全錄公司 (XRX) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Xerox Corporation first-quarter 2004 earnings release conference posted by and Anne Mulcahy, Chairman and Chief Executive Officer. She is joined by Lawrence Zimmerman, Senior Vice President and Chief Financial Officer. During this meeting, 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 rebroadcasting of this call are prohibited without 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 factors that could cause actual results to differ materially is included in the Company's 2003 report for 10-K 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 thank you for joining us today. We're going to begin with slide 4, which provides a summary of our Q1 results. We've had a good start to the year, as we delivered another quarter of steady, consistent, positive performance aligned with both our strategy to grow as well as delivering on earnings expectations. We delivered better-than-expected earnings, 25 cents including an 8 cent benefit from the sale of most of our ownership stake in ContentGuard.

Highlights in the quarter included in increase in equipment sales and installs, post sale trends continued to improve, and with the industry's strongest force in digital color printing, color revenue continued to grow significantly. And improvement in operating margins despite a decline in gross margins due primarily to product mix, which Larry is going to talk about in a couple of minutes, and another strong quarter of cash flow at $243 million, up more than 50 percent year-over-year. Larry will walk you through the income statement and the cash flow in a moment but I would like to spend a few minutes on revenue and installs. Before we take your questions, I will wrap up with a few thoughts on second quarter.

So you can see that equipment sales trends continue to show improvement pre- and post-currency. Nine percent growth in Q1 and the currency benefit in Q2 was five points on equipment sales. New technology is continuing to fuel equipment sales. The payoff of earlier decisions to continue investing in technology and creating the industry's broadest digital portfolio. And while equipment sales are growing, post sales continued to improve as the revenue stream from the new digital systems and services increasingly offset declines from Light Lens. And we expect this trend will continue. It is a logical progress. Equipment sales growth means there are more digital systems in the field that depend on Xerox supplies and services. This is business that flows through to our post sale revenue and will have a sustaining benefit for our topline results.

The equipment sales growth we are experiencing is expected to flow through to post sale growth for the end of the year. Quarter 1 total revenue was up two percent and includes a five point currency benefit. And at current spot rates, we anticipate that currency will benefit our top line by about three points in the second-quarter.

If you turn to slide 6, here is a closer look at the revenue story. In first quarter, the growth areas of our business, which now represent about 71 percent of our revenue, grew 9 percent. The major declining area of our business, Light Lens and SOHO was down 37 percent in the quarter, but for quarter 1 those declining areas now represent only about 8 percent of total revenue. This steady trend of improvement is proof positive that the business model is working and that we are winning in the marketplace through services led technology that adds customer value, giving Xerox the competitive edge.

No one knows document management better than Xerox. In document intensive industries like health-care, education and insurance we're increasingly becoming a valued partner who efficiently our customers' endless flow of information.

And as I mentioned, color continues to be a highlight, with total color revenue up 26 percent and color revenue now represents about 23 percent of total revenue. Yet color accounts for about 4 percent of total pages printed on Xerox technology. These results are indicative of the leverage that color has on our results and that the opportunity for color remains huge in equipment sales and the flow through to post sales.

So if you turn to slide 7, we will focus on the production business, where installs were up 27 percent. Install growth of 28 percent in production black and white due mainly to increased demand for the Xerox 2101. And initial sales of the DocuTech 100/120 copier/printer are very strong. The product started shipping in March, so we will see the first full quarter of this install activity in the second quarter.

The March ship date did impact overall DocuTech sales for the quarter as installs of the older DocuTech systems slowed down for January and February in anticipation of the DocuTech 100/120 series.

Our market development continues with the iGen3 with expansion in new markets. By midyear, we expect DocuColor iGen3 to be available in every major North American and European market, as well as new Latin American and Eastern Europe markets. And increasingly our commercial print customers are relying on iGen to fuel their business growth. In fact, more than a dozen iGen3 customers on multiple systems, customers like Consolidated Graphics, which recently purchased six iGen3s and named Xerox its exclusive provider of digital color technology for 65 locations. And full year 2003 marketshare reports again validate our leadership in production color and production monochrome.

So sharing some of that data in black and white publishing with Xerox's U.S. share at 69 percent, we were up two points for the year. Q4 results in the United States alone drove much of this moment of as share increased 11 points.

In Europe share declined 1 percent for the full year but we maintained the number one share position at 56 percent of the market. In production color, we maintained our number one share in both U.S. and Europe. In the U.S., we grew share five points and ended the year with 51 percent share; and share in Europe grew three points to 61 percent.

We are ramping up for next month's Drupa, which as you know is the world's largest graphic arts and printing show where you will be hearing from us from new monochrome systems and additional FreeFlow offerings as well as enhancements to our production color, wide formats and continuous feed lines.

So turning to slide 8, we will focus on the office, where our growing portfolio and expanded sales channels are generating demand for more and more small and medium-sized businesses while our services led approach for enterprise document management continues to fuel wins with large companies.

Installs of our competitively priced desktop multifunction systems drove a 10 percent increase in office black and white digital. And color was up again and a highlight was our multifunction systems up 45 percent and color printing up 46 percent; largely due to the highly successful Phaser 8400 solid eight color printer priced at under $1000.

So the value of Xerox technology integrated with the our incomparable service offering is always best explained by our customers, like Cingular, who recently engaged Xerox to help provide its mobile phone customers with personalized information packages. The solution includes a print OnDemand application with customized information about specific billing plans, geographic wireless ranges and phone features, all produced on a Xerox Phaser printer right at the Cingular store. Real-time customer communication that equates to a really significant cost savings for Cingular as they eliminate inventory in the cost of reprinting dated materials.

Similarly the full year 2003 marketshare reports indicate share gains despite the competitive landscape. On a year-over-year basis, our black and white digital copiers and multifunction devices in the 21 to 90 page per minute speed range; our U.S. share was up a point with U.S. share at 14 percent.

In Europe share was up two points; with 15 percent share of the market, and in quarter 4 alone, we grew share by three points to 17 percent in the US. And in color digital copiers and multifunction devices our U.S. share was up two points to 26 percent. In Europe lost one point of share but maintained our number one position at 34 percent share of the market.

But we are not resting on our laurels. Earlier this month we launched our lowest priced laser printers yet, the Color Phaser 6100 starting at 699 and the Monochrome Phaser 3130, which we launched first in Europe and is now available in the US, priced at 299. Next month, we will continue to grow our product line with new segment two offerings.

So if you turn to slide 9, we will focus on DMO, where business continues to improve. DMO equipment sales were up 33 percent and revenue grew 6 percent. A post sale decline of 1 percent is a five point improvement from last quarter. But there are still some -- these are challenging economies. We are keeping our expectations balanced with the variables in this tough marketplace.

In Russia, Central and Eastern Europe, we continue to see growth areas, especially as these emerging markets leapfrog technology transfers and quickly adapt to digital.

So before I turn it over to Larry, let me just provide a quick summary. On the revenue front, its good news in every region and in targeted growth areas. As equipment sales increase, we are also winning non hardware business that relies solely and Xerox's expertise in document management. For example, we are now working with Accenture in Europe to digitize health-care information for a major regulatory agency. Over two years we will convert 65 million Department of Health documents into digital form and then upload the images into a customized retrieval system. Improved efficiencies in the retention and accessibility of key documents will get new medicines to patients sooner while maintaining high standards of safety and quality.

And through our Lean Six Sigma based consulting services, Xerox is helping customers like the Intercontinental Hotel Group improve productivity. Xerox Global Services won their business and trust we streamlined their desktop support and help center workflow with a solution that significantly reduced their annual cost. So through consulting in imaging services like this, Xerox Global Services continues to significantly increase its customer base and strengthen the pipeline for future service based revenue. So that is the revenue story and Larry is now going to walk you through our financials. Larry?

Thank you, Anne, and good morning, everyone. I would like to start by saying we're very pleased and encouraged with first-quarter performance. Our goal each quarter is to advance our business forward in four key areas. One, deliver on commitments. Two, drive unit volumes and equipment growth. This will lead to post-sale growth. Three, to improve our operating margin and expand our earnings; and four, to continue to strengthen our balance sheet. All four of these goals were accomplished in the first quarter, so let's be more specific and go to slide 11.

This slide summarizes our solid performance. Back to our goals. We delivered on commitments. Our earnings range was 13 to 16 cents and we delivered 17 cents. In addition, we successfully turned an intellectual property investment into profit and cash. ContentGuard was worth eight cents a share in the quarter. Not only is this a positive in and of itself, it will allow us to invest more in our future.

Next goal, drive unit volumes and equipment sales growth. Equipment sales growth was 9 percent, 4 percent constant currency. Five quarters in a row of positive growth. This leads to improvements in our annuity revenue stream post sale, and eventually growth. In addition where we invest in R&D digital, we grow. And Anne showed a chart with 9 percent growth for this quarter.

The last point is color grew 26 percent and because color only represents 4 percent of our pages, there is a huge opportunity for revenue and profit. Third goal, deliver improved operating margin, which will yield significant earnings growth. We improved operating margin 1.5 points from a 4.7 to 6.2 percent, which drove earnings expansion to 17 cents. We did all of this by driving revenue growth and the combination of results in gross profit SAG, R&D, and interest expense.

Gross margin this quarter was 39.8 percent, driven primarily by a change in our traditional product mix and the transfer of iGen3 sustaining engineering from R&D to cost. SAG remained at 27 percent of revenue in spite of currency and pension and benefit pressures. Significant improvement in interest expense driven by our recap last year and our cash flow, which give us much lower debt.

Our fourth goal is to strengthen our balance sheet. Our cash flow was $243 million for the quarter, $2.3 billion of cash on hand, $3.7 billion of reduced debt year-to-year, and we lowered our non financing debt-to-capital ratio almost in half from 69 percent last year to 36 percent this year. So all four goals for the quarter were achieved.

Slide 12. A summary of first quarter '04 and first quarter '03. Key points. Revenue grew 2 percent. Equipment sales, 9. Post sale, flat with a 5 percent benefit from currency, all in proving trends. Operating margin delivered a 1.5 percent improvement, driven by revenue and the dynamics of gross profit and expense, all of which I will cover in the next couple of slides.

Tax rate was 33.2 percent, which was lower than our statutory rate of about 36 percent due to a favorable California tax law change. ContentGuard was $83 million after-tax gain or 8 cents a share. So total earnings for the quarter, 25 cents a share.

Slide 13. Anne covered this chart but I wanted to make a few points in addition to the fact that digital products are growing 9 percent, both post-sale and equipment sale. Consistent with what we said at the investor conference, on a weighted average contribution to growth, so weighted by revenue, digital growth areas are getting stronger at plus 6 percent contribution.

DMO is now a positive contribution at 1 percent, and as Anne said, Light Lens now is 8 percent of our total revenue and just two quarters ago at the investor conference it was 13 percent and now represents a 4 percent decline and other is at 1 percent. So the good news here is that the digital growth areas are now driving through and we see them on the bottom line, and this is going to be very helpful in the future for revenue growth.

Slide 14. So the key point on this chart is that we are managing our business to deliver improved operating margin and earnings expansion. Each area has a different effect in each quarter, but the result is that we consistently deliver operating margin improvement.

Let's go through each one. Gross margin, product mix driven by growth in segments one and two printers and light production without the benefit of our new DocuTech 100 and 120 for the full first quarter accounted for 1.2 points. The shift of iGen3 sustaining engineering from R&D to cost accounted for 0.4. We got the benefit in R&D.

Lastly, productivity fell slightly behind price by 0.5 and we intend to catch up quickly on this. Our view is that mix will be more favorable in the second quarter and drive a higher gross profit margin, and we expect to be on our model range of 41 to 42 percent this year.

SAG increased $16 million year-to-year due to $47 million of currency effect, to offset 17 million of infrastructure reductions as well as continued improvement in our bad debt performance, so 14 million.

R&D declined $43 million driven by the iGen3 sustaining engineering shift to cost of $16 million and the efficiencies we gained with our platform strategy of $27 million.

Finally, interest expense due to our recapitalization of last June coupled with our significant cash flow, we reduced debt significantly and therefore lowered our interest expense by $51 million year-to-year. This is how we delivered improved operating margin of 1.5 percent, up 35 percent year-to-year.

Slide 15, cash flow. Another very good quarter on cash from operations and cash balance. We had $243 million of cash from operations for the quarter, up $84 million year-to-year. This was primarily driven by net income performance, as well as Accounts Receivable, depreciation and amortization, and finance receivables. In addition, we made an investment in inventory primarily in new products to make sure we can meet second-quarter demand.

ContentGuard cash is in cash flows from investing, as is CAPEX, which was $48 million for the quarter. We ended the quarter with $2.3 billion of cash, $600 million less debt and another positive cash flow and cash balance quarter.

Slide 16. Our balance sheet continues to strengthen. Our goal is reduce debt, align debt with financing business and leverage financed receivables to provide efficient funding. Our performance debt reduced 3.7 billion year-to-year 0.6 from 12-31-03.

Align debt with financing business. Non financing debt to capital down from 69 percent 36 percent in one year. And leveraging our financed receivables, we would have 59 percent of our receivables securitized, all very significant improvements.

So a quick summary. Solid first quarter performance. We delivered on revenue, operating margin, earnings expansion, EPS performance, cash, and balance sheet performance. I will say we are confident and optimistic about our ability to continue to deliver, and I thank you for listening and I will give it back to Anne.

Thanks, Larry. I'm just going to quickly recap. We delivered another strong quarter of steady progress. Our competitive position remains exceptionally strong with the industry's broadest portfolio of systems and service offerings.

Revenue metrics continue to trend in the right direction, with increased equipment sales, color revenue growth, and wholesale improvement. These are all the critical drivers of future revenue growth and our business model is working. We are remaining diligent about cost, generating cash and prioritizing profitability in every business division and in every operation around the world.

Which brings me to our guidance for second quarter. During Q2, we expect to recognize a 2 cent gain from the previously announced sale of our interest in ScanSoft, which is another company founded on Xerox innovations. We plan to invest this gain in additional marketing activities like increased advertising spend and some modest restructuring activity. With this, and continued progress in the marketplace, we expect earnings in the range of 14 to 18 cents per share.

We're going to continue to ramp up marketing initiatives in the second half of the year, investing a portion of the gain from the Q1 ContentGuard sale back into the business and further market development. We're going to finalize the amount of this incremental investment in the next couple of months. So during our Q2 earnings call, we will give you an update on how much of the ContentGuard gain will flow through to full-year earnings.

For now, we certainly remain comfortable with our 67 to 72 cent full-year guidance and remain optimistic that we will be at the high end of the range. So we believe we are off to a really good start for another year of strong performance, delivering on our commitments, building value, and winning and keeping customers.

Thanks for your time, and now Larry and I would be delighted to take your questions.

(OPERATOR INSTRUCTIONS) Steven Webber at SG Cowan.

Yes, a couple of things. Anne, can you make remarks about what the page volume looks like in your office black and white and your production black and white? Because the rental in-service trends looked improved from where they have been. And then secondly, could you talk about the decline in Segments 3 through 5 installs? How are you performing versus plan? Is there anything you are worried about here?

Great, Steve. First let me talk just a minute on page volume. I think we're pleased with the progress on page volume at office black and white and that is a really due to the strong set of new offerings we have and the improvements in share we've seen in the marketplace in the black and white digital and both copying and multifunction devices. So that clearly is moderating and we feel good about it.

In the production black and white space, we are continuing to see declines in the page volumes there. And particularly in the high-end of the customer segment, where we've seen page declines that have actually paralleled the whole, if you will, corporate resizing -- it's almost a one-for-one. We just got an analysis actually of that in our major account segment. It's one of the reasons why -- and by the way that obviously partially offset by the increase in color page volumes we have gotten from our strong DocuColor performance. But it's one of the reasons why we are very pleased about bringing the new DocuTech 100 and 120 to market, because there is no question that that the price point on the DocuTech 100, 120 is going to be real incentive to continue to do digital black and white printing on those devices. And we think that will really provide a good platform for moderation in terms of the black and white printing decline.

So I think we feel good about the office and we think we have introduced a platform in black and white Digital Production printing that will really help us moderate the declines in the high-end as well. And of course, we've got now 10,000 DocuColor install folks here in the field, so the power of those color pages offsetting declines in black and white is pretty impressive as well.

In segments 3 and 5 we did have declines in the first quarter offset by a 33 percent increase in segment 1 and 2 installs, so it was overall positive in office digital, a 10 percent increase in installs. We've looked at it and we're not overly worried. I would say one of the characteristics of Q1 was a much weaker January/February than we had expected and a much stronger March. When we look at the activity trends in March, we think that our 3 to 5 segment is on track for improvement and we're going to focus on that and ensure that that happens for Q2 so we get a little bit stronger mix. But overall, we've been putting a lot of emphasis on small and medium-sized business, so we were really happy to see the segment 1 and 2 take off.

Shannon Cross from Cross Research.

Good morning. Can we talk a little bit about your gross margins? Obviously they were below where we were and most of the street expected you to come in. It sounds like equipment shift. Can you give us maybe an idea if you've had it had DocuTech for the full quarter, where you might have come in? And then also, can you talk about that first?

Okay, well, I think Larry pulled proposals together on the overall margin decline, which was primarily mix. There is no question a full quarter of DocuTech 100 120 helps, but it is not the only issue there. As a matter-of-fact, interestingly enough, we had very, very strong color performance with weaker DocuTech performance because of the introduction of the 100, 120 at the end of March, and we just talked about the fact that in the office it was leveraged to the low-end of the segment.

That combination of events is really what drove the mix impact, and we do think that that will go back to what I would call a more traditional mix as we get back into Q2 and balance of the year. But there is no question, DocuTech 100/120 -- it helps us certainly some in the short term, but the long-term impact of those production pages is just huge. So we are optimistic and that is why we feel confident that we can tell you that the margin will improve going forward.

Okay, so I think you said 41 to 42 percent for full year?

That is our full year model and we're still on it. On the other hand, I would say that we are very pleased with the install growth, the market share gains, and the overall revenue picture that we had in Q1, and we certainly have said we're going to stay within that margin range full year. But we think we can drive some activity early on that creates a great foundation for particularly the post-sale side going forward.

And finally, with regard to SG&A you've got Drupa, you've got the Olympics; and it sounds like you are going to be investing a little bit more and maybe the advertising around the Olympics. I'm not sure. Can you talk a little but about what we should expect in the next couple of quarters from those events and those additional expenses?

Yes, and we think it is really prudent to make some marketing investments because of the fact that we pretty much planned to our big hits for the year with Drupa and Olympics. As you know, they're not repeatable events and therefore -- but they are very focused during two very specific timeframes and we would like to ensure that we are covered for marketing perspective in particularly the latter half of the year. So we think those investments will get great returns as well as not create a sustaining increment going forward because of the fact that we don't have Drupa and the Olympics to deal with going forward.

Drupa is every four years and as you know, we have taken our top 10 sponsorship for the Olympics. That will be completed this year and we're reinvesting it in marketing evens on a more balanced basis going forward.

So primarily I would say advertising, and also I think our opportunity as well on the market development side, particularly on the iGen piece is a big opportunity for us that we'd like to take advantage of this year. So we really get a great foundation for iGen going into 2005 and beyond. So we are in the process of quantifying that and getting back to it -- getting back to you on it. We think the opportunity to invest some of that ContentGuard gain is really a wise thing to do and still flow through some of that gain to upside opportunity and bottom-line earnings.

Okay, thanks.

James Vleeschhouwer of Merrill Lynch.

Good morning. Larry, start with you on again the gross margin issues. Since you expect to be on the model for the year, are you anticipating that in any or all of the quarters remaining in the year that you will be above the model? In other words, to average out the model for the year, don't you need to be at least in one quarter above it? And if so, how would that occur? What are you assuming in terms of mix for that to occur? And secondly, in terms of consumables, with color now accounting for just 4 percent of pages, where do you think that could be by the end of the year?

What the number of pages could be by the end of year?

Right. In other words, what could the color percentage of consumables be by the end of year versus the four percent or so you're seeing currently?

First of all, I think obviously if you are below the average in one quarter, we're going to have to be above the average in one of the quarters and seasonality-wise the expectation would be that it would be that fourth quarter. So our expectation would be we would be above the model or it's 41 to 42 percent, so we would be above it in one quarter and that would be the fourth quarter. So that is the skew question.

On the consumables, I think we would be somewhere around 5 or 6 percent by the end of the year. We are not going to dramatically jump to some huge number but some increase.

I was just going to say that if you look back by the middle of last year, we were at about 3 percent. It moved to about 3.5 percent by the end of the year. We have now close to 4 percent and one of the great opportunities is that we are growing revenue at such a fast rate on quite frankly relatively modest increments of pages, so we view that as a lot of good news as it relates to color market opportunity.

Are you standing by your iGen install forecast of 400 or more units for this year? Is there anything to suggestion that you would be either more towards the low end or the high end of that range?

We're certainly standing by the forecast and we feel pleased with the progress. I think that one of the most significant events of the year as you know is Drupa and it is both a demand creation event as well as an order taking event, particularly in Europe. So there is no question that it will be a driver for some activity leverage the second half of the year on iGen.

Lastly, if you could comment on what you're seeing in the vertical markets, any particular comments on graphic arts, commercial printing, government, and the like?

I think in graphic arts we have absolutely seen improvement. There is no question about it. One of the things that we are pleased about is that I think when we talked to you about for example iGen last year, we talked about the really great performance we were having in commercial print. We are now seeing that on the commercial account side too. So that is definitely a positive. But overall I would say graphic arts continues to improve and the trends obviously have been very much towards color, and that is good news for certainly our business and for the industry as well.

As it relates to government, I think probably the headline for us would be that we are winning and getting on more and more government contracts, which really is a function of both the breadth of the product line as well as the price points that we are offering across the product line, but that is really a big deal for us because even if doesn't generate a ton of current activity, it is money in the bank for the future when you're on the contracts and we are seeing those wins really move up considerably.

Thank you.

Carol Sabbagha of Lehman Brothers.

Good morning. One quick follow-up on guidance and then a couple of more relevant questions. But I want to make sure I understand. The 14 to 18 cents for the second quarter includes the two penny gains that you're saying you're going to reinvest back in the business, and the 67 to 72 for the full year, that doesn't include the ContentGuard gain that you recognized this quarter? Is that a proper understanding?

Yes, first bottom-line 14 to 18 cents. So inclusive of both the gain and the investment, so that is clear on second quarter. And we are staying with full-year expectations and it does not include the 8 cent ContentGuard gain, but I think that message that we've delivered is that we will not be flowing through the entire gain because we think we have an opportunity to invest in some second half marketing that will drive revenue and be a better use of those dollars than just flowing them completely through.

So our intent is to come back to you after the first half with a more precise approach, both in terms of what we will be marketing in and certainly the reasons why, as well as what will flow through from the ContentGuard gain.

Thanks and on production your equipment sales have been doing very good for the last four quarters, up excluding FX, but the post sale and production is not doing as well. Are you kind of excluding FX, haven't seen any significant improvement in the revenues. What is the primary reason behind that?

Okay, let me really describe it in two categories. The first is mix and the mix really is the fact that because we were not -- did not have a full quarter of the DocuTech 100/120, all of the leverage got played by color in the 2101, which are lower margin than the 100/120. So it really is an anomaly as it relates to the particular mix of production products first quarter.

Larry also indicated that we did see some also impact from the fact that our cost actions did not completely cover our price investments as they flowed through on some of the post sale actions, which is something that we are very focused on ensuring that we catch up on, as Larry indicated, in Q2. So I think it was primarily mix and the fact is it was a quarter driven -- almost completely by color and 2101 versus usually the strong mix of production publishing.

And the second one would be that we did have a slight negative effect of about 0.5 points from the fact that our price actions were a little bit more than the cost actions flow through that we will be dealing with. The other piece of this is just in terms of total operating margin is that we did make some investments in SAG on coverage and market development that we think are important for the future that were exacerbated a little bit by currency, but good investments. But we also had good news in R&D as well. So fairly balanced.

I might have asked my question a little bit wrong. The equipment sales are growing but it's the revenue -- more the post sale production and that you're saying is covered by the mix this quarter? Okay? And then on the servicing, you mentioned that the opportunity that you've invested in pricing and the productivity didn't make up for it, you expect that to improve going forward. What can you do on the productivity end to help that along?

Let me the clear on this. Its monochrome only in terms of the pricing flow through. We do believe that the digital efficiency opportunities are there for us across the service perspective. By the way, it's both across office and production, and we are very focused on making sure we capture some of those efficiencies and we talked about some modest restructuring that we could do as part of that two cents reinvestment. And certainly, digital service efficiencies would be at the top of the list in terms of the opportunity there, which would clearly have an impact on the productivity associated with offsetting the pricing actions.

Okay and one last question on iGen3. Coming out of Drupa, how many orders for iGen3 would you like to have coming out of Drupa to get to your 4 to 500 number?

I think what we would like to see is we would like to see our backlog in Europe really indicate a full-year perspective of what we'd hope to see Europe deliver. It is less impacted quite frankly in the U.S. than it is in Europe, but we do expect a really strong outcome from a European perspective. And we watch iGen3 pre-pipeline and prospect levels and steps in the sales very, very carefully and coming out of Drupa, we will really have certainly a lot of precision about the prospect levels and activities as it relates to our European opportunity. So it is a big deal.

Thank you.

Jack Kelly of Goldman Sachs.

Just to finish off on that productivity and price question which is a slide 14 of the numbers. You had mentioned on the productivity side, cutting costs. Could you give us a little more color on the price side, because in the press release you discussed the fact that pricing looked like it was stabilizing, maybe a little bit better. But the implication of some of yours and Larry's comments in the first quarter that price wasn't exactly where it should be, maybe you could just focus on that?

Let me split it into equipment sale and post sale, Jack, because that is really the story. On production, actually equipment price declines moderated. We had talked about a 5 percent trend coming out of 2003. We calculated to be about 3 percent in Q1. And in the office, it really stayed at the 5 to 10 percent level and actually moderated a little bit too. So on the equipment sale side, we definitely see good news in terms of the stabilization of pricing.

The area of pricing that we saw flow through on the post sale side with only on the production side, not on the office side, and that was the piece that we talked about in terms of -- and it was really service efficiencies that didn't offset some of the post sale or service, if you will, price reductions that have flowed through over a longer period time. And that's why we are pretty -- we know exactly where we have to go. We know exactly what we have to do to ensure that issue gets addressed going forward. But it was strictly a flow through post sale pricing, probably over the last 12 months that had an impact, and not offset. By the way we would look at it and say we really now had two quarters of light DocuTech activity based upon the introduction of the new DocuTech 101/120 platform. As that ramps up, and we're pretty excited about the pace on DocuTech 101 and 120, that will also be an offsetting factor in the monochrome production space as well.

Secondly and finally, on the post sale number which was flat year-over-year which showed continuing improvement, could you review your expectations as we go out to the second, third, and fourth quarters and what the run rate might be in the fourth quarter?

The most important message that we can deliver is that the trends will continually improve. We are delighted its flat, but we did have the benefit of currency, which we are very much aware of. Therefore, we have to -- we constantly look at this on a constant currency basis to make sure we really understand what's happening. The good news is that the trend is positive on a constant currency basis. And I think the reason we're basically saying that we expect the post-sale turn to happen towards the latter part of the year is that we are also expecting the currency is not going to be quite as strong in the second half of the year. Therefore, I think we're being appropriately conservative when we talk about that turn taking place. That is the turn in post sale. We are obviously delivering total revenue growth right now, but for us when the post sale turns, that will fuel our ability to grow revenue at a much faster pace.

So in your view you're right on track on the pre-currency basis for post sale?

Absolutely.

Ben Reitzes from UBS.

I want to go over guidance a little more. The way I look at the quarter is you had a couple cent benefit from lower tax rates, about a penny benefit from higher equity income that it didn't impact. And then you're keeping the high end of the range but you are flowing a gain. If I were to keep the same tax rate and the same equity income, I actually get you lowering the core earnings guidance that we were all expecting by a good 10 cents or more. Can you go through the math there?

Ben, I just want to be real clear on this. Because we're certainly not lowering the expectations on the operating core. First of all, that range does not include any gain from ContentGuard. That does not. The tax benefit that you talked about was a penny in the first quarter and as Larry indicated, it was due to a one-off kind of a California tax law that actually drove that, so we're not anticipating that will continue through the balance of the year.

What does it g back to?

It goes back to certainly what we said, which is around 40 percent. We've been fortunate enough to deliver about 38 or so, but we are leaving our estimates around 40 percent for tax rate. So I would look at this and say that number one, don't flow through that particular tax rate, that our expectations are absolutely all operational improvement on core and that we will get back to you with how much additional upside there is on the ContentGuard gain. But that is not included in the current range.

Back to the fundable question then. With regard to new products with regard to the R&D and I know a lot of it is the switching of iGen and all of that but there are some efficiencies in there. What are we supposed to think of as far as Xerox's product launches in the second half of year and going into '05? I've been thinking a lot about a new color device myself. So if you can just give any directional statements with regard your product pipeline, I would appreciate it.

What we said in our discussions this morning is that that will be announcing some new Segment two office products in Q2. We also talked about basically announcements across the board at Drupa, which is coming up in a few weeks. And I think the best way to describe it is that we really have a taste of new product installs that you can view as a consistent driver of constant refreshing of the portfolio. So that as we look at it now, this is really going to continue to be a case of very consistent announcements on the product technology and services side that will be consistent with what you've been seeing over the last two years. And we've been talking about well over half the revenues being delivered from products that we've launched in the last two years and we view that as a major driver of revenue growth and we've been able to do that with a consistent level of R&D, perhaps spent a little bit more efficiently we think, but we think that is a huge opportunity going forward.

Larry, just on the equity income front, do we keep that number going forward or is there something that really caused a nice boost there?

I think the equity income was based on results of Fuji Xerox for the most part, and that was their closed fourth quarter, so I don't think we can anticipate having that every quarter, so I wouldn't anticipate it. Just a final comment here, Ben, our guidance here is consistent with what we've been saying, and I think it represents 35 percent earnings growth in expansion for each quarter and for the year. And in some cases you get a tax break and in some cases you don't. But I think on balance when you look at a 35 percent growth rate here it's pretty significant and pretty bullish guidance.

Okay, thanks.

Bill Shope with J.P. Morgan.

Could you give us a bit more color on where exactly feel you still have room to put squeeze product costs in case the mix and pricing continue to work against you particularly over the next quarter or two? And then could you give us an idea of exactly how you might be able to squeeze those costs over the near-term?

Finally on the post sale-side, I know there has been a lot of questions on this but can you give us a little more color on the what types of services you discounted? And is part is part of the issue here that perhaps there is some competitive response to the pricing actions you put in place earlier last year?

Let me start on product cost, because I think that is the big opportunity for us and certainly a lot of are a Lean Six Sigma efforts -- we've got 400 black belts in place right now that are on the product cost side, both design as well as the support side of the product. So we think we've been a lot of room for improvement in things like parts utilization. We have a major effort going on right now, a cost competitiveness effort that is really attacking very aggressively. Some big opportunities that deal with things like remote serviceability, so that we can cut down on the amount of direct field spend on service. And the whole -- if you will diagnostic capability, things like we're doing with iGen with the control center where we monitor all iGen installs across the world and are able to fix a large percentage of the problems without having to send out a representative. Its an area we can expand and we are expanding to lots of other products, so I think the opportunity for us to get more efficient on the service side is significant and both the operational capabilities with a Lean Six Sigma focus as well as the design enhancements we're making on diagnostics, both provide a lot of opportunity. So we're quite confident. There is a lot of room there and we will take full advantage of that.

On the post sale side where we took the pricing investment, it really was on technical service. It was on the service contract side of it and that really was -- and it was all black and white or monochrome high-end production, and it really is what drove, quite frankly, a lot of the stabilization of our share as we were looking at a marketplace that was getting more competitive at that point in time with products like the Digimaster. We've obviously gained back that share and feel very strong about our position, so I don't anticipate we will need to do more of that now. It's just ensuring that the efficiencies flow through to restore the margin, which is what we're focused on.

Okay, great. Thanks.

I think we have time for one more question.

Chris Whitmore of Deutsche Bank.

Thanks a lot. Good morning. A couple questions. First on the R&D line, I was surprised that it was down so much on a year-on-year basis. What is a good number going forward for R&D as a percentage of sales? What should we think about? Tied to that, are you giving up anything in terms of new product development, new product pipeline, etc. as a result of the reduced R&D, or are you just driving more efficiencies there?

We've been saying our model is 5 to 6 percent of revenues for R&D, and we believe we will probably be closer to the 5 percent of revenues. That is really driven by two opportunities. One is that I think as of the second half of this year it will be built into the model, but we have moved some of the engineering costs as iGen3 got launched out of R&D and into the cost line. So therefore, that represents about I think $50 million a year of spend in R&D that is moved to just another part of the income statement.

And the second piece of it, absolutely has to do with efficiency, and it is really due to our focus on platform development, as well as the tools we're using in terms of designing for Lean Six Sigma. So we are really pleased because our whole intent is to get a better bang for our buck in R&D by being more productive and focusing on platforms, and that seems to really be playing out right now.

IGen is not product. It's a platform. DocuTech is not just a 101 platform. The 8400 printer that we just announced came off a platform, so our ability then to drive new products in much tighter time-to-market cycles at much more efficient R&D costs is really starting to flow through. So we think it's all good news.

Great, thanks a lot. One follow-up. On currency, do you know what currency added to earnings in the quarter -- just on the earnings line? Secondly, I don't think I got a currency impact on the post-sale line. And that is it, thanks a lot.

Okay, so on currency we don't actually come up with a the figure on earnings because there are so many puts and takes on it in terms of obviously the cost side and the revenue side. But it is really difficult to give you precision on the earnings side. It obviously has a lot more leverage than it does on the revenue side. On the revenue side it was 5 point on the post sale. The same as it was on the equipment sale line. So I think that answers your question.

Okay, so once again we want to thank you all for your participation today. As I mentioned earlier, we will be making more news this quarter, second quarter, with announcements in early May at Drupa and new offerings in the office market. So hopefully you stay tuned for those positive developments and as always we thank you very much for your continuing interest. Have a great day.

Thank you. Ladies and gentlemen, this concludes our conference call. You may all disconnect and thank you for participating.