全錄公司 (XRX) 2005 Q1 法說會逐字稿

Welcome to the Xerox Corporation first-quarter 2005 earnings release conference call posted 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 be 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. (OPERATOR INSTRUCTIONS).

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 factors that could cause actual results to differ materially is included in the Company's 2004 report 10-K for the period ending December 31, 2004 and filed with the SEC. The Company does not intend to update any forward-looking statements made during this meaning.

At this time I would like to turn the meeting over to Ms. Mulcahy.

Thanks, everybody, for joining us today. If you turn to slide four we can begin -- which provides a summary of our Q1 results. As you can see, we met the high range of our earnings expectations by delivering $0.20 per share, a year-over-year EPS increase of 18% from continuing operations. The business conditions in the quarter did impact equipment sales which were flat year-over-year and fell short of our expectations. However, we are optimistic for growth in the balance of the year driven by a series of new product launches that will ramp up in Q2 and provide leverage for the second half of the year.

Total revenue was down 1%; color remained a highlight with color revenue up 15% in the quarter. Margins improved close to 1% and we remain diligent about cost and expense management while investing in sales. In fact, SAG was down 27 million to 26.8% of revenue. And as important, the balance sheet remains healthy with operating cash flow of 337 million contributing to a worldwide cash position of 3.3 billion. And at the same time we reduced year-over-year debt by close to $1 billion.

Larry will talk in more detail on the income statement as well (technical difficulty) first I would like to spend a few minutes on revenue and installs. And of course, before we take -- after we take your questions we'll wrap up -- or excuse me, before we take your questions we'll wrap up with thoughts on Q2.

So if you'll turn to slide five. The targeted growth areas of our business -- digital office, digital production and value added services -- grew 3% in the quarter. While a small but growing portion of the total, revenue from our value added services was up 23% in the quarter. Beyond the technology we're winning more and more business through cost-effective ways to simplify workflow like digitizing document intensive processes.

As I mentioned, color continued to be a revenue driver, up 15% and representing 27% of total revenue. Our marketing and innovation investments are closely aligned with strengthening this core competency. In the first quarter we launched a multimillion dollar advertising campaign that focuses on the business sense of color. We also launched the industry's first solid ink color multifunction system and we'll be making more color news in Q2 as we continue to expand our portfolio in both production and office.

So color remains a strength, but (indiscernible) black and white office and production had an impact on revenue and much of this is due to segment shifts and product launch schedules. During the first quarter Light Lens and SOHO drove revenue down 3 points. As expected this rapidly declining area of our business continued to put pressure on post sale and total revenue. Light Lens was down 42% in the quarter which is an absolute decline of 122 million, but it now represents less than 5% of total revenue.

If you'll turn to slide six. In the production market color revenue grew 20% in the quarter largely due to strong sales of the Xerox iGen 3 and DocuColor 5252 and 8000. These products contributed to an 18% increase in Production Color infill activity and, along with other high-value systems -- high-volume systems, drove production color pages up 34%. In Production Monochrome activity was slow across the board largely due to delayed decisions as well as the ramping affect from new product launches.

For example, as we mentioned before, the Nuvera digital production system began North American installs in late February, so we didn't have the full benefit in the first quarter from this significant launch. And in Light Production, where we've quickly become the market leader, the new Xerox 4110 digital copier printer launched March 1st. We're encouraged by the initial feedback on Nuvera and the 4110 and expect that these systems plus next month's Production Color announcement will bolster equipment sales flowing through to a strong second half revenue performance.

If you'll turn to slide seven. In our office business total revenue was down 2% for the quarter with digital revenues growing 3%. Office color revenue grew 13%. Installs of color MFDs grew 21%. During the first quarter we had accelerated demand which outpaced supply for the WorkCenter Pro Color systems that we launched last October, an issue that we have addressed. And we recently announced the WorkCenter C2424 which is the industry's first solid ink system that prints, copies and scans. It's up to 60% more affordable and has color speeds twice as fast as leading comparable products. Early reviews and demand for the 2424 support our confidence in this proprietary technology. It just launched on March 30th, so we'll begin to see its initial benefit in Q2.

Strong growth in office color printing continued in Q1, up 180% driven by laser printers including a significant benefit from our OEM business. As important, we grew pages by 15% in office color multifunction. In office digital black and white, revenue was down 3% but installs are up 17%. This dynamic was due to a shift in product mix. We have 48% digital install growth in segments two to five heavily rated toward lower-priced units in segment two.

Expanded sales channels are extending Xerox's reach in small and midsize offices. And at the same time our services led approach in the public sector and large enterprises is as effective in office environments as it is in production. For example, KeyBank has entered into a multiyear agreement with Xerox and our partner Evob (ph) that will save Key $6 million by replacing single function devices with 1100 Xerox multifunction systems and network printers. Value added services and innovative technology do give us a competitive advantage in this market and you'll hear us make more news about the office late in June.

So if you would not turn to slide eight. For our developing markets operations the trends are improving in Brazil. Yet in the near-term Brazil continues to have a drag on our post sale and total revenue performance. In fact, excluding Brazil, DMO grew 5% this quarter. We expect the benefits from the two-tier distribution model in Brazil to fuel a second half 2005 turnaround in Brazil's performance. As you know, this model generates about 50% of DMO's equipment sale revenue and continues to work exceptionally well in other developing markets like Russia and central and eastern Europe.

So I'll do just a quick summary before I hand it over to Larry. We had strong earnings performance in the quarter which is evidence of our continued effective execution and disciplined approach to managing our business. Growth in the quarter came from key investment areas, especially color and value added services. Equipment sales were lighter than we expected, our 2005 model did plan for a slower Q1 due to the product launch schedule, but some other conditions factored into the results including a more challenging environment especially for large contract signings, supply constraints that didn't keep up with accelerated demand for office color MSC systems and also a tougher compare with Q1 2004.

You'll recall that new product launches from the second half of '03 fueled our strongest equipment sale results in the year. Considering the ramp up of new products this year and the benefits of our lean and flexible business model, we remain confident in our full-year revenue expectations and continued strong bottom-line results. So on that note, here's Larry to walk you through the financials. Larry?

Thank you, Anne, and good morning. Let me build on Anne's comments with some key highlights that support the effectiveness of our strategy and business model. In the first quarter we delivered growth in digital, growth in services, growth in color, strong cost and expense management, solid balance sheet performance and we met our earnings commitments expanding earnings to deliver greater shareholder value. Here's a closer look at the results, slide 10.

We already shared with you detail about our equipment sales and total revenue in the quarter. This slide also calls out revenue trends in post sale and financing. As you know, sales of our digital systems flow through to post sale growth in the future driving top-line gains. In the quarter post sale was down 2% largely due to the drag from older Light Lens products as well as the impact from Brazil and our developing markets operations.

Slide 11. We've talked a lot about targeted growth areas and this slide shows the effect these businesses have on total post sale. The growth areas were up 3% in the quarter and now represent 71% of the post sale total. Post sale revenue from color grew 14% and now represents 25% of the total post sale revenue. However, only 6% of our pages are printed in color so the opportunity remains huge for color growth.

Light Lens and SOHO, which is declining at over 40% for quarter, is only 6% of the total down from 10% last year. As the size of our Light Lens population decreases the growth in our investment areas will flow through. Improving trends from Brazil are strengthening DMO's posed sale results, progress that we expect will continue throughout the year.

At the investor conference I discussed our shift to flexible operating leases and offering that is more responsive to our customers' requirements and reflects the services-based contract instead of front end equipment sales. This is a market-driven response to how we manage our business and is changing the pace of our revenue. In the short-term operating lease impacts equipment sales revenue but boosts post sale in the long-term. The net effect will strengthen our results over time.

Considering these factors, mitigating declines in Light Lens, Brazil improving and flow through from digital sales and service related contracts, we continue to expect that post sale will turn positive in the second half fueling a return to total revenue growth for the full year.

Slide 12. The income statement continues to be a strong story. Gross profit margin in the quarter was 40.7%, a year-over-year and sequential improvement. Market pricing trends remain consistent. Price investments in the quarter and the impact of product mix dynamics were offset by cost improvements. On cost and expense management, we continued our sharp focus while investing in the future.

SAG improved to 26.8% of revenue from 27.1% last year. During the quarter we invested in additional advertising and selling resources and absorbed the impact of 20 million of currency. Yet at the same time SAG declined on an absolute basis by 27 million largely due to a 51 million decline in G&A and bad debts. Other net includes a gain of 93 million from the sale of Integic which was offset on an after-tax basis by 85 million of restructuring. This restructuring is part of our strategic cost competitiveness effort which is yielding results and will continue to do so in the future.

The restructuring was related to business model changes and cost reductions in our service maintenance business, supply chain as well as consolidations in DMO in Europe. We saw a significant improvement in our pretax profit margin from 5.3% to 7.7%. Our return on sales increased from 6.1% to 8.6%. Our tax rate was 40.1%, up from 33.2% last year. This was higher-than-expected due to the mix of country statutory tax rates as well as how we tax effect some specific items during the quarter. I still expect our full-year tax rate will be approximately 38%. Bottom-line we delivered earnings per share of $0.20; our model clearly yielded strong results.

Slide 13. Here's the detail on our cash flow which was quite strong in the quarter. We generated 337 million of operating cash flow primarily driven by earnings depreciation and amortization. Finance receivables were a source of cash yet were primarily offset by an increase in inventory as we position for growth in the second half of the year. CapEx was 33 million; for full year we expect CapEx will be about 250 million. We reduced our secured debt in the quarter -- expect for this to be a continuing trend as we go forward.

Last week we contributed 230 to our U.S. pension fund which brings the plan to 100% fully funded status on a current liability basis. And we ended the quarter with 3.3 billion of cash, up 80 million from Q4. This progress keeps us on track to deliver full-year operating cash flow of 1 billion to 1.5 billion.

Slide 14. The balance sheet remains healthy with debt down to 9.6 billion, a decline of close to 1 billion from first quarter 2004. At the same time cash has increased by $1 billion. Our debt to capital ratio is now at 27% on our non-financing operations and we expect that this will improve significantly through the year. We'll pay down 1 billion of term debt in the second quarter as well as reduce secured debt each quarter as we go forward. This debt reduction will be funded by cash flow and strong cash balance.

By the end of 2005 most of our debt will be associated with our financing operations and our cash balance will be in line with the operating requirements of our business. So our fundamentals are sound; we have a rich pipeline of new products, a growing services business, and are encouraged by the progress in Brazil. These factors and more support our confidence in continued progress on all fronts. Now let me turn it back to Anne who will share our expectations for the balance of the year.

Thanks, Larry. Let me provide some thoughts on the second-quarter and full year. As we mentioned, (technical difficulty) we met the high range of our Q1 expectations. For Q2 we expect to deliver earnings in the range of $0.21 to $0.24 per share. That keeps us on track to deliver full year EPS of $0.90 to $1. And we remain confident in our full-year expectations for 3% revenue growth.

Through our Color Everywhere strategy we expect color will remain a highlight leading to healthy long-term gains in post-sale revenue. Through Global Services we're providing customers with what we call smarter document management and this value proposition will continue delivering double-digit increases as we aggressively ramp our services business.

Through investments in innovation we'll bring to market more technology and services that will further strengthen our portfolio. Through a lean business model we'll deliver this technology at competitive prices and through a clear focus on the fundamentals of our business we'll continue generating cash and prioritizing profitability in every business division and in every operation around the world.

We remain confident on our strategy, affective in our execution and committed to our expectations for strong full year results. Thank you for your attention and Larry and I would now be pleased to take your questions.

(OPERATOR INSTRUCTIONS) Steven Weber, SG Cowen.

A couple of things. Could you provide some more color on what happened to your equipment sales? Was there any distortion by month? Was there any particular geographic affects? The product transitions -- to what extent they might have affected you?

Let me talk a little bit about equipment sales. We kind of covered most of this through the script, but I think it's helpful to put it all together. First of all, from and equipment sale perspective, if we think about the quarter by month there's no question that January was weak with an equipment sale revenue decline whereas February and March were both growth months for us. So certainly slow start, pace picked up by the end of the quarter.

We did see and mentioned that if there was any slowdown that we noticed it was really on the big deals -- kind of a delayed decision, but having said that we're not losing and the pipeline looks very good which gives us confidence certainly in balance of year.

Another factor which clearly influenced color equipment sale was the fact that we really overachieved our demand case in a very big way for the color multifunction product we introduced in October. So we did have a supply constraint almost throughout the entire quarter. Larry mentioned something -- so there's a number of factors here, some of which certainly we have addressed and which give us confidence going forward.

Larry mentioned operating lease impact, which is really coming from our services contracts that go into the annuity stream versus the equipment sale stream. And if you looked year-over-year, that actually reflected a 2 point decline in equipment sale that now will flow through to our annuity stream which is good business, but it does create a little bit of a pace issue on the equipment sale side.

I would also focus on product cycles. We were cycling the launch of our Light Production 2101 and Nuvera copier printer which clearly had an impact as well as a new portfolio of our office technology that was really in full swing first quarter of last year. So having said all that, I think having examined them all in detail and looking at clearly what we have within our control, we wanted to reiterate our position with regard to our ability to grow for the balance of the year.

Okay. Just one other thing. In your release, the detailed release -- it mentioned that there were licensing some of 26 million in post sale revenue, but my remembrance is that you had very, very strong paper sales one year ago in the first quarter. Can you just give us whether that netted positive, negative year-over-year and perhaps even size it a little bit?

Yes, if we looked at all the elements of post sale revenue and actually it was almost an even trade-off between the decline in paper sales for the quarter which is an anomaly for us versus the increase in the licensing revenues. As you know licensing revenues are part of our strategy to really commercialize our IP. We've done them before, we'll do them again, they're not something that's predictable on a quarterly basis. It just so happens in this quarter we didn't see the full flow through of the revenue benefit because of this weakness in paper sales which flowed through and really basically negated the value.

Thank you very much.

Caroline Sabbagha, Lehman Brothers.

Going off of Steve's question on equipment sales, do you think -- it seems like -- I don't think you're losing share in the markets, it seems like the market slowed down in little bit, as you said, in the first quarter and also in the fourth quarter. Do you expect the market to improve -- just the underlying market -- as the year progresses or is it just your product introductions and fixing the supply situation in the office color that's going to help the numbers?

I think it's actually a little bit of a different story on color and black and white. Obviously we only have share data for Q4, but if we look at that share data, we actually gained some share or held share in black and white office which means the market did decline and we held our own and actually gained a little bit in that environment. I think on the color side the market stayed a lot healthier and that's really clearly one driven by new product introductions and why we're quite confident that the product we introduced in October of 2004 will actually have a very positive impact when we see first quarter shares on office color. Along with having just introduced the 2424 along with what we've got scheduled for the balance of the year.

So I am quite confident that we're either holding our own or winning share in the marketplace in most key segments. Product launches clearly do have an impact. And particularly when we look at even the black and white office segment, we would say that -- product launches particularly there in the segments three through five which haven't occurred in a few quarters clearly will have an impact when we bring out new technologies. But yes, I think we'll see good results on share, good results in terms of win rate and some spikes due to the timing and cycling of product launches.

And what do you think, Anne, is an achievable equipment sales number now for the year? Or what was it before if you're reconfirming it?

I think we said mid to high single digits in terms of equipment sale. I think we're in the same range which suggests obviously strong balance for the balance of the year and that's what we're reiterating today. Clearly Q1 did not meet our expectations on equipment sales, but we do believe that we've got some really good momentum for the balance of the year.

And then a follow-up on the office -- segment two was really strong in the quarter. I know you have some new introductions coming out in three to five. Do you think that on a relative basis the lower end segments have been stronger because of new product introductions or has it been -- new product introductions and you reentering the market where there's some new distribution structure? Or is it really that customer demand is shifting more towards the low-end products and black and white?

I think it's some and some. There's no question that we see a shift to segment two and we're actually looking now at segment two and three almost together and saying the declines in segment three are more than offset with the activity in segment two. So we're not concerned about that and we think we're in good shape to optimize and have been outpacing the market in segment two growth which I'm very pleased with.

Actually segment four was solid. It was up 11% in terms of activity. Segment five we definitely believe is an opportunity for improvement for us and we did see softness in segment five. But a lot of the indications are still good. We look at pages as much as we look at activity. And digital mono pages were up year on year by about 3% in the office. And with the product launches we have coming in June, we think that the signals are there that we can do better in the full office segment and not just totally have it be a down-market kind of activity.

One last question on pricing, we're hearing in the market that pricing has continued to get a little bit worse. We don't particularly see that in your numbers but what would you say about the pricing environment both in the office and in production? We've heard that the pricing has been more aggressive around national accounts and color.

So, we've looked at this really carefully. In office it's definitely stable to slightly improved. So we would normally talk in the range of 5% to 7% in terms of pricing and I think it was much closer to 5% in terms of the quarter. So the low-end of our range for pricing impacts. In production we usually talk 3 to 5. I think production was probably a little bit closer to 5, but all of that is being driven by entry Production Color. We're driving a lot of it with some of the actions we've taken on 2045 and 5252 to make sure we're more aggressive with regard to the Konica competitive offering. So all in all I don't think pricing was a big concern in the quarter.

Thank you very much.

Ben Reitzes, UBS.

I just want to talk a little bit more about this revenue guidance that you have and kind of put it in a light and have you paint the picture maybe a different way. I have obviously a tough first quarter where I think you came in and around 80 to 100 million below most people's expectations, but yet you're keeping 3% revenue growth for the year when we have a declining currency benefit throughout the year. And also in the post sale the way I would think about it is if you have less installs in this quarter perhaps the post sale growth maybe comes a little later than you might have expected. So if you could first, tell me if I'm not thinking about this right and then talk about how you can still get to your guidance in light of those things if I am making sense.

It does make sense. I think one of the things that we had certainly known was the cyclical nature of our product launches. So we had planned a relatively modest Q1 and we've said we're disappointed so it wasn't as modest as we delivered. But the fact is that it probably wasn't off as much as potentially the analyst estimates of the revenue.

As it relates to our guidance, I think we definitely believe that the back half of the year for a number of reasons will be stronger. I'd mentioned product launches but that's a big deal. The DMO improvement trend is pretty dramatic second half. This is our, if you will, our last bad compare on the developing markets area and it gets stronger. But second half is going to be very, very helpful to us. And the fact that we still have confidence in the post-sale trend improving.

You actually said with less installs; interestingly enough that's not the case. Installs were quite robust. Obviously it didn't translate as well into equipment sale revenue, but that had less of an impact, if you will, on the post sale streams which stay more robust. So, the strength of the install cases -- and it is across the board, I have to tell you. The install shares are quite positive and that will drive I think a very healthy post-sale turn.

So overall, yes, we believe it's going to turn positive. We've done the math, we obviously look at currency and manage the business on spot rates and have been -- have encompassed all of that still feel that the range of revenue expectations is still deliverable.

What did Europe do in the quarter and how -- some companies with comparable kind of -- somewhat comparable to you have mentioned some Europe weakening. Any trends there that we can highlight?

I wouldn't point out Europe as a particular causal for us. I think the only causal we saw wasn't so much geography related as it was a little -- a postponement in some of the big deals and the decisions associated with the big deals. But we didn't see Europe weakening to any significant degree that we would call it out as a causal.

One last thing, sorry, here for Larry is with regard to -- or maybe this is for you too -- with regard to licensing being I guess the 26 million, could you just talk about how that -- I think it's really hard to predict -- but now that looks in future quarters? Is that something we can rely upon or should we look at that as kind of a onetime pop? And then with regard to other expenses, when you take out the gains and charges it looks like you have a lower non-financing interest expense than I had expected. Should we just extrapolate that forward, Larry, because it actually can be a few pennies a quarter?

I think the licensing is an opportunistic thing that we do with IP and we've had it other quarters and we'll have it again. It's a hard thing to predict. I don't think it really changes how you model the Company; at least it doesn't change how I model it, because in every quarter you have some things that pop into it that you weren't expecting on both sides of it. So I wouldn't really change how I model on that -- on that basis.

On the interest expense, I think we're down more significantly than you thought because of this as if accounting on a number of shares. And there's a trade-off there. I think it's about $20 million of the -- maybe a little less -- of the 36 that we went down that now are in shares because of this trust two that was called back. So you do see better interest rate than you would have expected, but it's back because we added more shares. And so when you talk about EPS it really doesn't have any effect.

Thanks a lot, guys. I appreciate it.

Jay Vleeschhouwer, Merrill Lynch.

First a question on the drivers to color growth. You not only had -- or you and some of your peers like Ricoh and Konica had some introductions over the course of last year that gave particularly good growth in segments two and three. But the other thing that seems to be driving growth is the reduction in the premium of color versus black and white in terms of the acquisition of the technology. There's a lot of reduction in that premium on average versus black and white. And I'm wondering if you think there can be as much ongoing improvement to make color increase in the economical versus black and white or if you think the best improvements in that cost difference have already occurred?

Let me just talk a little bit about the color market. We talked about revenue growth of 15% and obviously it was higher in the production side of the color market than it was in the office market and I do want to just note that we did have some constraints in terms of our equipment sale revenue on the office side as well. Activity across the board was just fabulous. Office MFDs up 21%, color printing was off the charts, Production Color entry was 12% up and iGen was more than double what it was last quarter -- a year ago. So the activity was great.

When we look at what's happening in terms of price per page and then the cost economics, we've been able to actually manage pretty well that trade-off. So we've always talked about color in a four to five times leverage for both profit and revenue. We've actually talked about it more in the five, and I would say it's still within the four to five as a range in terms of leverage versus black and white. A big part of the cost equation for us comes in solid ink. We just launched this 2424 which is certainly for us the cost leader, if you will, in terms of value proposition for the customer and margins as it relates to the post sale stream for the color products.

So we're not done by any means in terms of cost efficiencies. Our intent is to continue to trade off cost efficiencies for price investments to make it more attractive to customers. That's the path we're on and to preserve the margins based upon those efficiencies going forward. Apart from just -- I think we've gotten really good at UMC productivity and overall service efficiencies, but the actual technology breakthroughs are associated with solid ink and clearly some of the unique technology associated with iGen have -- are far from being fully exploited.

Now your growth in color overall was about 15% which, of course, above the corporate average. But the color growth has been better than that last year. Do you think it's more likely that your color growth will stay in the mid teens or perhaps even improve back to the mid-20s for some time? Or that instead over time color will move more towards a single digit growth kind of a market?

Well, we certainly don't see it in single digit growth in the near-term by any means. In near-term I think we're looking certainly a couple of years out and that's driven by the fact that we only are doing 6% of the pages in color, so the opportunity case is huge. I'm encouraged actually -- color page growth was 23% which is a very nice ratio in terms of color page growth. So clearly that's where the dynamic in terms of the post-sale stream comes from and we're quite pleased with that. I think you'll see it vary a little bit quarter-to-quarter based upon the strength of what kind of product launches we have although I would say that the balance of the year is certainly stronger than first quarter on color product launches so overall you'll see improvements in color. But I think we are pleased with color pages. We are pleased with our growth of activity in the field; it was up 21% year-over-year. Although the revenue numbers came down a little bit, the page and the activity growth are very robust which really drives up the post-sale piece of this stream which obviously is where all the profit is.

Could you comment at all on what you have seen specifically in graphic arts and commercial publishing and print-per-pay markets particularly in terms of consumables and post-sale in those markets, maybe you could update us on the iGen page rates? For instance, Adobe keeps taking their numbers up for their design products and for Acrobat, there's a lot of overlap of course with you in those markets. Is there some corollary to improvements they are seeing and what we should expect to see ultimately in those same overlapping markets for you?

Yes, we are pleased with graphic arts which is indicative of the growth we had in Production Color in the quarter. When we look at for example, iGen installs we are maintaining a 70% plus kind of install rate in the commercial print marketplace, Jay. Great penetration into commercial print. We have talked about the fact that this story only gets better and better because in the early days of iGen installs obviously there is some pressure on the cost side and as we build the population it gets more and more attractive from a cost perspective. But when we talked about kind of big deals delays that was much more with regards to the commercial market than it was to the graphic arts market. I think we're pretty bullish on it and as you know we actually work pretty synergistically with Adobe in terms of partnering around the workflow and the graphic arts environments. They are much more of a partner and I think indicative of just the health of that marketplace as well.

Okay, thank you.

Jack Kelly, Goldman Sachs.

On your overall forecast of 3% for this year, Anne, can you give us what portion of that is coming from new products? And the reason for asking the question is if the overall environment is getting a little soft and let's say it persists for another quarter or so it does really put more pressure on new products to kind of help you make the numbers. Maybe a sense of what new products contributed this year versus last year? Secondly, Larry, if you can just give us a sense of the restructuring charge that was taken, the 85 million in the first quarter, can we expect some payback on that this year in terms of actual savings and if not this year, how would it flow over the next year or two?

Let me began with just the role of new products. I would actually think it is probably comparable year-over-year in terms of our flow and portfolio product introductions has been pretty consistent, this is the third year that we are on I think, a relatively good base of product launches. I think what we're dealing with is more the anomaly in a quarter versus the full year in fact but clearly office color particularly is very much of a new product, new innovation kind of marketplace where it is very important to maintaining high levels of color growth.

The other one, Jack, that we actually see that is due to market softness more than it is just pure product innovation is the black and white office, segments three to five. Clearly we will spur growth there with some of the product launches we have for the balance of the year. I wouldn't say it is significantly more important this year than it was last year in terms of delivering the total revenue. The other two pieces of the equation which really do make a significant year-to-year difference is the developing markets impact on revenue as it relates to the second half of this year as a post-sale turn. Those to me are more significant in terms of actually leverage on the 3% revenue than perhaps just the new product piece.

Is there a way to just take a piece of that 3% or 300 basis point increase you expect and attribute that to new products -- 50 basis points, 100 basis points?

I'd like to take a look at that, Jack, and maybe we can, when we talk, just give you a better sense of it. But I really would hesitate to be precise about that now.

Okay.

On the restructuring, this restructuring -- the payback usually is weighted by the fact of which geography you're in. And the U.S. normally has the best pay back and this is probably 75%, two-thirds to 75% U.S. So yes, we would expect to get some of the benefit of this as we go towards the end of the year. It would be towards the six to nine month range of when you'd get the benefits.

So six to nine months you'd get the entire --?

Yes, you'd start to get most of the benefit.

Okay. And just finally on advertising expense, you mentioned it was up in the first quarter even though SAG was down. Can you give us maybe in dollar terms how much you expect that advertising to be up '05 over '04?

So just to be clear, I think selling was up around $27 million obviously offset by G&A and bad debt. Some of that $27 million, probably two-thirds of it was associated with just pure coverage investments in services particularly in selling resources. So I'd say the vast majority of it was more on coverage than it was just on advertising.

We have a modest increase and very modest full year marketing approach this year, Jack. And that's because last year we had drupa and Olympics and a whole bunch of events that really kind of tightened our belts on the generic advertising area, but we don't expect to see any big spikes in terms of advertising for the year.

Okay, good. Thank you.

Matthew Troy, Smith Barney.

I hate to circle back on this one, but I was interested it in your comments on some of the weakness you were seeing in the bigger contracts at the enterprise level. Was your sense, because it sounded like from your comments you were indicating that the quarter got worse -- or excuse me, better sequentially. I wanted to get a sense of just as you look at the landscape in April, how does it feel? Obviously you guys are a bellwether in the office equipment technology space and there's a lot of skittishness in the market right now. I was wondering if you could provide a sense of spending expectations or just what you're seeing at the enterprise level.

I don't think -- I wouldn't reflect certainly our feelings as being skittish. We do see -- it's just taking longer to close. And by the way, we saw some of that in the fourth quarter as well; it's just not brand-new in the first quarter. So particularly when you start looking at the kind of contracts that we're closing on document services, they are more complex, they do seem to be taking a little longer and therefore not extending, if you will, the decision time period more than we would have seen in the past.

I'm not sure that April right now is a great indicator. We do certainly have an outlook for the quarter that we're quite comfortable with and we manage that pipeline very closely. And even with the delay in deals first quarter, we did deliver good Global Services growth of 23% which is really, if you will, a headwind indicator of what the opportunity, the annuity opportunity is behind it. So we continue to believe that this pipeline will yield and deliver and the slow start in January clearly had an impact as well as some of the longer decision cycles, but not something that we're panicked over by any means.

Okay. Two follow ups if I could. One would be with the upgrade of the iGen 3 and the recent introduction of the -- the fall introduction of the 8000, potentially another device between the 60 and 80 page per minute range in short order, could you just talk to me in terms of distribution strategy at the high-end production? Now that we're several (indiscernible) deep into this product migration and fleshing out the portfolio, are you happy with your distribution approach? Might there be tweaks you need to make in '05 and '06?

Yes, I think we're very happy with it, particularly the investments we've made in coverage in the commercial print market which is really yielding in terms of good experience, good background and the yields we're seeing there which obviously with a marketplace we had not really been able to get to before. So, I think we're quite pleased with it.

I think we continue to adapt our coverage to what's happening to the marketplace. So as entry Production Color goes further down market, we create less specialist cover and create more of a generic coverage for some of those products that I think will help us over the long-term. So we are adapting to the marketplace as we go. But I think the investments we made in commercial print and graphic arts coverage are yielding very, very nicely.

Last question for Larry. I think you paid down 500 million in debt in the first quarter and I think I'm looking for about a billion or so on the second quarter into the balance of the year. When are the credit rating agencies going to stop looking in the rearview mirror and start looking at what you folks are doing on the balance sheet?

That's a rhetorical question, not for me, right? You'll have to tune into the rating agency quarterly calls.

But I would assume your dialogue with them continues?

Yes.

It certainly does.

I think we continue to put very positive balance sheet as well as P&L results on the board here. That's our part of it.

Thanks, guys.

Bill Shope, J.P. Morgan.

Just digging into the second half recovery story a bit more. Clearly you're signaling that DMO is going to be one of the primary drivers of this recovery. Looking at DMO, obviously Brazil is a key problem here. So last quarter DMO ex Brazil you grew at about 10%. This quarter it looks like you grew it about 5% ex Brazil. Can you give us some color on acceleration (ph) there and is it really just a comp issue or is there something else going on? And could you give us an idea what the growth should be on a steady-state basis and what type of growth we should have at least ex Brazil in the second half to hit this 3% revenue growth target?

I think just a comment on Brazil because we talked about the fact that it's still -- it's certainly creating pressure on the overall company metrics. But Larry and I actually were down in Brazil two weeks ago and spent a lot of time and came back very encouraged about the progress in Brazil and the ability for Brazil to really make a big contribution in the second half of the year and clearly just get better each quarter progressively. So I did want to kind of share a view that although certainly the first quarter was not a homerun in Brazil that the recovery is on track and it will provide leverage for us in the second half of the year.

So the growth rates were down a little bit. Part of that was supply constrains and particularly for the two-tier distribution with some of the color multifunction products. So that did have some impact on it. There's no question that our outlook for developing markets will be above the corporate average in terms of equipment sale growth and total revenue growth for the second half of the year. So they are going to be a helper full year and we're quite confident about that turn for the entire developing markets group.

Okay. And then one more question on the office segment. Obviously the growth right now is being compressed somewhat by the build out of the low-end installs and the lower ASP products. When should we expect really the post-sale growth from these products to sort of counter this negative mix shift impact? Is this a second half story or is it going to take a bit longer in that respect?

I think you'll see it in the second half. I think it gets -- obviously it gets better as we look at the kind of activity increases we're seeing in those segment areas. This is an area as well that we've talked about particularly segments three through five that some of the uptick in installs based upon new product launches will also have a positive impact as well on the pages. Because a lot of the pages get done in those higher segments which is a driver of post-sale.

I mentioned before that when we look at our office digital mono performance, the drivers of post-sale are really our installs in the field as well as pages. And pages in that sector were up 3% and what we call machines in field of the overall net additions were up 9% year-over-year. Those are good determinants for good post-sale performance going forward. So yes, there is a lag but the drivers of post-sales seem to be going in the right direction.

Okay, great. Thanks.

Chris Whitmore, Deutsche Bank.

Just following up on that last question in terms of the mix shift towards the lower end equipment in the office. Do you expect the same type of post-sale usage rates on a per revenue basis or per equipment basis as you get at the higher end of the market? And then secondly, you provided a fair amount of color on post-sale or page trends in digital mono, can you maybe provide some color overall on how pages trended across the entire fleet? That would be helpful. Thanks.

I'm not sure -- I mean I'm answering your first question correctly, but obviously on the higher segment products we get more revenue and more post-sale because it's more pages on those. But on the per page, then the economics are very similar. So it's a good per page story, obviously more pages on higher-end office technology. Is that what you were asking?

How about on a dollar basis on equipment. In other words, for each dollar of equipment installed at the low-end do you get the same usage as the high-end per dollar of equipment installed?

Yes, I mean it's basically still a 3 to 1 ratio in terms of equipment sale and aftermarket. So it is the same business model as you get into the lower segment office products as well.

Okay, great.

Pages in general got better both year-over-year and from Q4. That's encouraging. They were still negative, but if you looked at previous positions, pages were declining by around 7% -- 6% or 7% and they're now looking around 4% or 5%. So there was an improvement as it related to the page scenario in Q1 versus prior year and prior quarter.

One last question. You mentioned the OEM business was extremely healthy. Can you provide a little color on how big the OEM business is today and maybe some color on partnerships in that business?

We don't breakout OEM from the overall color printing business, but you can be assured that the unit growth of 180% is coming from the OEM business which is the very low-end of the printing spectrum and clearly that's where the unit growth is coming from. But the revenue page and profit performance comes from the core laser and solid ink business that's the Phaser branded products.

Did you consider OEM'ing the solid ink technology?

I think under the right circumstances we believe that OEM is a good way to leverage technology and get a better return for our investment. So we are not shutting off any possibilities but it's got to be the right set of circumstances.

Great, thank you very much.

I think we have time for one last question.

Shannon Cross, Cross Research.

I guess I made it in under the wire. Can we go back just to talk about digital post-sale up 3% year-over-year obviously against a tough comp? But other than paper was there anything there or did you just see basically people doing fewer page volume? I'm trying to get my hands around why it was up only 3%?

I think -- we've done a lot of digging there as well. I have to tell you that we don't see anything that creates a long-term concern for us. There were some anomalies in the quarter just in terms of compares and one-offs quite frankly that aren't necessarily worth going through in any great detail. I think the big issues were the office black and white space clearly was under pressure, and we talked about that, and paper were the two big causals that did create a little bit of pressure on the post-sale. But as we look at it, there's nothing fundamentally awry with our projections or our expectations for balance of year.

Okay. And then as we look at next quarter which a year ago it was only up 4%, which is obviously a lot of the DMO. That's really where the kickers would start to come in, correct?

Clearly DMO in second quarter is going to be a driver of positive performance for us, yes.

And then going to the gross margin, which was really solid this quarter -- last year you were obviously were weak and then you had a nice rebound sequentially. What should we think about for second quarter in terms of gross margin given all the puts and takes with more the low-end product going into the market and yet on the other side you've got Nuvera?

I think what we're saying is that we're pretty confident about building to our 41 to 42 expectation for the full year, Shannon. And that we are going to have some quarterly shift depending on mix and product launches and a whole set of things. So it's probably dangerous to get too precise. But I think what we've really managed to deliver on is that even with a little bit of shift in gross margin we're able to really deliver bottom-line expectations and that the business model is really yielding. We certainly don't expect any major shifts in gross margin in second quarter and we're pretty confident that based upon what we see that 41 to 42 is in the -- certainly confident that it can be done for the year.

Okay. And then Larry, one just quick tax question. I think you stated on the call that you were still comfortable with 38% for the full year. So would you anticipate one of these quarters being -- I mean it has to be lower than that and is there anything specific that's driving that?

No, I think, as I've said many times, predicting the exact rate here when you're talking about weighting statutory rates and then you have specific discrete items in a quarter. And then you also have how you tax effect things in a quarter. For example, restructuring is tax effected differently than other costs might be. You get this variability. So I don't consider the 2% above to be any kind of aberration and obviously we've have to be below 38 in one quarter here to make it happen.

Thank you.

Thank you all again for your time and your participation. We really do appreciate your interest. Have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your presentation and you may now disconnect. Have a wonderful day.