bit slower recovery in major enterprises where I think capital spending is still somewhat constrained, and our greatest success in major accounts has really been with our services-led kind of office assessments and Asset Management kinds of opportunities where we're able to provide additional savings and productivity to our customers.

So I'm in the sure that I would translate that into a real loosening up of capital acquisition. I actually think we're trying very hard with our customers to provide value that actually allows them to still reduce and provide more productivity going forward versus invest more, and that's really been the way I would characterize the success. So I think I probably am a little bit more, you know -- or less optimistic than some of the signals that I'm seeing from other companies, but part of it is that we want to plan our business around some fairly conservative assumptions so that we don't disappoint and depend upon economic recovery to deliver to expectations.

Two quick questions on 2004. Your new product platforms in 2004 compared to 2003, and just the outlook for pricing, do you think the levels we've been seeing over the last couple quarters will continue or maybe get worse or ameliorate?

Ok. I think I would characterize 2004 as a continuation of technology innovation that we've had in 2003. This is not -- I think we're trying to run this business so that it's not an on again-off again type of approach with product launches, that there's really kind of a cyclical approach in terms of refreshing our technology portfolios that we're managing to kind of stay ahead of the curve, so I would not characterize 2004 as a slowdown as it relates to, you know, new product launches or new services that we'll bring to market. We feel actually pretty excited about our product launches in 2004.

In terms of pricing investments, it's something we've been watching very carefully, and I would characterize it as having been stable in the last three quarters, and we're seeing about 5% in the production environment, about, you know, 10% in the office, and that really hasn't changed, so our planning assumptions have worked out quite well. I don't think I would expect any major shifts. I do think that price pressures will stay in place, so we're planning for that and ensuring that we build in enough productivity in our plans, which really gets back to Larry's point on being best in class from a competitive perspective so we can retain our margin while we continue to make pricing investments in our offerings to our customers. So we're not anticipating any step function change in pricing, and I think the assumptions that we have in place are pretty aggressive based upon the trend that we've seen.

Thank you very much.

Ok. Thanks, Carol.

Thank you. Our next question comes from Craig Ellis from Smith Barney. Please go ahead with your question.

Ok. Thanks. And at this point, just some clarifications. First Larry, back on the comments regarding six Six Sigma and the opportunities there, can you give us a sense at what pace you might be able to advance on the opportunities that are around that $9 billion in annual ex-pens?

Well, we're on a schedule, as I said, we're building up the whole Six Sigma. We have 300 people that are fully employed in it, and, you know, it's a question of buildup as to what kind of timing. I think we're going to see, you know, small victories here in the short time, and big victories in the long time. I don't -- you know, I don't have a timetable of when each one is going to hit us, but we expect to get benefits next year, you know, pretty significant benefits next year as we go forward to contain our costs. You know, there's so many rising costs here of pensions and benefits and everything else, just to stay in place here, you know, you'd have to take significant kinds of actions to be competitive.

And if I may add too as well, I mean, we've made a big investment in ramping up our knowledge levels and our resources, and we believe actually that investment will break even this year and deliver returns next year. Every single project is managed to a bottom line economic profitability with a very disciplined system in place. So this isn't soft stuff, this is hard stuff in terms of the way it's being managed and really ensuring that we managed the bottom line improvement very, very carefully.

Ok. Great. And then a clarification on the product side, Anne. Given that in the third quarter, we probably didn't have a full quarter of shipments of all the new office products, how should we look at mix over the next couple of quarters? Is it going to be skewed more towards the office than it was, say, over the last three or four quarters?

Well, I mean, I think when we think about fourth quarter, it generally is skewed more towards high end to tell you the truth. We usually have a stronger production fourth quarter than the previous three, and I wouldn't see this year being radically different, particularly with iGen 3 ramping up. So although we didn't see a full quarter in the office with the new products, I think we'll continue to keep the ratio of office and production fairly consistent because of the strength of the production portfolio and the seasonality of Q4 decisions in the production business.

Ok. Thanks. And then just lastly, on the pricing comments, have you seen any sounds like you haven't, but just to make sure, have you seen any competitive price responses to the lower prices that you brought out with the new office products?

Well, you know, I think I would characterize certainly the environment as very competitive, and, you know, I guess we would look at it in kind of the activity growth and the share results, we're winning more than we have in the past, and still maintaining our margins. So I wouldn't say we've seen anything terribly unusual. We often see, you know, sometimes some crazy deals in terms of, you know, uneconomic kinds of arrangements, and we tend to not participate in those, but I think our ability to participate in the vast majority of deals very competitively and win the business is there. So nothing that I would say is different than what we've seen in the past.

So a manageable pricing environment?

Definitely. And Tough, but manageable. And I think we have time for one more question.

Thank you. Our final question comes from Shannon Cross from Cross Research. Please go ahead.

Hello, guys. Just snuck in there.

Hello, Shannon.

Just a couple of questions. And then a clarification on the earnings outlook for fourth quarter, now that equipment sales are 25% color, has there been any change in how you guys are looking at post sale, any trends that are different from what you've seen off of black and white, you know, perhaps since the toner shipments or the cost of the toner, you know, on a per piece of equipment basis is higher, maybe it would come through a little earlier. Just any changes off your original assumption?

Ok. I think that we had anticipated actually, you know, when we built our kind of post sale model the growth rate of color built into when post sale would turn, and we're pretty much on target for that, Shannon, in terms of, you know, the color growth we're seeing and the leverage it plays in the post sale environment, so, you know, color clearly will be a vehicle for us to, you know, ensure that we do turn the corner despite the fact that light lens and Soho will literally be disappearing by the end of next year. We're actually going to spend a lot more time on that at the investor conference too, because we understand the hydraulics of cages and margins in color and black and white are certainly important to understand, so I think you'll see a lot more detail from us then.

Ok. And then just a clarification on your earnings outlook for the fourth quarter. You had said that you would have exceeded the 50 to 55% range except for this additional charge, is that correct?

Yes.

Ok. And so then looking at the numbers now, you've done -- I think it's 38 cents year-to-date?

Right.

So it will be -- your new range is somewhere between -- or somewhere around 15 cents then, if you took the midpoint of the 50 to 55-cent range?

I think 13 to 16 is probably the right range to look at.

Ok. And just so I've got the math right, the 30% to 40% additional expense, that's what, 4 centish?

30 to 40 million.

I'm sorry, 30 to 40 million.

I think somewhere around 3 or 4 cents.

Ok. Great. Thanks.

Ok. Great. Well, let me once again say thank you for your participation, and I will also place a reminder that our investor conference is November 24th in New York, and we really do look forward to seeing all of you there. Thanks again. Have a great day.

Thank you. Ladies and gentlemen, this does conclude the Xerox Corporation third quarter 2003 earnings release conference call. You may all disconnect, and thank you for participating.