全錄公司 (XRX) 2008 Q2 法說會逐字稿

Good morning and welcome to the Xerox Corporation second-quarter 2008 earnings release conference call hosted by Anne Mulcahy, Chairman and Chief Executive Officer. She is joined by Ursula Burns, President and Larry Zimmerman, Executive Vice President and Chief Financial Officer.

During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor. At the request of Xerox Corporation, today's conference call is being tape-recorded. Other taping and/or rebroadcasting of this call are prohibited without expressed permission of Xerox.

After the presentation, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

During this conference call, Xerox executives will make comments that contain forward-looking statements, which, by their nature, address matters that are in the future and are uncertain. Actual future financial results may be materially different than those expressed herein.

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

Thank you, Lauren and thanks to all of you for joining us today. We are going to begin at slide 4 and you'll see a summary of our second-quarter performance. The strength of our global annuity model resulted in second-quarter earnings and cash in line with our expectations. We reported earnings of $0.24 per share, which does include $0.05 per share from a previously announced restructuring charge. We are seeing the challenges in the US economy affect us primarily in large enterprises where there is a hesitancy to purchase higher-end technology.

However, this pressure was largely offset by steady growth in developing markets, consistent performance in the small and midsize business segment and an increasing demand from customers looking to drive down costs by using our Document Management services. While these areas contributed to revenue growth and support our healthy annuity stream, they did have an impact on gross margin. We are managing the pressure on margin with a clear focus on cost reductions and operational improvements to ensure we deliver solid bottom-line results.

Total revenue of $4.5 billion is up 8%, largely driven by 10% post-sale growth. Currency gave us a four point benefit. Our gross margin was 39.2% of revenue, down a little more than a point. Selling, administrative and general expenses were 25.8% of revenue, about flat from this time last year. We are staying the course with our marketing and sales coverage investments this year.

While the tougher economy has forced a hard look at all business decisions, we believe that expanding coverage, making pricing investments and acting on more marketing initiatives serves us well today, as well as in the long term. We are already seeing these actions benefit us in developing markets through Global Imaging and from the install activities for our Office color systems. And at the same time, we are managing the balance sheet well, generating $442 million in cash from operations during the second quarter.

We repurchased $377 million in Xerox shares this quarter, investing $711 million in stock buyback during the first half of the year alone and our Board of Directors approved an additional $1 billion for share repurchase, bringing the total available authorization to $1.7 billion.

So if you turn to slide 5, we will overview our Q2 revenue. So here is a look at the revenue trends noting the year-over-year compare in actual and constant currency. The adjusted column on this chart assumes that global total revenue for Q2 '07 is included in our results for the same period.

You will recall that we closed on the Global Imaging acquisition in mid-May of 2007, which gave us a month and a half of benefit in the second quarter last year. So going forward, we will no longer need to adjust for the Global Imaging benefit since we have now lapped the acquisition date. Again, total revenue was up 8% in the quarter to $4.5 billion.

When we adjust to compare for Global Imaging, revenue was up 5% with four points of positive currency. The leverage from post-sale continues to be significant. It was up 10% in the quarter. That is an increase of $306 million with Global Imaging. Adjusting for Global and the benefit from currency, the trend in post-sale remains strong, up 4% in Q2. While we are seeing that most impact from the economy is in Production equipment sales, which led to equipment revenue up 2% in the quarter, but down 5% without the benefit of Global Imaging and currency.

As I mentioned earlier, our Document Management services are an area of strength for us. In fact, during the second quarter, we signed our largest outsourcing win to date in the US -- a $100 million plus agreement with a major telecom company to manage the print operations of its 9000 sites serving more than 300,000 employees.

And this deal is consistent with what we are seeing from our large enterprise customers -- services-led deals that help them reduce cost and get more from their technology for less. It is a great value proposition for our customers and a marketplace differentiator for Xerox and it is working. Our services offerings have generated $1.8 billion in annuity revenue in the first half of this year. That is up 8% from the first half of 2007. And color continues to be a strong growth driver as well. So turn to slide 6 and we will take a closer look at color.

The adoption of color printing is accelerating. So far this year, more than 25 billion color pages have been printed on our systems, putting us on pace for 50 billion color pages in 2008 and that is a 25% increase over last year. Revenue from color grew 11% this quarter to $1.7 billion, including a six point currency benefit. Post-sale revenue from color grew 17% and that is without factoring in any benefit from Global Imaging. And color now represents half of our total equipment sales and 40% of total revenue.

There are two key factors resulting in the flat equipment sales for color this quarter. First, the economic pressure in the US and second, the timing of major new production launches delayed purchases this quarter. We will see the benefit of those launches in the second half, especially coming through our European and developing markets operations.

So if you turn to slide 7, we will give you more details on our Production business. Total Production revenue grew 4%, including a five point benefit from currency. Most important, color page growth lifted our post-sale revenue up 9% in the quarter. So keep in mind that no one else in the industry comes close to generating the production pages we do. According to the research firm, InfoTrends, our DocuColor and iGen presses account for about half of the total worldwide color pages printed by high-speed digital systems. They tell us that is more than twice as much as our nearest competitor.

In May, at the industry trade show known as Drupa, we launched six production color systems, including the iGen4, the most productive and highest quality cut sheet digital press in the industry. We also announced the Xerox 700 entry production color system and the DocuColor 5000AP for midmarket production color printing. Along with our new color continuous feed system, we significantly upgraded our portfolio and sent a strong reminder to the industry of our leadership in this marketplace.

Drupa was a huge success for us and it exceeded our expectations at every turn. Order-taking was 30% more than our goal heading into the show and we sold more than 300 systems and software applications, including a multiple iGen4 and iGen3 order to a photo and print lab in Switzerland and four color continuous feed systems to Stralfors, a large European printer. We took advantage of the order-taking opportunity at Drupa to unveil these new systems, but installs primarily don't start until late Q3. The result of the timing is a decline in production equipment revenue in Q2 with momentum building in the second half of the year.

We are seeing strong demand for the iGen4 with many large customers holding back on iGen3 orders in anticipation of the iGen4. And the Xerox 700 meets the need for high-quality production printing at a very attractive price point, so much so that we are already seeing demand outpace supply. It is a good problem to have and one that we are addressing with urgency heading into the second half of the year.

So if you turn to slide 8, we will take a closer look at the performance in our Office marketplace. With the benefit of Global Imaging in our results, total Office revenue was up 9% in the quarter and 5% in constant currency. Our competitive play to install more and more Xerox units helped to boost post-sales, which was a 10% in the quarter. Equipment sales were up 5%. And we continue to expand distribution, bringing the quality of our brands and extensive portfolio to more businesses of any size.

Global Imaging acquired Florida's Saxon Business Systems in Q2 and last week purchased a company that extends its coverage in Nevada. That is seven acquisitions Global has made since we bought the company last May. It is a strategy worth repeating and that is why we purchased Veenman, the largest office technology dealer in the Netherlands. And we are looking for other opportunities to extend our coverage to regional distributors. Veenman gives us access to more than 4000 new SMB customers and more than doubles our salesforce in this region. More distribution translates into increased install activity, up 34% in color MFDs and 10% in black-and-white multifunction. And installs of color printers were up 12%.

During the quarter, we continued to aggressively expand our product portfolio through the SMB marketplace with competitively priced printers and multifunction systems. And there is more to come in the second half of this year, priced right and available through our multiple channels of distribution. And that is clearly what is driving DMO results in the Office with equipment sales growth of 16% and total Office revenue up 14%.

Turn to slide 9 for a closer look at our performance in developing markets. While the results from our developing markets are reflected in the Office and Production segments, here is a look at the overall regional performance. Revenue from DMO was up 19% with post-sale up 19% and equipment sale revenue up 18%. Anyway you look at it, it was a strong quarter for developing markets across the board. About a third of the overall revenue growth generated this quarter came from our developing markets, progress that we expect will continue throughout the year as demand picks up for our technology, both Office and Production systems and for Document Services.

So on that note, I would like to hand it over to Larry and then, of course, I will be back to wrap up and discuss Q3 expectations and then Larry, Ursula and I will take your questions. Larry, over to you.

Thank you, Anne and good morning. In the second quarter, we delivered to our expectations with earnings per share of $0.24 and $430 million of core cash flow. I would categorize the quarter as good overall results with strong performance in some areas, post-sale growth, DMO and Office, balanced by weaker results in Production and pressure on gross profit margin due to the mix of channels, products and price.

The economy, as well as the timing of new product introductions, played a part in a slower Production business. DMO and Global Imaging played a very positive role in Office. In addition, our cash flow performance and optimism going forward gave us the confidence to continue to invest in distribution acquisitions and buy back 27 million shares.

So let's go to slide 11 and review the P&L. Anne reviewed the revenue with you, but it is important to note again the 4% growth of post-sale revenue in constant currency and apples-to-apples in Global Imaging drives our earnings and cash flow in a tough environment. Gross profit margin declined about 1% driven by product and channel mix, as well as the year-over-year price effect of first-quarter price actions. The channel mix effect is reflective of the slower performance in the US large accounts versus considerable growth in DMO and services, but through time, this should self-correct.

From a second-quarter view, we actually saw some improvement in price and margin sequentially. With restructuring actions, we would expect to see continued improvement by fourth quarter. Having said that, our gross margin business model is 40% to 41% and with the first half at 39.3%, we expect to be in the 39% to 40% range for the full year. As we have said before, we believe our model is flexible and we plan on adjusting it so that we will deliver earnings consistent with the full-year guidance that we had given in the first quarter of $1.26 to $1.30, including the second-quarter $0.05 restructuring charge and any additional we feel we need to do later.

In expense management, we delivered productivity in R&D with improved expense to revenue, which will continue and flat expense to revenue and SAG as we invest in distribution. The major part of the year-over-year SAG dollar growth is currency and Global Imaging. As we guided last quarter, we took a $63 million, or $0.05 a share, restructuring charge, primarily gross profit-related and that will help margin going forward.

Net income was lower, including the $63 million restructuring charge. The tax rate was 24% flat year-over-year, but the rate was 26% if restructuring is pulled out. Restructuring was tax-affected at approximately 32%. Going forward for the remainder of the year, we would expect the tax rate to be 26%. And finally, EPS was $0.24 in the middle of our guidance, $0.23 to $0.25, inclusive of the $0.05 restructuring charge. Next slide.

We are pleased with second-quarter results of $430 million of core cash and $442 million of total cash from operations. This keeps us on track to maintain our full-year commitment of $1.1 billion core cash flow allowing for the $795 million for litigation settlement we talked about last quarter. We expect settlement cash will run through cash from operations in the fourth quarter.

No surprises in cash flow. It is driven by earnings and working capital is at the levels that we expected. Cash from investing included $88 million capital and internal software spending, $138 million for acquisitions to support our expanding distribution strategy and $138 million partial payment into an escrow account for our Carlson litigation settlement.

We have been active in share repurchases as we repurchased $377 million in the quarter and $711 million year-to-date, approximately 50 million shares. We announced an additional $1 billion Board authorization, which gives us approval to repurchase a total of $1.7 billion. We plan on being active going forward consistent with cash flow and appropriate leverage and at the same time maximize shareholder value. Lastly, we paid out $39 million for our quarterly dividend. Overall, very good cash performance that we continue to be dedicated to strong liquidity and investment-grade rating. Next slide.

Our business model is driven by annuity. In times of economic uncertainty, this provides us with a stable revenue stream and good source of cash flow. The leading indicators for our annuity continue to be positive. As we go through the scorecard, keep in mind that machines in the field, as well as page data, do not include printers, developing markets and Global Imaging and all revenue measures exclude Global Imaging. Including these items would improve the results.

As our channels of distribution evolve, this limits our ability to measure pages and machines in the field and does not provide a complete picture of post-sale dynamics. Going forward, we will need to supplement the scorecard as DMO and Global Imaging lead the way in Office and are too significant to not include. Our estimate of their impact on digital pages would show a change from down 1% to approximately up 1%.

Looking first at the top left box, digital revenue in the quarter was up 8%, MIF was up 6% and digital pages were down 1%, but would be approximately up 1% when we include DMO, Global Imaging and printers. Color continues to drive digital growth with 16% revenue, 37% MIF and 29% color page growth. This, along with the positive impact of color on price per page, continues to provide us a great opportunity as color only represents 21% of the MIF and 16% of the pages. Black-and-white MIF is stable with declines in pages being driven in part by the transition of pages into color and color-capable devices. Black-and-white MIF stability along with our strong color growth is a positive indicator for future annuity. And Global Imaging, DMO and printers would increase this.

We also continue to see strong growth in services, another key post-sale indicator and an important element of our growth strategy. Services annuity is up 8% in the first half and we see the growth continuing as more and more customers look to Xerox to help them reduce their costs by optimizing and simplifying their document management. These leading indicators, as well as the strong DMO, Global Imaging and printer performance, reflect well on a continued annuity performance.

So in summary, we delivered earnings and strong cash flow. We delivered shareholder value with acquisitions, quarterly dividend and share repurchase. We invested in coverage. We took actions to improve gross profit margin and we are maintaining our full-year guidance. Now I will give it back to Anne.

Thanks, Larry. So we continue to say it, but it is an important message to leave you with and that is our annuity-based business really is the driver of our profitable growth and it is an asset in tougher economic times. With the leverage from color and services, we are confident in sustainable strength of this model for the long term.

So far this year, we have launched 23 products, including a significant refresh of our Production line and expanded offerings for the SMB marketplace and we will start to see the benefit of these innovation investments later this year as equipment activity drives page volume, pages that help boost post-sale. You know the story.

In addition, our broader distribution, developing markets and Global Imaging organizations are rapidly growing our brand presence in SMB. And with the additional $1 billion in share repurchase authorization, you will see us continue to buy back Xerox stock. And at the same time we are managing the balance sheet with a close eye on the bottom line, making the marketing investments needed to drive growth while controlling costs and ensuring flexibility in our models so we can deliver on earnings expectations and generate strong operating cash flow. So we expect Q3 earnings in the range of $0.28 to $0.30 per share and full-year EPS of $1.26 to $1.30.

So thank you all for joining us today and Larry and Ursula and I will be pleased to take your questions now.

(OPERATOR INSTRUCTIONS). Shannon Cross, Cross Research.

Good morning. A couple of questions. The first, if you could talk a little bit about -- if you hadn't seen the dip in color production demand prior to launching the iGen4, any idea on how the quarter might have tracked, what your production color might have looked like? I am just trying to get an idea of sort of the magnitude of impact from delays in installs. And then also if you can give us any update on sort of demand for some of the new products like the 700, that would be great. Thanks.

Okay. So if we look historically at kind of our revenue growth in color production, it obviously had a significant impact on the quarter. Second quarter is our second strongest quarter in the year, so obviously it would have changed the story significantly. I will say that I would look at it and say, in the US, I do think that there is more economic content quite frankly to the production story.

But in terms of Europe and DMO, there is no question that we had demand we couldn't fulfill from the announcements of the new products. So it would have helped in a number of ways. Obviously it would have helped equipment sale revenue. It's our higher-margin area of the business, so it would have helped margin as well and it would have helped color growth rates. So there is no question.

I think you know, Shannon, that we decided to really go out more aggressively in Drupa because we didn't want to miss the window and particularly in light of competitors preannouncing products that weren't available quite frankly for a longer time, we thought it was a wise thing to do to go out and announce products, get the momentum built since we are bringing these products to market late in the third quarter. So we will see some benefit in the third quarter, a lot in the fourth quarter.

The 700 is the product that has clearly exceeded our expectations. Early demand says that it is way more than we had anticipated. It is priced right. It is in a sweet spot in terms of entry production color. We are now working on increasing the supply as aggressively as possible so that we can take advantage of this demand through the balance of the year. But I think, Ursula, it would be fair to say we will install every single one we get.

We have already installed every single one that we have gotten and we are working at, as Anne said, on getting more. The uptick in the 700 shows primarily in Europe. That is where we've launched it first. We will launch it in the US and some of the DMO territories in the third quarter of this year, early fourth quarter of this year. And we will see an additional pickup in that segment as well.

Okay, and then just sort of a follow-up to -- assuming that the color production demand remains relatively solid at least in countries other than US and then sort of looking at the numbers that you provided, are you sort of taking a conservative outlook given all the economic factors that are out there? Because when you look at your EPS guidance, especially with the benefit from lower tax and continued aggressive share repurchase, is this basically looking better to be conservative and prudent than aggressive kind of an attitude looking at your numbers given some of the tailwinds you probably will have in the second half?

Well, we are certainly not looking for any economic improvement balance of year. So should there be some, then I think we would clearly take advantage of some of the upside that it would bring. But that is not something that we have considered as we have done our outlook for balance of year.

It is an interesting scenario because the pressure on margins coming from mix and the good news on tax rate is coming also from geographical mix. So there is a little bit of a trade-off there, Shannon, in the sense that the lower tax rate is being generated literally by the weakness in the US, which is the higher tax area and the fact that the benefit from the disproportionate amount of the revenue that is coming from the emerging markets in Europe. So I think it is fair to say that, as the US gets stronger, we will see that tax rate potentially go up a bit as well, but what we are looking at for the balance of the year is basically what we have seen through the first half of the year.

Thank you very much.

Keith Bachmann, Bank of Montreal.

Hi, thank you. I wanted to ask just a couple of questions if I could. Anne, could you just talk about how you are thinking about, given that economic backdrop and the mix, how you are thinking about pricing on both the Production side and the Office side through the end of the year? And what risk to do you see in the implications to gross margins that have ticked down over the course of the last four quarters, five quarters? If you could address that as it relates to the demand environment. Thanks.

So I think we would view the pricing environment -- it is important to say, by the way, that pricing moderated a bit in the second quarter. You may remember we were pretty aggressive, particularly in the mono production area. So we have brought that back a bit and think it was a wise thing to do. So pricing did moderate a little bit, but it is still clearly a source of pressure on margin and we would expect that to continue.

Now, importantly, it is primarily on the equipment sales side still, so getting the installs still is a priority and maximizing our channels of distributional is a priority. But we don't expect the pricing environment to deteriorate much more nor improve significantly for balance of year.

But I have to say that if you look at margins, I would say that, for the balance of the year, we have a number of things that are going in our direction for margin improvement. The first is the impact of the restructuring. The second is, as I mentioned, production color, which clearly is a helper in terms of improving performance in production color. And the third is, as we get into the second half of the year, that some potential improvement in the ratio of SAG and RD&E is also a helper. So I think we have more helping us than hurting us, but I don't think pricing will be the major helper going forward. It will come from restructuring, better performance in production color and some improving ratios on SAG and RD&E.

Okay, if I could just ask one more then, Anne. I want to change subjects for a second. I wonder if you could address how you think some of your acquisitions have performed, particularly in the software side of things like Amici and how you think about your acquisition portfolio going forward away from the distribution side.

Well, I think we would tell you that the biggest and most significant acquisition we have done is Global Imaging and we continue to be more than pleased with Global Imaging. They had a very strong quarter. Amici, which is now known as Xerox Litigation Services, is a great performer. It is a high-margin, high-value, services business that we think still has lots of legs to grow.

The XMS, which is the mortgage processing business, as you would expect, is under some pressure, but the reality is is that what we have invested in clearly is going to be even more important to the mortgage industry going forward, which is a systemic digital mortgage processing platform that clearly has already got marketshare in the mortgage industry and I think will only gain. So we think that is an investment that will yield more in the future.

The other one is XMPie, which we are thrilled with. I mean XMPie continues to be a great acquisition. Our graphic communications space is a world that is driven by applications and primarily personalization and to have XMPie in our portfolio is terrific. So all in all, I think we have been careful. I think we have set our sights high, but I think our acquisition process has yielded great results.

Anne, with that as a backdrop and then I will cede the floor, but would it make sense in your mind if you have been successful in those areas, which I presume also would eventually lead to an improved margin profile, why not go after more on that side of the fence rather than the distribution side, which doesn't necessarily diversify your revenue streams?

Well, I think we are. I think this is more a question of finding the right properties. We are looking and saying, to the extent we can do more, particularly on the vertical services side than the software side, we are very open to that. I wouldn't -- by the way, whatever we do in distribution becomes a channel not just for our traditional business, but it is a channel for our services business and we are demonstrating that with Global already that we are changing the boundaries of what those channels distribute with the wider portfolio of offerings. So in one sense, distribution just gives us a bigger pipe to take all of our offerings through. So it is a driver of growth for the entire portfolio of the business. But I would look and say I think we are selective and we are totally open to acquisitions that will help us on the services and software side and continue to look at them and have them in our pipeline as well.

Okay, thank you.

Jay Vleeschhouwer, Merrill Lynch.

Thanks, good morning. Anne, how are you thinking about the continuity of growth for DMO, specifically post-sales within DMO? You have been seeing some good mid-teens growth there year-over-year, but, at least in the second half of this year, the comps do start getting quite a bit harder versus the second half of last year. So maybe you could talk about how you are thinking about DMO both on the Production and Office side.

Secondly, with respect to the gross margin, is the 39% to 40% just the reality of this year that you have to acknowledge or is this a leading indicator of another reset of the gross margin in future notwithstanding some potentially favorable mix trends?

So on DMO, we did see extraordinary growth this quarter. 18% to 19% growth is pretty ambitious, but if you looked at where we are investing, particularly on the marketing and the coverage side, you would see it is disproportionately allocated to DMO. So our intent is to continue to capture growth in DMO by investing in future sources of growth and I think the model is very different from the rest of the world. I mean when we look at our post-sale in the rest of the world, a lot of it is driven by Document Services, technical services, financing.

In DMO, it is really a consumable post-sale model, which does yield a higher set of returns in the post-sale than you have from the blended post-sale stream you see in the rest of the world, Jay. So you will continue to see kind of a higher ratio of post-sale in DMO because of the makeup of the kind of razor/razor blade model that we have in DMO.

So I am not suggesting that we will see 18% potentially over the long term, but I think we have double-digit growth in DMO for a long time to come and we are investing in making sure that we have got the ability to get it. And I would say that we have, in the services and the production market, we have clearly not yet really capitalized on the opportunity going forward there. I know Ursula and I were both at Drupa and I would tell you, the excitement from the developing markets on the high-end technologies and even I think the order rate from DMO, Ursula, was higher than it was from Europe?

Right, we are impressed at the pickup of the high-end technology, particularly color technology, in the territories in DMO -- Russia, Brazil, Mexico, the Eurasia companies, India. So all of the Production equipment actually plays very well in those areas.

And on the margin, I think we would characterize 39% to 40% as the reality of the economic mix that we are seeing right now. And that is why I wanted to kind of make clear that when you have got weakness in US, weakness in Production, you are really looking at your highest margin businesses kind of not producing their fair share and the extraordinary strength we are seeing from DMO and Global and services, which are all doing very, very well as lower margin businesses are really driving it.

As the US and production comes back, there is no question that the gross margin will improve. So we basically believe this is a temporary outlook, one that we are adjusting our business model to so that we can maintain our expectations outlook, but that it will be conditional to economic improvement in the US. But for as long a time as we are dealing with that, we believe we have got the right actions in place so that we can really not have to deteriorate the overall business returns. On the flip side of that, Jay, as the margin gets stronger with US then you will see probably a tax rate change as well.

Additionally, Anne, can you comment on any areas where you feel that you need to capture or perhaps recapture share? We have seen some interesting trends in both Office and Production with respect to Canon's numbers, Ricoh's numbers, [Osay] in continuous feed. Where are the holes that you need to try to run through?

Yes, I mean I think -- by the way, if you looked at the last share results through Q1, we actually grew share almost everywhere, which gives us one area of focus that we are focused on like crazy and that is the entry production color area and particularly the low end of the entry production color area and that is why the introduction of the 700 color press is so critically important and the success of it because that is our path to be very aggressive in gaining back share in that area. But other than that, I have to tell you, we are really pleased with share across the board.

All right. And lastly, the usual question on vertical markets, graphic arts, transactional, public sector, financial and so forth.

I think the only one that we would break out would be graphic arts and graphic arts only in the US and that clearly is feeling the pressure, but any of the other industrial verticals, government, we think none of that is material in terms of the results.

Ananda Baruah, Banc of America.

Hi, Anne, thanks for taking my call. Just a quick question I guess on kind of intertwined installs and margins. Just interested in where you guys were maybe most surprised or I guess what led to kind of the biggest surprise in the install activity this quarter. I am going to sort of assume that you guys probably or did you expect some delays in purchasing sort of ahead of Drupa or were you surprised by that?

And then secondarily, depending on the answer to that question, did that also lead to I guess some of the sort of sequential decline in the margins, which I am sort of assuming you were a bit surprised by because I got the sense coming out of last quarter that you were expecting at least a slight uptick sequentially in the gross margin.

So let me just talk about installs first and I think that we clearly -- I can't say we were totally surprised by it, but the production color install rate was way off certainly our traditional production color rate. Now, we definitely changed our mind about bringing the production color products to Drupa that weren't available till Q3 and we did it to position ourselves competitively. It's the right thing to do. We couldn't miss that window to create excitement about the new product based upon what competitors were doing. But it definitely put a hold on the vast majority of our production color orders in the second quarter.

So it is a surprise I think in terms of where we thought we were at the beginning of the year and certainly first quarter, but once we assessed the state of Drupa, we made the decision, we knew there would be an impact and we certainly got it and it really is due to the strength of the refreshed portfolio. So that is the only one.

If you look through all the Office categories, we had 10% growth in Office black-and-white. I think about 35% in color MSP. I mean we have been looking at results like Lexmark 12% decline in laser printers. We had a 12% increase in color printers. So we would look at it and say Office was strong and our weakness was production color. And I guess we sort of did it to ourselves, but this is a full year, not just a quarter and we think that is the right thing. Ursula?

And a major focus area in production color was the high end of production color where we had accelerated the introduction or the showing of iGen4. In the DocuColor 700 space, our activity in that space was flat on a yearly basis. So we didn't see a decline, but what we have seen is a significant pickup in orders or demand for the 700. So that should add to that already solid base. The iGen4 is the place that we actually decided to accelerate and saw delayed decisions for that.

Got it. So -- sorry.

Go ahead. You wanted me to comment on margin, sequential margin?

Sure. Yes, that would be great, thanks.

I think when we talked about margin last quarter, we said that we would see the impacts of restructuring in the second half of the year. So we really had almost no impact in terms of restructuring in the second quarter. It was a quarter of implementation. And I think understanding the impact of the production color business on margin -- had we not had that dip in production color, I think you would have seen a sequential improvement in margin based upon the strength and the impact of that part of the portfolio. But we haven't lost it. It is literally coming in the second half. So this is one where I think our projection on margin, we can be confident in improvement because of the flow-through both from the pent-up demand on the new Production products, as well as the restructuring impact.

Great. Just a quick follow-up if I could, Osay's continuous feed numbers weren't great for the quarter. I know that has been an area that you guys have been talking about or at least pointing to as an area of expansion. I don't doubt at all that that is going to continue to be the case. But have you seen anything in that market through the June Q that has maybe dampened the enthusiasm around that market, your opportunity to sort of go into that market in a bigger way in the second half of the year?

This is Ursula. Absolutely nothing that dampens our enthusiasm at all. Actually everything that we have seen, especially on the color continuous feed has boosted our enthusiasm on that market segment and our ability to be competitive in that segment.

Okay, thank you.

Chris Whitmore, Deutsche Bank.

Thanks. Back to the gross margin, hoping to get a little color on the decline in post-sale gross margin. On the year-on-year basis, that was down over one percentage point and you haven't given much color on that. What was the primary driver of that margin erosion?

The strength of services really drove -- I mean that was the answer on post-sale. Nothing else. Services does come at a lower margin and because of the weakness -- this is right back to the same weakness in US, particularly high-end hardware and the strength of our services business combined to have an impact on the post-sale gross margin.

Are you seeing any pullback at all in printed pages amongst your Production, your highest volume Production printing customers?

Yes, I think -- on black-and-white pages, there is no question. You saw it in Larry's chart that we are seeing some accelerated declines on the black-and-white pages side and that is primarily a US phenomenon.

How does that weakening page volume kind of outlook or scenario impact your outlook for equipment sales going forward in Production? And relatedly, you just showed about 5% declines in equipment revenue growth on a year-on-year basis. What should we think about as a target for the back half of the year as an organic equipment revenue growth number?

I think that this would get back to the question is what kind of assumptions have we put into our outlook for the balance of the year and we are not expecting US black-and-white pages to improve. That is something that, until the US economy starts to improve, I think that there will be a relationship on the page side, not so much on color by the way. Color seems to be holding up a lot better than the black-and-white page, which is more the transactional side of the business. So I think we have made the assumption that it is what it is until we see some kind of economic improvement.

On the actual equipment sales side, which is unrelated from the page discussion, I think we should see improvement based upon the fact that we have got the benefit of the new product portfolio in the second half of the year versus what we saw in the second quarter of the year. So we would look and say we don't expect equipment sales to be a robust growth factor, but it should be improving based upon the new product introductions. I mean that is really going to help, but we still think our model is a post-sale model and you are going to see overall revenue growth clearly leveraged through the post-sale stream.

Final question is for Larry. Larry, bad debt expense is up slightly sequentially. Can you talk about your collections and customer credit quality? If you are seeing any meaningful changes there, that would be helpful. Thanks a lot.

No, we haven't seen any meaningful change there. We would call [them material] customer payments here. If bad debt goes up, revenue goes up. Bad debt goes up and it is just that.

Mark Moskowitz, JPMorgan.

Thank you, good morning. A couple questions. Getting back to the commentary on pricing, Anne or Larry, can you talk a little more about some of the drivers to why the price moderated in the quarter? Did you have some upside in other areas that allowed you to pull back in production monochrome and if there was upside in certain areas, how sustainable should we think about those drivers going forward?

So, Mark, I think when we talked about it in the first quarter, we talked about the fact that the pricing pressure came through selected big deals. That is where you see sometimes the biggest impact on pricing. Generally what we don't do is kind of, if you will, reduce the water level for the entire portfolio. We try to do it selectively to win kind of lighthouse deals, which gives us the opportunity to manage it going forward. What we did was clearly just manage and not offer the same level of pricing in Q2 as Q1 and we had the opportunity to do that. As we look at pricing investments across the board, still under 10%, which is not untraditional for us and better than Q1, but it was mostly big deal-driven versus any particular category or product.

Okay. And then getting back to the production refresh, Ursula, and yourself talked about the demand outstripping supply right now. How should we think about your ability to perform just given you are implementing a considerable level of restructuring activities in the second half? Is there any wiggle room to restructure if the macro gets worse just given that you are trying to unleash this new product with some pretty exciting demand levels at this point?

So on the demand side -- this is Ursula -- and supply side, we are confident that we can meet the demand as we ramp up the Production line. It is a pretty standard product introduction cycle that you go through, so we have very high demand on the 700. That demand will be met with supply as we come to production curve ourselves in Japan. And the restructuring wouldn't have anything to do with that at all.

The restructuring is very focused. It has literally, I think, zero impact in terms of our ability to execute against the plan, and I think that if the economy gets worse, I think that is something we actually are pretty good at. We literally know how to deal with anticipating and making sure that we take advantage of any cost opportunities to make sure that we don't, quite frankly, disappoint in terms of bottom-line expectations. So you can be assured that we have all of our contingency approaches understood, hopefully not to implement, but we know what to do.

I think in a price-performance technology company, you have to constantly reduce cost. And the only way to do that is through some small kinds of restructuring. We have done that a lot, and we are prepared to do it in the future, and we would do it within the guidance that we have given.

Okay, thank you. One more question, if I could. Any update -- I may have missed it, so I apologize. Any update on the distribution inventory activity? Is it across the US? I remember last quarter you did talk about some of the distributors having some hesitancy to take on inventory. Has that changed or not?

I think we talked about specifically in the reseller channel, and I think we would say it is a continuing trend. It has not worsened, but there is no question there is a very conservative approach to inventory in the channel, but I would not say it has worsened from Q1.

Thank you.

Richard Gardner, Citigroup.

Thank you for taking the question. I had two questions for you. I was hoping that you could give us a little bit more color on the timing of shipments and installs for the new Production products in the third quarter. Is it going to be fairly linear or is it going to be heavily back-end loaded in the quarter?

And then secondly, Larry, I was hoping that you could give me a little bit more detail on the specific types of costs that were affected by the restructuring actions in Q2. Thank you.

Okay, timing on the -- absolutely will be back-end loaded in Q3. So we will get as much as we can done, but primarily, I think a September kind of delivery. For example, iGen 4 and the 5000, particularly I think you will see a more steady 700 availability, although not available until probably Q4 -- or September of Q4 in the US.

So definitely back-end loaded. That is comprehended within our outlook. It is why we know that we have got a lot of momentum particularly going into the fourth quarter as we look at the Production business. But we are staged in ready and we will take as much advantage as we can in the third quarter. On cost and restructuring, Larry?

On cost and restructuring what we said was that two thirds of it was gross profit related and that had to do with supply chain and also service, rate fixed service were the two primary areas.

Okay, thank you.

Last question I think we have time for.

Carol Sabbagha, Lehman Brothers.

Thanks. A question on the increased share buyback authorization. Just a question is why now; you still had $700 million left on it which is kind of the level you have been running at for the first half. Does it imply that you are going to do more than the $700 million for the rest of the year that you had outstanding? And associated with that, given sort of what we think may be the bigger buyback than you intended in the beginning of the year, the incremental cash out for the litigation settlement, what is your view looking out 12 months or so on where you want the balance sheet, what sort of cash levels do you feel comfortable with, what sort of leverage do you feel comfortable with?

Well, I think, and I think we have said this, Carol, but basically somewhere around $750 million as a cash balance is what we have tried to do. We have generally fallen into around $800 million if you look back at the last quarter since we said that. We probably could do it at less than that, but that is sort of a comfort zone number.

I think we just saw some opportunity to be active with share repurchase because of the share price and so that is what we did, sort of bought ahead, maybe a little bit ahead of the cash flow in anticipation that we really have a strong fourth quarter on cash flow in this company and that we can meet what we say there. And I think the authorization was just simply a statement of the fact that we are kind of dedicated to that idea that share repurchase is important for us and just increases it and the timeframe might increase because of the higher amount that we had there. Share repurchase is done and consistent with cash flow.

So as far as debt levels, I think in the second quarter, we had a 7 to 1 ratio of debt in our financing business leverage and we had about $400 million or $500 million of core debt and somewhere around that is a comfort zone of where we think core debt should be.

Okay. And then one quick question on the product side. We have been talking or you guys have been talking some at the analyst meeting last November about a higher-end solid ink product coming out in 2-8 and I think second half of the year. Where are we in that process? And I know you were testing out the price elasticity in solid ink with existing products. Again, what have your results showed?

We are on track to bring solid ink upmarket at the end of 2008 with market introductions and the financial impact in the beginning of 2009. As far as our test-out goes, we are still testing out obviously, but the feedback has been good. Strong on our color MSP, low-end color MSP introduction that we made last year. So on track for both ends.

Terrific, thank you.

Okay, thank you, Carol and thanks to all of you for participating today. Have a great day.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.