全錄公司 (XRX) 2004 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Xerox Corporation fourth quarter 2004 earnings release conference call, 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 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 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 2004 report 10(Q) for the period ending September 30, 2004, and 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.

Thanks and good morning everyone. Thanks for joining us today. Hopefully we are okay, but good morning everyone and thanks for joining us today.

If would you please turn to slide 4, you will see a summary of our Q4 results. We ended the year with another quarter of consistent positive performance driven by increased sales of our industry leading color technology, demand for document services, and continued operational excellence.

So here are the highlights for the quarter. Earnings per share of $0.24 contributing to full year EPS of $0.86, which exceeded our expectation. Total revenue growth of 1 percent with improving trends in post-sale and continued growth in our targeted investment areas, which were up 5 percent in the quarter. Accelerated demand for Xerox' digital color systems with color revenue up 21 percent in the quarter.

Product mix and weak performance in Brazil had an impact on gross margins, which were 40.1 percent in the quarter and Larry is going to talk more about this during his financial review.

We remain diligent about cost and expense management. In fact SAG, at 25 percent of total revenue, is its lowest in a decade. In addition we delivered another quarter of expecting strong operating cash flow of 816 million, contributing to a healthy worldwide cash position of 3.2 billion. And at the same time, we reduced year-over-year debt by more than a billion dollars.

Larry will walk you through more detail on the income statement and cash flow in a moment, but first I'd like to spend a few minutes on revenue and install and, of course, before we take your questions, I will wrap up with a few thoughts on quarter one.

If you turn to slide 5. Okay, so here's a look at the revenue story. Our Q4 total revenue was up 1 percent from Q4 2003 and includes a 3 point currency benefit. As I mentioned, our targeted growth areas, digital office, digital production, and value-added services continued to drive our top line with 5 percent growth in the quarter. These investment areas now represent 76 percent of the Company's total revenue.

Value-added services revenue increased 25 percent, largely due to major contract signings for content and asset management, imaging and consulting. For example, Xerox Global Services is creating a digital imaging and repository solution for Marriott International. We will be processing each year about 4 million Marriott invoices and 9 million images from their vendors. The agreement called for Xerox to support 800 North American Marriott properties by the end of this year and expanding to Europe and the Pacific Rim in 2006. This is a services led win that leverages Xerox' competitive strength in end-to-end document management.

Color too is a powerful core competency and continues to be a strong revenue driver. Total color revenue was up 21 percent in Q4 and now represents about 27 percent of total revenue, an increase of 5 percentage points from Q4 2003. And close to 6 percent of total pages are printed on Xerox color devices, a consistently improving trend that reflects the huge growth opportunity in color, both in equipment and pages.

The major declining area of our business, Light Lens and SOHO, was down 42 percent in the quarter and now represents less than 5 percent of total revenue. We've been consistent in saying that the impact from Light Lens and SOHO will no longer be an issue after 2005. Although does it provide short term pressure on total revenue. In Q4, the overall post sale trends improved as the revenue stream from new digital systems and services offset declines from Light Lens.

If would you turn to slide 6, the production market. Color revenue grew 29 percent in the quarter, largely due to strong post sale growth and sales of the Xerox iGen3 and DocuColor 8000. Production Color equipment sale revenue was up too, yet installs decline, a dynamic of the product mix we saw this quarter. In addition the year-over-year install compares are skewed by the strong placements of the Q4 2003 launch of the DocuColor 5252, which actually launched in the second half of '03 and was fully available in the fourth quarter.

For Q4 2004, activity was heavily weighted towards higher end systems like the iGen30 and 8000, which generate more revenue through much higher print volumes than other devices. In fact during the quarter commercial print shops made up 70 percent of the iGen3 installs. Plus 70 percent of Production Color installs represented new business for Xerox, reflecting success of our aggressive market development and awareness initiatives this year.

Production Color pages also grew, up 38 percent in the quarter contributing to post-sale growth in Production Color of 42 percent. With color pages about 5 times more profitable than black and white, this trend is a strong indicator of long-term profitable revenue growth. And we are seeing similar color page and post-sale growth in the Office, which I'll talk about in a moment.

In Production Monochrome, the Xerox Nuvera 100 to 120 and Xerox 2101 continued to do exceptionally well in the Light Production space. As we've mentioned in the past, we do see these production markets converging with technology like Xerox Nuvera blurring lines between Light Production and Production Publishing. And we're also seeing traditional office customers buying up-market to the 2101, evidence of the strong opportunity in this space.

The success of the Nuvera and 2101 product lines only partially offset decreases in Monochrome Publishing and Printing. As we discussed last quarter we do believe customers have delayed their purchasing decisions until the launch of the Xerox Nuvera Digital Production System. The system started shipping in Europe in October with a ramp up in North America beginning next month. We will continue to broaden our offerings in the Production market providing businesses and graphic art customers with more choices for the industry's most advanced technology. And you can expect to hear from us this this quarter about a new product in the Light Production space.

If you turn to slide 7, we will talk about the office. Our Office portfolio is growing as well with 12 new products launched in October. This month we launched 8 more products, including two multi-function systems in the 41 to 90 page per minute segment, which represents a substantial portion of the Office market. For fourth quarter, our Office revenue and install picture was largely driven by accelerated demand for desktop devices. Total Office revenue was flat for the quarter with Digital revenues growing 6 percent. Color again was a highlight with Office Color revenue up 18 percent in Q4. Installs of Color MFD's grew 17 percent.

As important , post sale revenue from Office Color grew 16 percent, driven in part by 22 percent page growth in Office Color Multi-function. We saw a major jump in Office Color printing, up 135 percent, driven by strong placements of laser and solid ink printers, including a significant benefit from our OEM business.

In Office Black and White, revenue was down 7 percent but installs were up 8 percent. And this dynamic was due at a shift in product mix. We had 18 percent install growth in segments to 2 to 5, heavily weighted toward lower priced units in segment 2. This had a weakening effect on the year-over-year revenue compare, but the strong volume of activity lifted our year-over-year install rate. It's also important to remember that in Q4 2003 we benefited significantly from the launch of our new office portfolio, impacting the Q4 2004 year-over-year compare.

We continue to expands our channels and reach new customers in this competitive market. For example we recently won a national bid for Auto Zone's business, knocking out a competitor's product with Xerox Phaser 4500 printers in Auto Zone's 3500 North American stores. And at British Telcom, we built a key competitor in securing a 5 year renewal for fleet management plus installing Xerox Office Systems to transition BT to a multi-functional print environment.

Our full year install results prove that our strategy for growth in the Office is working with office color Multi-function devices up 28 percent and color printer installs up 74 percent in 2004. In this year we will make news with the expansion of our solid ink platforms and you can watch for that launch in early second quarter.

So if you turn to slide 8, DMO. In our developing markets, we continue to deliver strong growth in Russia as well as Central and Eastern Europe. However, weak performance in Brazil offset gains from other DMO Regions. In fact, excluding Brazil our developing markets revenue grew 10 percent. In several of these countries -- our developing market countries -- we have implemented a very successful two tiered distribution strategy. The model works and we are aggressively implementing a similar strategy in Brazil to drive profitable revenue growth. We are also adjusting the cost base in this new model and centralizing several support offices for the region. In regions where we sell through two tiered distribution, revenue is growing at a rate of about 30 percent and this model generates about 50 percent of the developing markets equipment sale revenue.

So we are making steady progress on our growth strategy, generating positive results in our key investment areas especially color and services, and trending more favorably in post sales. At the same time we continue to improve our cost competitively through a lean and flexible business model, contributing to strong bottom line results.

So now I would like to turn it over to Larry, who will walk you through the financials. Larry?

Thank you, Anne, and good morning.

The fourth quarter bring us to the end of a very successful year for Xerox. Much progress was made in moving our Company forward and positioning ourselves for revenue growth, as well as continued earning expansion and cash performance. We have handled some bumps in the road and in the end, have delivered on our earnings and cash commitments every quarter and exceeded the guidance we gave back in November of 2003. We are planning on continuing on the path of consistency, predictability and increasing shareholder value, and you should plan on it, too. Now I would like to cover the specifics on the fourth quarter results and end with a slide summarizing 2004 performance. Next slide.

Total revenue grew 1 percent with approximately 3 points of benefit from currency. This quarters revenue performance was driven by a nice improvement in our post sale revenue stream which, as you know, is an important part of our business model. Equipment sales grew 3 percent and reflects delayed customer decisions pending the launch of the Xerox Nuvera Digital Production System, strong demands for desktop devices, as well as weak performance in Brazil.

We continue to believe equipment sales growth will be strong in 2005, as we ramp up Xerox Nuvera and other recently launched products such as the DocuColor 8,000, expand our office product portfolio further, maintain strong growth in Color, and see an improvement in Brazil. Color is an important part of our story growing 20 percent in the quarter and representing one-third of our total equipment sale revenue. This will add attractive color pages for growth in post-sale in the future. Next slide.

The trend in post sale continues to improve on both an actual and constant currency basis. We see a marked improvement towards growth compared to where we were at the end of Q3. As you can see growth areas grew 6 percent and now represent 70 percent of total post sale revenue. This compares to 66 percent in the same quarter last year. While the growth areas contributed 4 points of growth during the quarter, it was offset by a 5 point decline in Light Lens and SOHO, which declined 6 points in the third quarter.

As compared to fourth quarter 2003, Light Lens and SOHO revenue is down 140 million and now represents only 7 percent of our business. So as we have been saying, the 6 percent growth in our growth areas will start to flow through to the total as Light Lens becomes a smaller percent of the total and DMO Improves. In addition, Color grew 22 percent, now representing 24 percent of total post sale, but representing around 6 percent of our pages. So there is a huge opportunity for growth in the future. Next slide.

As have I said many times, each quarter has its own set of opportunities and challenges and this quarter is no different. As we already discussed revenue, I will take you through the rest of the income statement.

Gross profit margin was 40.1 percent in the quarter, driven by product mix and DMO. Market pricing trends remained consistent and this quarters price investments was offset by cost efficiency. The change in product mix is centered on declines in Production Monochrome as well as shifts to low end, black and white devices in the Office and Office Color Printing. DMO, particularly Brazil, contributed 1 point to the decline.

On the cost and expense side, we continued our record of tight management while still investing in the future. R&D improved 9 million due to efficiency of platforms. SAG of 25 percent of revenue was the lowest in a decade, improving 31 million over fourth quarter last year driven by improvement in bad debts. SAG included 15 million in incremental marketing investments discussed in our guidance.

Other net was 49 million higher, but excluding a 61 million litigation credit in the fourth quarter of 2003, it was 12 million lower, primarily due to lower non-financing interest expense. Our tax rate was 36.6 percent in the quarter and, for planning purposes, the tax rate you should assume is 38 percent.

We expect that the launch of the Xerox Nuvera new office multi-functions and an improvement in DMO will drive gross margin higher in 2005. With full year margin at 40.6 percent, I still believe that we will be in the 41 to 42 percent range, albeit closer to 41 percent. If the market drives us below 41 percent, we will manage our cost and expenses to deliver earnings commitments while still investing in the future. And this is the flexibility of our model. Finally we delivered a very positive $0.24 per share for the quarter. Next slide.

Our cash performance continues to be very positive. Cash from operation was 816 million for the quarter and 1.8 billion for the year. The drivers were earnings, improvement in accounts receivable and inventory in the fourth quarter and improvement in accounts receivable full year. For the year we also had 409 million contribute to our pension plans, 210 million of which was to our U.S. plan, making it fully funded on a current liability basis at the time.

The reduction in our financing receivables portfolio was a source of cash for the year and a use of cash in the fourth quarter. In 2005 we expect the combination of finance receivables and on lease equipment to transition to a use of cash as we grow revenue, which is contemplated in our cash flow from operations of 1 billion to 1.5 billion for 2005. Capital expenditures for the quarter were 73 million and we ended the year at around 200 million.

On the cash flows from financing for the year, proceeds from secured debt and payments on security debt largely offset each other and we paid down 1 billion of debt in the fourth quarter. So in the fourth quarter, we started with 3.4 billion of cash, paid 1 billion of debt, generated 816 million cash from operations, and ended the year with 3.2 billion of cash on hand. Slide 14.

It's also a great story on the balance sheet. As I discussed at the investor conference, our goal is to return to an investment grade company. To meet that objective we are optimizing our cash flow, we reduced debt in the quarter and year, we will be re-balancing our mix of secured and unsecured debt, and we are focused on optimizing the cost of capital. With that said at the end of 2004, our debt was 10.1 billion, and finance receivables were 8.5 billion.

By the end of the second quarter 2005, after a 1 billion debt payment, almost all of our debt will be associated with our financing business, which is in line with our strategy. Also after second quarter 2005 we will have little term debt maturities through 2008.

We continue to maintain cash flow performance, which has been 1.8 to 2 billion for the last 4 years. And as I said previously, we ended the year with 3.2 billion of cash on hand.

Finally our core debt to capital is 28 percent, compared to 67 percent in 2002. Recognizing that the financing portion of our business is at a 7 to 1 leverage ratio. We are extremely pleased with our performance and believe it will continue. Slide 15.

Now I will go back to where I started. 2004 has delivered significant progress in moving our Company forward and positioning ourselves for revenue growth, as well as continued earnings expansion and cash performance. Each quarter has its own performance characteristics, but I believe it is important to look at full year results to judge accomplishments over a sustained period of time. Slide 15 summarizes the key metrics and represents a positive platform for growth consistency and predictability in the future.

Let's go down the list. We achieved equipment sale growth of 5 percent for the year, including around a 7 percent in our growth areas, where we invest. Wholesale is improving as we grow in invested areas as Light Lens becomes a smaller part of the total business and as DMO starts to improve. Total revenue was flat, but invested areas grew around 7 percent. Gross margin was 40.6 percent, slightly below our model driven by mix and DMO. I think we can be above 41 percent gross profit margin; however, we will watch this very closely and, if the market drives us below, we will adjust our model to deliver earnings. That's the flexibility of our model.

R&D is at 4.8 percent due to efficiency not cost cutting, which gives us the opportunity to invest in 2005. SAG at 26.7 percent, while investing in sales, 88 million, reducing other G&A 17 million, and making a significant improvement in our billing and collecting so bad debt, as a percent of revenue, is 0.7 percent.

In addition, interest expense is down 161 million year-over-year or 1 percent of revenue. Restructuring is also down, but will continue to be used as needed for our strategic cost competitive initiatives. Our partner, Fugi Xerox, has had an excellent performance in their territory, which drove equity income. Our return on sales is 7.1 percent for the year and we expanded earnings, consistent with our business model, driving towards 10 to 12 percent return on sales.

On the cash side, we have 4 years of 1.8 billion plus cash from operations and have held significant cash balances. We've extended maturities on our 10.1 billion debt and have tied debt to our financing portion of our business. Core debt to capital is 28 percent as of year end and Moody's upgraded our credit 2 notches in the third quarter.

So if you look at our business model and look at where we've been and where we are, you can see significant progress. And where we are going is toward growth, expanded earnings and strong cash performance.

Thank you for your time and now back to Anne.

Thanks, Larry. I'll quickly recap.

We met, even exceeded our expectation in 2004, delivering improved full year earnings of $0.86 per share. Our technology investments continue to fuel growth with about 2/3 of all equipment sales generated from products launched in the past 2 years as well iGen's rate. Color continued to be a significant growth driver, leading to healthy, long-term gains in wholesale revenue.

And through Xerox Global Services, we are providing customers with a clear competitive advantage. It's what we call smarter document management -- more efficient and cost-effective ways to manage work flow and document intensive work processes. We remain diligent about cost, generating cash and prioritizing profitability in every business division and in every operation around the world.

For quarter one, we expect to deliver earnings in the range of $0.17 to $0.20 per share, setting the stage for continued earnings expansion and profit growth in 2005. And we remain quite comfortable with our full year '05 expectation of $0.90 to $1.00 earnings per share. As we head into the new year, we remain quite confident in our strategy and the effectiveness of our execution. Xerox is the global leader in document management, technology and services. It's a position of strength and we will continue to solidify it this year while building value for all of our stakeholders.

So we would like to thank you for your attention and now Larry and I would be pleased to take your questions.

(OPERATOR INSTRUCTIONS) Matthew Troy of Citigroup.

Good morning. I have a quick question. If I take the historic seasonality of earnings and apply it to guidance for the first quarter, I come up with an implied full year target of roughly $0.85 to $0.95, which is in the neighborhood or slightly lower to your previously stated outlook for $0.90 to $1.00. Admittedly that's rough math and perhaps the last couple years haven't been a good indication, but can you talk about perhaps the linearity of the earning expectations for 2005, given that the outlook does put you at the low end of the existing range?

Yeah, Bill, I would be happy to -- I think -- excuse me, Matt. A few things that will influence the pace of revenue and earnings for full year 2005. The first is just on the equipment sale and mix perspective, we do believe that the second half will have the full benefit of all of the product launches, particularly Nuvera, production publishing, which is a big driver for us of both pages, as well as revenue. And also our solid ink platform in the second quarter.

We also just announced our 65 and 75 office black and white units, so we do believe that there is going to be some strength in the second half due to the fill in of the portfolio that we will be announcing during the first half of the year.

Secondly, there is no question that DMO will be a positive in the second half of the year. It will continue to improve, but the real leverage from the Developing Markets Group, particularly Brazil, will be second half loaded as we make continual improvements in that business model quarter by quarter.

And third as you know, our post sale trends, which is positive turns completely positive in the second half of the year and that's the single biggest leverage with a 3 to 1 ratio in terms of its influence on total revenue. So there are definitely factors that would suggest the pacing will be such to drive the delivery of $0.90 cents to $1.00 that we'll look at some continuous improvement quarter to quarter.

Great. Second question. I guess, if color as a percentage of total page is still trending, I don't know, I think last update we got was 4, 5 percent.

Actually it's great news. Color pages now represent about 6 percent of the portfolio. It was about 4 percent as we ended last year. But if you look at the growth rates in color pages, they are outstanding. In production, they are up 38 percent. In office, they are up 22 percent. So total color pages are up 28 percent, driving the increase to 6 percent of the portfolio. So we are really pleased with color page growth.

If I were to drill down a little bit more specifically on the office side, how do those numbers look on a same store basis? Specifically of your color enabled equipment in the field, what is the average break out between color pages versus black and white? How does this typically trend over the course of first year following a new install. And where do you see that going? I mean, what's the optimal mix of color versus black and white in a typical office install?

We expect to see color continue to grow double digits in total. We've obviously seen that throughout 2003 and 2004. So we don't expect a total -- there shouldn't be any, if will you, moving of pace in terms of both color pages and color installs. It definitely is new product driven.

For us the big bang opportunities are the compounding of these iGen3 installs which average over 400,000 pages per unit. So when you look at the ramp up of iGen3, it does more for color pages more than any product offering anyone can bring to market. We think that the leverage on color just becomes more important based upon the strength of the product portfolio, particularly the products that seem to be driving the greatest page utilization, which we are pleased to have.

Okay. Thanks, Anne. Thanks, Larry.

Okay.

Ladies and gentlemen, your next question comes from Stephen Weber of Xerox. Please proceed.

I don't think it's Xerox, but good morning.

I don't think so either, Steve. (laughter) If it were, I would give you the question to ask.

Then I would be conflicted. Good morning. Just a couple of things, back. Could you give us some more color on page volume, particularly the production black and white -- how that's trending and how -- was the color pages accelerating through the year?

Okay. Steve, I think I gave you some of the page growth numbers, color clearly has accelerated and it's production color driven, obviously. As well as we are doing in terms of office color growth, the pages and production color just outweigh anything else. In production color, we have delivered I believe 8 billion pages of production color pages this year, which is so far outpacing any of our competitors. It's obviously the biggest single leverage we have in the Company, as it relates to the power of the color impact on both revenue and profitability.

As we look at black and white pages, we are seeing a fairly consistent trend, actually pages are up a little bit in North America. They are down a little bit in Europe. But it's very consistent from a worldwide perspective. About 7 percent is the decline in the production total worldwide, a little bit better I think in the U.S. perhaps. But that's really one that we feel that we can positively impact because the production publishing side of the business is where the vast majority of pages are versus light production. So bringing the Nuvera production publisher into play will really help us on the total pages front.

So as would you expect, I think black and white is down overall. In the office, black and white digital pages are up about 6 percent , but Light Lens is falling like a rock. In production it's down -- one that we think we can drive positively with the Nuvera production unit. And color, it's is good news everywhere, in the office and in production and in total. So I think the strongest part of our story is the page story which, as you know, really is the best metric for long-term growth and profitability.

Just a follow up quickly. If color pages were up 28 percent in the fourth quarter, what were they for the full year? And what is happening to revenue per page? Is there any material shift here -- anything that we should take note of?

Yeah, I think on the -- on color pages for full year, they were slightly less than 28 percent but the fact is that iGen is -- the amount of iGen installs is driving an accelerated page growth and that only continues as we are in 2005.

So, and price per page generally has been looking pretty good. it's actually, in total, up a bit with color kind of flat and color production up, color office down a little, bit but basically flat. So good news in total on revenue per page and one that's been pretty stable.

Okay. My last question is, just trying to read between the lines, are you less positive about the turn in DMO because of Brazil or are you actually feeling better? I couldn't tell which way you were leaning and how that --

Well, let me just characterize if for you. If you heard us last quarter, we really talked about the issue being more generic to our Latin American region. This quarter we've been more explicit about the problem really being centered on Brazil and the reason is that we've seen the turn in the rest of Latin America, which is a good signal. The two tier implementation is working well. We've gotten a lot of productivity out of the rest of Latin America.

So, I think the answer is we've seen more evidence that the turn is coming, based upon the flow through to the rest of Latin America. We have a new management team in Brazil as well that we are very bullish about and confident about. So I would say that the expectations that we've set for performance improvement in developing markets are consistent and remain certainly continued improvement and with the full impact I think of the two tier implementation of Brazil hitting in the second half of the year .

Thank you.

Okay. Thanks, Steve.

Carol Sabbagha of Lehman Brothers.

Thanks very much. Just a follow-up on DMO and a couple other quick questions. On DMO, it looks like a lot improvement next year is coming from that. What do you think that business can run at in terms of margins on a steady state basis and do you think you can get to those margins in the second half of '05?

I think -- we do, by the way, believe that DMO can drive a lot of the improvement. If you look at some of the metrics of the DMO performance without Brazil, you will see that total revenue in DMO grew 10 percent. Without Brazil, equipment sales grew 19 percent. Without Brazil. the margin impact of Brazil was about 1.5 on the overall margin in the Company. So it's a big deal.

So we are pretty bullish about this in the sense that we've managed to improve the portfolio. There's no question that a low end mix and two tier distribution is a lower equipment sales mix for us, but we are also taking out the cost to ensure that the total margin can be within the model. So we don't expect that DMO will be a detractor in terms of total margin as we see the results of the full model.

And that implies kind of EBIT of 10, 11 percent. Do you think you can get there in the second half of '05?

Yes.

Okay. And on the guidance for '05, just a quick question. I don't know if it includes options expensing or what you are planning on doing around that?

It did not include -- our full year guidance did not include options expensing, but it's a good clarification because it might be less of an impact than people would think. It's about $0.02 of an impact. The reason it is rather small is we've taken the opportunity to make a change to move from options to performance shares and the impact of performance shares is already built into our expectations. So we've made that change and therefore the impact is relatively minor in terms of the expensing of options.

Great. One last quick question. If you look at '04, you've done extremely well. But if you look at what you've set out in November of '03 in terms of expectations for equipment sales, you've kind of fallen short on that, although all your new products have come out almost on time, except for the Nuvera. And from all that I can gather, they've had great acceptance in the market. What do you attribute the fall off in equipment sales versus your expectations a year ago?

Well, I do think that there are some mix implications that are good news in the long-term, but certainly put pressure on equipment sale in the short term. One of them is the incredible performance of color printing, which clearly put pressure on the equipment sales side, but yields great dividends downstream in terms of the post sale. I think the Nuvera delay certainly did cost us a lot in the sense that, when you look at what DocuTech has brought to our business over the year in terms of revenue contribution, not having the production publishing unit available really for the last two quarters has definitely done -- had an impact on our equipment sales side of this.

I think the third piece is the DMO piece. When you look at DMO's revenue without Brazil, you can see what the contribution should have been if Brazil was operating at the DMO model. Those three factors definitely offset, I think, some of the opportunity for stronger equipment sale. I think the good news is that post sale is certainly rebounding very nicely and, as well as the fact that we were able to compensate for that with I think just extraordinary cost discipline and SAG performance.

Thank you very much.

Thanks, Carol.

Jack Kelly of Goldman Sachs. Please proceed.

Good morning.

Good morning, Jack.

Just wanted to recap on DMO again. You just mentioned earlier, Anne, that possibly by the second half of '05, you could get to a 10 percent plus kind of margin. I assume you were talking DMO?

Yes.

Okay. In the fourth quarter, we are about a percent and a half. So the question is, if we were to look at the DMO model now and excluded Brazil -- you gave us the sales comparisons. If we excluded Brazil from DMO, where would the margins rough will be on DMO, ex Brazil? Just to give us a sense of how much of a hill do we have to climb? Is it all Brazil or does the balance of DMO also have to go up pretty sharply to get to that 10 percent plus?

It's pretty close to 10 percent and the reason is -- I mean you look at the impact of Brazil just on equipment sale, it took it down 2 points. It was a point on post-sale, a point and a half on margin, really did have quite a large impact. But if you look at the returns, and we do expect obviously Brazil to make continuous improvement, it's not that far off 10 percent.

So we look at DMO margins ex Brazil, they are close to 10 percent. So the whole swing to get the total to 10 percent is Brazil.

Yes.

Okay. Secondly you had mentioned, where you are experiencing or have installed the two tier model in other places in Latin America, you're --

Yes.

30 percent, was that sales growth?

30 percent revenue growth -- equipment sale revenue growth, and basically it represents about 50 percent of the revenues in DMO. Yes.

Okay. And then Brazil specifically, how far down the road are we with regard to the installation of the two tier?

Well, a lot of the relationships have already been formed and certainly that's what the number one priority is for this management team down there. So I think we would look at it and say, continuous improvement. If you look at revenue, it's very weak in Brazil for Q4. So we expect revenue to continuously improve and, by the way, I should mention as well we focus on two tier. But at the same time we are really driving the office revenue through two tier, we've actually invested in direct sales for our production systems, which has been very weak in Latin America as well. So it's kind of a two-fold strategy which also impacts margin. We've had very little production growth in Latin America and we think that's an opportunity as well. So I would look at it, Jack, and say continuous improvement, but we don't expect miracles in the first half of the year, we just would look at the second half really being as more indicative of it running at the DMO model.

Okay. Thanks.

Thanks, Jack.

Thank you very much, sir. Ben Reitzes of UBS. Please proceed.

Good morning.

Hi Ben.

Hi, Anne. A couple of things. With regard to gross margins, you guys did a pretty good job in your comments talking about how it would improve or that it would improve in '05. Could you just give a little more detail? We usually have gross margins -- have the peak in the fourth quarter and then go down and build up again throughout the year. So could you just talk about how gross margin plays out sequentially? And also, with regard to gross margin, I know you commented a lot on DMO and the point, almost point and a half impact hit. Did you mention the mix to color, low end color lasers? Because -- and could you talk about what strength in the low end color laser market is doing to the margin dynamic?

Sure, I think we talked about -- when we talk about margins, the first and most important quote that we gave was mix. And that does come from a lot of strength in the low end printing market -- 135 percent growth in color printers, both laser and solid ink. And although does it put a lot of short time pressure on the margin because of the equipment sale margins, it is money in the bank downstream in terms of the high margins that come from consumables. So it's a model that we're -- we'd take 135 percent growth from color printers any day of the week.

I think what complicated it was two other things. If we look at office black and white, it was weaker at the high-end than we would have liked. One of the things we are pretty excited about is we just introduced our office black and white multi-function devices at the 65 and 75 pages per minute. So we kind of already have, if you will, a remedy for some of the weakness we saw at the high-end of the office suite.

We had great growth in segments 1 and 2, but obviously that put pressure on margin. The Nuvera -- certainly a delay in North America was -- takes a significant chunk out of what's a high margin product for us and that's one that we begin remedying in North America in February with Nuvera installs and finally DMO.

So it was a number of factors that drove kind of the growth margin impact, all of which we think are addressable with either product launches or actions that we have coming into 2005.

So can we buck seasonality actually and have gross margin be flattish to even up in the first half or should we just model it like normal?

I certainly think that we expect to see kind of flattish or slightly improving gross margins. You will see an improving trend. First quarter may not be the highest of the year by any means but you will see an improving trend, we believe, from Q4.

It's interesting with the color lasers getting to be such a big piece of your business. Lexmark (indiscernible) 50 percent price cuts in that area. Did you see the same thing and do see that moderating at all throughout the year or do you grow it like 100 percent and continue to get that price down?

I think what we've seen is there's no question, the price pressure on equipment sale in color printers is definitely the highest of the whole portfolio. But as you know, that is the razor, razor blade business. So we don't get overly concerned as long the after market looks as strong as it does and certainly with solid ink, particularly, the after market is very, very robust. There's no question, the greatest pricing pressure has been in color printers.

Sorry to take so long, but one more I got for Larry. Good job on accounts receivable.

I wish I could take credit for all of it.

It's Jim, it's Jim. So the question is -- first time generating some cash from A/R, I'm getting to 3 years, if I'm right.

From finance receivables, you mean.

I mean regular A/R. And is it the tip of the iceberg there?

Well, I think we've -- I think over the last 2 years, we've had about $300 to $400 million of improvement of accounts receivable, even while equipment sales is growing. And I think in some geographies, we have room to improve and others we don't. For example I think the U.S. has an outstanding day sales outstanding, and there's probably not huge improvement there. There are other countries that I think we could improve.

So we still expect to improve but, remember, equipment sales will be growing in the future and that puts pressure on accounts receivable. So we could have good performance and still grow it and it wouldn't be -- it would be a use cash, not a source of cash. But we are focused on and I can guarantee you that. And we are also focused on inventory. So they will be at the lowest levels possible.

Thanks.

Thank you very much, sir. Jay Vleeschhouwer of Merrill Lynch.

Hi, Jay.

Good morning. I hope this isn't repetitive -- I got bounced from the call temporarily. First quarter for you, Anne, is regarding office color economics. When we look at what happened with various segments last year, there was particularly strong growth in segments 3, including growth and benefit of some of your competitors. And that seemed to have reflected a very sharp decline in average pricing there in that category. And so the question is -- do you anticipate that most or much of the growth by segment will continue to occur in segment 3? Do you anticipate being able to become more price competitive there? Or what are your general expectations about the price curve, as you move up the segment range?

Well, we have seen obviously a lot of product introductions that have kind of skewed some of the price points in the color multi-function segment. There's no question that our strength has been at the higher end of color office and we are not apologizing for that because that's where the pages are and that's really important. At the end of the day, the equipment placements are very important, but you've got to make sure that you get them driving the pages as well -- the color pages.

So we actually have just announced a portfolio of color products due to the fact that we did lose a little ground in the segment 3 side of it. So we've announced -- it was late in Q4 -- some products that we are very bullish about that have been extremely successful in Fugi Xerox and we think can have an equal track record here. So we are not walking away from any is segment of color. As a matter of fact, I think we are very strengthened going into the year, particularly in segment 3, with more to come, by the way.

So I think the combination of the extension of our solid ink platform into the multi-function market, as well as the product introductions we've made in segment 3, really fills out the portfolio and covers any market gaps that we had as we exited 2004.

All right. The next question, could you comment on how the software -- workflow software pipeline looks and as well as the professional services engagement pipeline?

We are pretty pleased. We didn't talk about it on the call before so I will just reiterate the fact that we had 25 percent growth in our innovation services, which really is our consulting services pipeline for Q4. I would tell you that the majority of our enterprise level deals right now are definitely front loaded with regard to our services offerings, assessment services, consulting services. So we are real pleased about that and the pipeline looks very strong.

On the workflow side, the best indicator for us there is really our success quite frankly in some of the high-end solutions like iGen, most of which are associated with workflow solutions. So they've become a big enabler for us in terms of the placement of iGen3s.

So we are very, very pleased with the progress we are making overall in our services business and there's no question that both the consulting services and the workflow software are jump starting most of the major deals that we are getting in the marketplace.

Did you happen to say on the call whether you hit your 350 number for iGen placements or --?

I didn't and no one asked so. In any case, although we are not going to give you -- we've made a commitment that we would install around 350 and we did. I will say that we made that commitment and now we are moving on to 2005 and expect to do a lot more.

One last one for Larry. Do you have a target for what you think year end debt to capital ratio might be for 2005?

For next year? We have an internal target, but I am not going to go outside with that right now .

Your final question comes from Shannon Cross from Cross Research. Please proceed.

Good morning, everyone. It's actually Rob Cross.

Oh, hi, Rob.

On iGen, I had a few question since no one had asked. The 350 goal was met. Have you set a goal for '05 in terms of installs?

This is kind of a repeat of Larry. Yes, we have, I think we prefer not to share it only because the ramp up of iGen is very back end intensive. So it's not exactly a great indication quarter by quarter. But we did hit approximately 350 and the pages continue to be really strong on the iGens at over 400,000 per unit and headed up, so we couldn't be more pleased with the progress on iGen.

Leading into that , the breakdown of color pages -- you're at a billion color production pages. Could you disclose the percent that are on iGen?

I actually gave out a new number during this call. I said there's 8 billion on production color in total from 2004. Okay? So I think that's probably the best way to look at it now because -- particularly when you look at some of the competitors' comments, which they will compare against this iGen, I think it's really important to look at production color in total and 8 billion is outpacing anybody.

Finally on iGen product positioning -- is it coming down as you expected in terms of sales of 6060s, 8000s, iGens. Is that going as you hoped?

Yes. I think particularly strong this quarter was 8000. We launched it and obviously it was a successful launch of the 8000. So we are particularly pleased at the high-end and, as we go forward, we definitely have the best portfolio from the 2045 up through the iGen. And our goal is to capture all the pages in the production color segment and continue to introduce products that allow us to do that.

Okay. Great. One housekeeping item for maybe Larry on SAG, at 25 percent -- a little bit better than we expected. There is 17 million in G&A improvement, bad debt is down. Is that a new baseline for us or how should we view that?

That's a new baseline, I think. We expect -- I mean obviously when you get to that point as a percent of revenue, it gets very difficult to improve. But we are going to still work at it.

Okay.

Thanks, Rob. And let me thank everyone for their participation and their interest today. We appreciate it and have a great day.

Thank you very much, ladies and gentlemen, for your participation on today's conference call. This concludes the presentation and you may now disconnect. Have a good day.