全錄公司 (XRX) 2008 Q4 法說會逐字稿

Good morning and welcome to the Xerox Corporation fourth 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 express 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.

Thanks, Nikita. Good morning and thanks for joining us today. We are going to begin with slide four. And before I get into the results of the quarter, here's a look at the dynamics we are facing, the fundamentals of our business that give us confidence in our model, and the actions we are taking to help offset the challenges from the economy.

The continued weakening economy and rapid shift in exchange rates put pressure on our business in the fourth quarter. The impact on earnings was largely due to the strengthening of the yen and deteriorating developing markets' economies, particularly in Russia and Eastern Europe, which started in the latter part of the quarter. With increasingly widespread economic concerns, we are finding that more of our customers and partners are scrutinizing investments, which is delaying decisions on major contracts. In addition, our distributors are reducing inventory of supplies, creating an impact on post sale revenue this quarter.

Despite this challenging marketplace, our business model delivered $265 million in adjusted income for the quarter or $0.30 adjusted EPS. The basic fundamentals of our operations continue to deliver solid results, giving us flexibility in these uncertain times and strengthening our competitive position. As you all know, more than 70% of our revenue come from our post sales. We track the success of this annuity stream by closely managing the metrics that drive it, including MIF or machines in fields, which means the number of Xerox systems in the marketplace. The better our MIF, the more pages printed on Xerox systems, especially color pages. And these metrics continue to be positive. A growing services business also flowed through to post sale.

With a value proposition that helps customers reduce costs, we are getting more and more interest in our outsourcing and other document services. And we are consistently generating solid cash flow while containing our capital investments. We generated more than $1.7 billion in adjusted cash flow from core operations and $1.36 adjusted free cash flow per share in 2008. These fundamentals will continue to serve us well.

While better positioned than most, we certainly have not been immune from this increasingly difficult business environment. We are taking swift actions to help improve earnings while maintaining investments to drive growth. The fourth quarter restructuring will deliver $200 million in savings this year. In addition, we remain relentless in our focus on reducing costs and on generating cash. And like others in our industry, we have made price adjustments to better support our business model in this environment.

We are not underestimating the seriousness of today's challenges, but we have a resolve that we know what to do and we will do whatever it takes to navigate Xerox through this period of uncertainty. We have an experienced management team that's been tested in the past and emerged a strong and confident group that knows how to take on challenges.

Now let me take a moment to review our Q4 results. Larry will then share more detail about our financial results. I'll provide some guidance on the coming year, and then Larry, Ursula, and I will take your questions.

So please turn to slide five for a summary of our fourth quarter performance. As I mentioned, adjusted EPS was $0.30. This excludes the previously announced restructuring charge of $0.27 per share as well as an equipment write-off of $0.03. Currency had a significant negative impact on results this quarter -- on revenue as the dollar strengthened against the euro, and on margin as the strengthening of the yen increased our product costs.

Total revenue of $4.4 billion was down 10% in the quarter, which included a 5 point negative impact from currency. Post sale revenue was down 8% or 3% in constant currency. Again, this was largely due to distributors holding lower supply inventory levels as they prioritize cash at the end of the year.

Equipment sale revenue declined 15% or 11% in constant currency, a reflection of weakened economies all around the world with an especially significant decline in key developing markets. I'll talk more about this in a moment. But for some perspective, consider that up until November our developing markets business was delivering double-digit growth. The rapid appreciation of the yen impacted gross margin. Excluding an equipment write-off caused by the retirement of a product line, the decline is due to the strengthening of the yen which increased our product costs.

Selling, administrative, and general expenses were 25.2% of revenue, up about 1 point from the fourth quarter of 2007 as we maintained our sales coverage investments, continued building, and our industry leadership.

Our cash flow remains strong. In the fourth quarter we generated $1 billion in cash from core operations, excluding the net litigation payments of $615 million, and we closed the year with $1.2 billion in cash and cash equivalents.

Now turn to slide six for a further review of revenue. The most significant revenue shift in the quarter was in our developing markets. Through the third quarter of 2008, revenue from DMO was up 17%. In the fourth quarter revenue from DMO declined 14%. 11 percentage points of this decline is entirely due to major shifts in currency in several developing markets.

Typically, we can manage changes in currency through pricing, yet this quarter the movement was so rapid and meaningful to our results that pricing couldn't catch up. So we are calling it out separately. Exacerbating the situation was the rapid decline in the Russian and Eastern European economies. So a very challenging external environment in developing markets clearly put unexpected pressure on our business.

In production, the weakening economy resulted in a 6% constant currency decline in total production revenue, largely due to a slower demand for monochrome systems. Installs of production black-and-white systems declined 11%. Color installs were up in production -- the benefit of a strong demand for the iGen4 and the Xerox 700 Digital Color Press, both of which have only been available worldwide since September.

In addition, we are pleased with the demand for our color continuous feed system, which just recently launched in North America. In the office, installs of black-and-white systems were down 18%, which contributed to a decline in total office revenue of 5% in constant currency. Yet like production, color was the highlight in the office as well. Installs of color multifunction systems were up 9% in the fourth quarter.

We continued to lead the industry in the number of color pages printed. And while fourth quarter revenue from color was flat in constant currency, color pages were up 23% and now represent 18% of total pages printed on Xerox technology. Color results exclude the benefit from global imaging systems.

Our document services help businesses work faster and smarter with lower cost, often saving our clients up to 30% on their document-related needs. According to Gartner, we hold the number one market share for managed print services, with more than 50% of the total global market. And in Gartner's highly respected Magic Quadrant report, we are in the leader's quadrant for managed print services. And by the way, the same holds true for our multifunction printers.

Our services business benefits our post sale stream and provides multiyear contracts that generated $3.5 billion in annuity revenue in 2008, a 3% increase year over year, and services signings were up 6% in the quarter. Through our services and technology, much of what we do is aimed squarely at helping our customers cut costs and operate more efficiently and effectively, so we remain confident that the value we bring to our customers can help them through this economy and help us build on our industry leadership in document management.

Now I'd like to turn it over to Larry for a deeper dive on our financials and then I'll return to discuss Q1 expectations. Larry.

Thank you, Anne, and good morning. In my presentation this morning, I hope to give you insight into our fourth quarter results addressing both economic and business model dynamics. Lower demand and significant currency changes represented the economic challenges, while the fundamentals of our annuity were stable and we had continuous strong cash performance.

So let's start with fourth quarter and full year cash generation, slide eight. In the fourth quarter we generated $1 billion of core cash flow, excluding $615 million of net litigation payments. Full year core cash flow was $1.7 billion, again, excluding the $615 million. This represents $1.36 of adjusted free cash flow per share for the year, full year.

Fourth quarter cash flow was driven by earnings as well as significant performance in working capital. Cash performance is the foundation of our annuity business model, and our performance along with our investment grade credit rating positions us well in challenging capital markets. Coupled with our $2 billion revolver, we have the ability to run our business and pay down debt with no requirement to access capital markets unless we choose to.

Moving to investing, CapEx and internal use software were $91 million in the quarter and $335 million for the year, a relatively small percentage of our cash flow. Full year cash flow from financing is driven by reduction in secured debt by $227 million, net proceeds on other debt of $926 million, reflecting our accessing capital markets at attractive rates back in April, $812 million of share repurchase and $154 million dividend. Ending cash was $1.2 billion.

Last week we paid down $900 million of notes due, reducing our debt by $500 million. So overall, solid cash and balance sheet performance which we expect will continue going forward.

Slide nine. Adjusted earnings for fourth quarter were $0.30 and $1.10 for the full year. The adjustments on a full year basis after tax are restructuring charges of $240 million, litigation net of recoveries of $491 million and an equipment write-off of $24 million.

Adjusted gross margin for fourth quarter was 38.8% and 39.2% for the full year. The adjustment is for the $39 million equipment write-off caused by our decision to retire a product line in the office segment. In addition, gross margin was negatively affected by the significant strengthening of the yen versus the dollar and the euro. This increased our cost in US dollars and reduced margin. At this point, I believe it is prudent to assume currency exchange rates will remain where they are now going forward.

RD&E declined $26 million and SAG declined $84 million, including $68 million beneficial impact of currency. While SAG spending was down, bad debt provisions were up year over year. Adjusted operating income as a percent of revenue was 8.7% in fourth quarter and 8.4% full year.

So although this year's results were not what we challenged ourselves to, they did deliver about $1.5 billion of adjusted operating profit and drove $1.7 billion of cash in challenging economic times.

Slide 10. On this next slide I want to cover some key points as we look forward to 2009. First and foremost is cash generation on the top left and our debt ladder on the top right.

Looking at full year 2009 cash flow, we start the year with $1.2 billion of cash on hand and expect to generate $1.7 billion core cash flow, with uses of $300 million of CapEx and internal use software, $200 million for dividend. We expect to pay down $1.6 billion debt, our entire debt due in 2009, and we will have at the end of the year a cash balance of $800 million. $900 million of debt has already been paid on January 15th, so in 2009 there is no requirement to access capital markets unless we see an opportunity that we want to take advantage of. Our $2 billion revolver and significant cash flow provides this flexibility.

One last point on the top right, our debt ladder is designed to be significantly below our cash flow and is roughly $1 billion a year going forward.

If we look at receivables, we can see that the metric of write-offs and provisions as a percentage of revenue is approximately 1%. The provision ticked up full year by $54 million or 0.3 points. This was caused by some customer bankruptcies in fourth quarter in the US, Germany, and UK.

So although we did see a move consistent with the environment, we believe that our tight credit and collection processes are functioning well. Aging has not increased significantly, day sales outstanding has actually declined, and we had very good collections in fourth quarter. However, from a conservative viewpoint, we are assuming this higher trend going forward.

Currency, there are two kinds -- translation, a non-US country's P&L converted to US dollars, for example, euros to US dollars. The dollar strengthening 15% since July '08, a huge change. If it stays there, we will have about a 5% to 6% negative impact on revenue for first half of the year.

Second, transaction currency is the conversion of costs from a shipping country's currency to the local country currency where the product is sold. For example, yen converted to dollars and euros. As you can see from this slide, we have had a significant strengthening of the yen in the last few months, 23% against the euro and 19% against the dollar. This raises our cost and reduces our gross margin. Our actions include price management, hedging, sourcing, and currency cost sharing with Fuji Xerox. If the rates remain where they are, it will continue to have a negative impact on 2009.

Slide 11. Now I want to spend a few moments on our post sale annuity, since it is a stabilizing factor in our model. It represents 73% of our revenue, and although it declined 3% on a constant currency basis, the impact is relatively small and did not result from a significant change in our fundamentals, machines installed, and pages.

$65 million -- 2 points, or about two-thirds of the decline, was driven by lower supplies sold to our distributors as they managed inventory and cash in fourth quarter. Other areas of post sale, outsourcing and service and rental, which totaled $2 billion and represent two-thirds of revenue, declined very modestly. Color usage grew year over year while black and white declined slightly. We did see the normal seasonal growth in these revenue streams from third quarter to fourth quarter.

Finally, we did not adjust for developing markets' currency, but it was significant in fourth quarter and cost us 1 percentage point on total post sale revenue. But we are focused on the fundamentals of installing machines, which generate pages and selling services.

Let's look at those results, slide 12. In spite of economic challenges, our annuity scorecard is favorable. Digital machines in the field, MIF, and pages continue to grow 6% and 1%, respectively, driven by color machines in the field up 33% and color pages up 24%. The pressure on digital pages has been in black and white, and we did see a decline in fourth quarter. The pressure on digital pages has been in black and white as I said. In addition, the decline in DMO supplies had a negative effect on how we calculate their pages, and this should improve in the future.

Color now represents 37% of the total revenue, 22% of MIF and 18% of pages. Positive influence of color on price per page will continue to be an opportunity. Services annuity continues to grow at 3% as customers look to Xerox to help them reduce their costs by optimizing and simplifying their document infrastructure.

As economic conditions and currency changes impacts our business, I believe that focusing on these fundamentals of our model will play out well going forward. Now I'll hand it back to Anne.

Thanks, Larry. So as we head into the first quarter, we do expect the weak worldwide economic conditions as well as unfavorable exchange rates will continue to put pressure on the business. We will have the benefit of initial savings from our fourth quarter restructuring actions and continued cost containment, as well as flow-through from products launched in the second half of last year and the strength of our services business. With that, we are setting first quarter guidance at $0.16 to $0.20 per share. The broader range reflects the implication of continuing currency pressures and a continuing weak economy and we believe this is a prudent approach in these uncertain times.

We also believe it's premature to go into detail on full-year guidance at this time. At the investor conference in November, we provided a broad range of guidance for 2009, reflecting the uncertainty from the impact of currency. Considering the fourth quarter trends, our expectations are now based on assumptions of continued economic weakness and unfavorable exchange rates. With that, we expect to be at about $1 per share for the year, at the low end of the range that we provided to you in November.

So now if you'd turn to slide 15, we will do a quick summary. Then we will take your questions. As I mentioned at the start of the call, the focus is on the fundamentals and ensuring we are executing with precision, not only to ride out the storm, but to come through it stronger. To that end, we remain confident in the long-term value of our business model. It delivers recurring revenues from multi-year contracts and generates strong operating cash flow.

This is a team that knows how to manage the balance sheet with a close eye on the bottom line. We are already implementing restructuring actions that will deliver more than $200 million in savings this year. As important, our industry leading services software and systems consistently deliver customer value and savings -- real dollars that mean even more in this economic climate.

Our distribution reached through an extensive set of channels, from resellers to global imaging to a network of sales agents, dealers, and a worldwide direct sales force to fill the broadest portfolio of products in the industry and continues to be a competitive advantage.

We are realistic about the challenges we face in this marketplace and we are recalibrating our investments, priorities and expectations to focus even more on profitability and cash while delivering the innovation, service, and value our customers expect from Xerox. In doing so, we fully intend to be in an excellent position to capture market growth as economies improve.

I'd like to thank you for your time, and now Larry, Ursula, and I would be happy to take your questions.

Thank you. (Operator instructions). And our first question comes from the line of Shannon Cross with Cross Research. You may proceed.

Excuse me. Hi, good morning.

Good morning.

I guess the first question, Anne, is can you talk a little bit about what you're seeing in terms of usage by the end customer? So there was inventory contraction, the channel on the supply side -- but from a page volume standpoint from just the health of the end customer, can you give us some idea of some of the trends you're seeing both in terms of color and black and white and just general page printing?

Well, I think as you can see from some of the data that Larry presented, we have seen some deterioration in terms of percentage rate on black-and-white pages. I do think it's important, Shannon, that we mention that pages were up from Q3 to Q4 in total, so this isn't an off the chart deterioration. We saw a seasonal uptick, not as much as we would normally see, particularly in black and white.

In color, growth has stayed very, very strong and we are very pleased with double-digit growth in pages. That growth rate has declined a modest amount, not significantly -- a few points, but color pages stayed quite strong.

I think the difficulty for us is that as we try to deliver to you the page growth rates, the methodology makes assumptions in terms of supply purchases translating to pages. I think that methodology is a little broken right now, because we saw the deterioration of inventories in channels that are not necessarily aligned with the actual pages being printed. When you see supply inventories going from six weeks to in many cases three weeks, it's hard to translate that accurately into what exactly happened with page growth. So we have a little bit of a question mark there.

We know the pressure would have been quite serious at the end of the year particularly to optimize cash, so we are hopeful that we will see a bounce back to more normal levels of pages as we enter 2009. So I think it would be fair to say that what we see is some modest deterioration, but nothing that is alarming in terms of the pages. And I think we will have better intelligence as we come through first quarter where hopefully we see a little bit of bounce back that will be necessary in inventories.

Okay. And then from a pricing standpoint, can you talk a bit about pricing for equipment as well as pricing for pages? Just, obviously, you talk about not being able to shift pricing in DMO, but I'm curious as to what you're seeing in Europe and the US in terms of both equipment and page of pricing.

So in terms of equipment pricing, in the range -- 5% to 10%, I think it was probably right in the middle of that range, pretty square in the middle of the 5% to 10% range in terms of equipment discounting, which actually moderated a bit from the first half of the year. So, no significant drop-off in terms of equipment pricing. And pages, very steady as you go. We -- color page pricing at constant currencies remains very stable. Obviously, the mix helps us in terms of increasing the average price per page because of the more color pages you get in the mix. So that would have been a helper, not a hurter, perhaps not to the extent it had been in past quarters, but it's positive. So nothing on pricing that is really significant.

I think the biggest issue for us is what we saw happen to the yen in the last six weeks of the year clearly created a problem in terms of being able to use pricing to offset that impact. Hopefully over the course of the year we will be able to get a little bit more pricing help than we were in the fourth quarter.

Okay. And then, Larry, one question for you on working capital improvements in 2009, and your comfort level with attaining the $1.7 billion in cash. Obviously you did it this year in a little bit better of an economy, so how should we think about cash generation in 2009 in what is apparently -- it's getting bad, if you listen to GE or anybody right now. How do we think about your cash -- your comfort with your cash flow generation for this year?

I think it's a little bit of what I said at the investor conference. I think we start off and -- just because of what you said, which is a tough economy, that working capital has to be something that we spend a lot more time on, not that we haven't in the past. But we just have to make sure that collections and inventory growth don't happen. So normally what you see is an increase in working capital from fourth quarter to first quarter, and we are going to make every effort we possibly can to flatten out that whole curve as we go through this downturn.

To answer it, I'm confident that we can make the $1.7 billion, so we are going to make it maybe slightly differently than we had planned for originally, but nonetheless, we will get there.

Okay. Great. Thanks.

Thank you, Shannon.

Our next question comes from the line of Richard Gardner with Citigroup. You may proceed.

Thank you very much. I have a couple of questions. First of all, Larry and Anne, I was hoping that you could help us understand how quickly margins can rebound as some of the things that you mentioned that help you manage currency kick in. In other words, how quickly do things like currency sharing kick in with Fuji Xerox, and how quickly can you adjust prices under your current long-term contracts? Thank you.

Okay. As we look at our agreements with Fuji Xerox on currency sharing, and we have discussed this in the past, I mean, they do happen in arrears and they are a sharing agreement. They don't offset the entire impact of negative currencies. But we should see some help certainly beginning in this quarter based upon the impact that we saw in Q4, which literally had no shade at all and cost us much more than we had anticipated at the investor conference. So we will see some help there.

Obviously, half of the restructuring that we announced was focused on gross margin improvement, but the dynamics of that will be more second half versus first half loaded because of the cadence of the action. So that will be more of a second half approach.

I think on the pricing side, we have certainly some ability under contracts to influence pricing, but it's, I think, more important as we think about the equipment transactions going forward that are impacted by the cost of the yen that we try to recover as much as possible there. And, obviously, most of our competitors are Japan-based competitors, so there's somewhat of a level playing field here as we think about the impact of the yen piece.

So we clearly as we have given you guidance for 2009 -- have mitigated the full impact of the yen with what we think is a reasonable approach of actions that we can see flow through.

Okay. Anne, it sounds like what you're saying is that we really shouldn't expect pricing to change a lot under current contracts, but you're going to be changing the pricing as contracts come up for renewal. Is that the right way to think about things?

Yes, and I think on new transactions, there's certainly some ability in current contracts. But where we are really getting hit is clearly on the new transactions, which are being impacted by the current cost economics of the yen. So this is equipment in transit from Japan now that's having a huge impact. You could see it in our equipment gross margin for the fourth quarter, which declined, I think, almost 3 points. It was a significant decline that was due to the cost implications. So that's really what we are focused on to try to get the most relief on.

Okay. And then just as a follow-up, I know that you mentioned that color page growth was still double digits in the quarter, but it did look like it decelerated pretty dramatically based on the full-year number of 24% that you talked about and the 29% that you had in the first three quarters. It looked like it could have been low double digits, maybe 10% to 12% in the fourth quarter. Can you talk about how much of that deceleration from Q3 to Q4 was related to the inventory correction and distribution and how much was related to reductions in usage by your end customers? Thanks.

I think as we looked at it, we saw the total color pages did, as I said, moderate some in terms of growth rate. If you looked at Q3, you would have seen about 23% growth of pages, in Q4 18% growth in pages. But interestingly enough, when we used to report pages, we did not include DMO and -- primarily and printers as well, and if you looked at our fourth quarter pages just for Europe and North America, that was a 23% growth.

So the implications of that say DMO was the major factor in terms of that dip, which clearly is driven by a two tiered distribution system where inventorying of supplies is a critical factor. So I would say that truly would be the primary cause for the deceleration of growth on color pages.

And it was still 18%.

Yes.

Okay. Thank you.

Okay. Thanks.

Our next question comes from the line of Mark Moskowitz with JPMorgan. You may proceed.

Yes, thank you. A couple questions here. Anne, can you talk to me a little about the DMO and just the BRIC regions in general? It's kind of a long-winded question, but here we go. I'm trying to get a sense in terms of the dramatic slowdown you're seeing -- how much is that is based on domestic customers in terms of corporations that are based or domiciled in those regions versus foreign investments in terms of US and European countries that have been investing in those regions over the past few years?

Okay. I mean, I should say probably as we look at the BRIC countries, the biggest impact to Xerox would be Brazil and Russia, where we have sizable high growth businesses. India is a relatively small business for us, so although certainly conditions there are not great, I wouldn't say it's had a dramatic impact overall. And as you know, China, we only see either the risk or the benefit through our equity relationship with Fuji Xerox.

So as we look at domestic and foreign investment, I think you have to look and say, first of all, in Brazil, it was less activity driven. It was more currency driven. So the real was really the primary issue in Brazil. Although there was some economic decline, it was not as radical as it was in Russia. In Russia it was clearly economic driven, major deterioration, literally we didn't see it until the second half of November. So dramatic shift in Russia.

And I don't think I would point to either domestic or foreign investment as being disproportionately responsible. We do a very, very large small and medium sized business in Russia, which would be more, I would say, domestic oriented business, but yet a big player with multinationals as well. So I would not point and say there was any significant difference there. I would say, though, two very different situations. Brazil's being more currency driven and Russia's being more economy driven.

Okay. That's helpful. I appreciate that. And then as far as just the revenue run rate profile, how should we contemplate the next couple quarters in terms of -- do we see a continuation of this double-digit year-over-year decline? I think based on Larry's commentary in terms of the currency hit continuing and hurting '09 it sounds like we should be more or less factoring in a 10% to 12%, maybe 13% year-over-year decline in the first quarter or two. At what point will you have to have to cut more costs? Where are you in terms of assessing the working capital and where you are?

Yes. Well, I mean, we should -- we almost need to separate it into actual and constant currency discussion, because actual currency based upon our assumptions, that will have a big impact. For example, as we look at equipment sale revenue primarily impacted by the euro, we would say for the first half of the year, if you looked at just the spot rates from December 31st, we would see a 5 to 6 point impact on the revenue picture just based upon currency. So that we will see the pressure, but clearly it will be more currency driven.

I mean, if you looked at that and said where are we? I mean, we have been seeing what I would call a mid single digit decline in equipment sale revenue due to pricing investment. We think that will continue. But combined with the currency impacts, you can see double-digit decline in equipment sale revenue and still be quite frankly on trend with regard to our activity, which is obviously where we are most concerned in terms of the impact on post sale revenue.

Post sale revenue, we actually feel we will see some resiliency in, particularly if we are correct and there does have to be some normalization if you will on the inventories that we saw really go into radical decline in December. So, as we look at things like our population, our machines in field, those were up 4% in December, really important. We talked about 18% color page growth. Our services business continues to be strong and, quite frankly, our signings indicative of flowthrough into the following year are up very nicely as well. So when you look at services, you look at color, you look at population, all of those play well for our post services.

We think there will be some business impact because certainly things like GDP and unemployment have some impact on business volumes, but quite frankly that should be moderate based upon the percentage of under-contract revenues that we have in post sale. So we would expect some improvement in post sale.

So all in all, I think we are being realistic in terms of saying, yes, revenues are going to be under pressure, assuming nothing gets better in terms of economies, but some moderation particularly in the post sale side.

Okay. I have one more question here for Larry and then I'll jump back into the queue. Larry, can you talk a little about the tax rate? I think heading into 2008 you more or less were guiding to around, I think, 30% tax rate and you had different one-time items and benefits to help you in '08. And now you're guiding back up for 2009 to 28%, so a pretty big jump up there. Can you talk about how confident you are of that 28% holding, or do you see some legislation or other geo type of shifts in terms of your revenue profile that can maybe bring that tax rate down over time?

Well, I think the tax rate, the -- what you're forecasting here is the profitability of every country and the tax rate associated to it. So the complexity plus tax credits and all of that. So the preciseness of the number is difficult to say in the least.

This year it was below what we called, mainly because of less revenue and profit in the United States and more in lower tax countries in the DMO area. The expectation is that given the results of DMO that we have seen, the change in business and currency there is that you swing back more towards the United States. And the United States has the highest tax rate, so you end up -- our estimate is 28%. Again, that could swing and hopefully we can beat that tax rate and we can certainly try, but that's what I use for planning purposes, so that's what I give to you for planning purposes.

Thank you.

Thank you.

Our next question comes from the line of Keith Bachman with Bank of Montreal. You may proceed.

Hi, guys. Thank you. Larry, I wanted to go back to cash flow for a second, if I could. In the slide that you lay out on page 10, certainly I think the objective that you're laying out is one that investors applaud as deleveraging. Yet if I look at the cash flows in FY '08, taking out CapEx, you did about $1.22 billion in free cash flow. And so if I look at FY '09, you talk about cash flow $1.7 billion even as earnings -- just rough estimate will be down 10% compared to '08, so how is it that cash flow goes up in '09, given those set of circumstances?

Well, the way I look at it, I mean, you took one number out of one number and you didn't take a number out of the other number, so --

Okay. So maybe it's a definitional issue. But, Larry, how do you -- are you suggesting that you're not going to have CapEx in '09?

No, I'm not suggesting anything. I think I put it on the chart, actually.

We are not having litigation in '09.

No, no, I put the $615 million back in, but -- so let's -- I see the CapEx is $300 million there and the dividend stays put, but what I'm suggesting is if I take out the equipment -- the operating leases and finance receivables, I think is the difference. But let's just start with the premise that it's flat, Larry. How do you think you get to flat free cash flow when net income is going to be down even by your own guidance?

By reduced working capital.

Okay. I mean, confidence associated with that? It's a --

High confidence.

Okay. We'll let's talk just two related questions, then. On -- I think at your analyst day you talked about ceasing -- or slowing down the buyback. It certainly showed up here. I assume that's still the case, given the environment's gotten a little more challenging.

Right now we have no plans to buy back shares unless the capital markets change.

Okay. All right. I'll cede the floor. Thanks.

Thank you.

Our next question comes from the line of Chris Whitmore with Deutsche Bank. You may proceed.

Thanks very much. First for Larry, I wanted to follow-up on the last line of questioning around expected cash contributions to the pension this year, and can you give us an update as to where the overall pension finished in expectations for pension expense this year?

At the investor conference, we said that pension expense would be up $50 million and we said cash contribution would be up $50 million. In both cases it will be less based on the current assumptions that -- you know, the Congress passed the smoothing of the stock market effect. Discount rate is about where it was there, which was year to year is an improvement in both expense and in cash contribution. So I think we actually could get a little help on the cash side from pensions. On the expense side, I think it will still grow, but not as much as we said.

Okay. And Larry, how much cash do you need to run the business?

Well, it depends what day, what month. We like to end quarters above $600 million. We have consistently ended quarters at around $800 million. We feel that we could run the business with a quarter ending $600 million. There's not a huge variation within a quarter. It's not wild swings. So we feel that that's adequate to run the business.

Okay. And, Larry, just looking at the math for Q1, you typically use a little cash in Q1, plus you've paid down the debt already in January. My math suggests you'll dip below that level and tap the revolver here in the first half of the year. First, is that accurate? And secondly, are there any covenants related to that that we should be aware of that are approaching relevance?

Well, you should be aware of them. That's public information. So you can get what the covenants effectively -- even exactly. We are not -- we have cushions in those, so they are not relevant to the discussion right now. First quarter, I expect us to grow cash flow in first quarter. That's my expectation.

But we will use the revolver and we stated that --

We will use the revolver. We've used the revolver now. I mean, looking back at last year when we bought Global Imaging -- we used the revolver at that same time. We use it to go through quarters, and by the end of the year it's mostly paid down.

I think the important point here is that if we look at the cash flow that we project, which I have a high confidence in, we look at CapEx and we look at our debt payments and our revolver, we have no requirement to go to capital markets unless we want to. And we can pay down if we choose to the whole $1.6 billion of debt due this year. So --

Okay. Great. One question on gross margins. Larry, in the past you've talked about 39% to 40% on gross margin expectations. Are you still comfortable with that number for fiscal '09?

And secondly, can you break out or quantify the impact of the yen year on year on that gross margin? So how much of that 3 points of equipment deterioration in the gross margin was related to the yen versus other factors? Thanks a lot.

We are saying most of it was caused by the yen, number one, so you can do estimates of what its effect was. We said it was going to be $0.02 to $0.03. It was above that by at least a couple of cents. And it will have an effect on gross profit margin to take it down in the 38% range 2000 -- because it's just -- you can't react to it that much in a given quarter or year. So we expect the range to be in the 38% to 39% going forward for the year at least.

And that's comprehended obviously within our guidance for sure. But just to reiterate, I think the vast majority of the margin deterioration, once you take out that write-off that we highlighted, was related to the yen issue, the cost issue. And that's not going to go away, although we will moderate it over the course of the year.

Thank you.

Okay.

Our next question is a follow-up from the line of Shannon Cross. You may proceed.

Just a couple of questions for you. The first one is we have talked a lot about Xerox and obviously all the issues you guys are facing in the industry. I'm curious as to what you're seeing in terms of the competitive landscape because, obviously, I have a feeling things are hurting others. So are you seeing market share shifts? How should we view what's going on on the competitive side of things?

Let me begin. Ursula, you may want to jump in. I think as we look at market share, the last information we have is the Q3 update, Shannon, and we were pretty pleased. We held or gained share in almost all categories, a little bit of pressure on entry production color due to the Canon device, but -- and by the way, that was pre the 700, so we feel we have got a lot of ammunition to come back on that one. But I think we will see that we have held or gained share in most of the segments, so that this is not a question of losing to the competition. We feel we are certainly winning more than our share. We have not seen anything unusual in the pricing environment -- nothing really crazy there. I don't know. At the high end production or office, Ursula, anything you need to --?

I think the point -- areas to point out are in high-end color. IGen4 full quarter of availability got it to the market in September, and it has done extremely well. It has done very well. IGen3, iGen4, iGen4 mix, really good mix towards the high end of the speed range. So we are pleased with the production color space. Anne talked about the 700, also to the market full in September, and we are seeing extremely good activity there as well.

Continuous feed color in black and white, still a small part of our business, but we are definitely taking share in those two segments as well. Black and white, we remain the share leader in the production space and gained share in the mono -- in the office space. So I think from an activity standpoint, you can see this in MIF and in pages, activity standpoint, we are doing good against the competition.

Yes. And we actually walked out of the year with nice backlogs in the 700 and iGen4, which is terrific.

And maybe that's a good segue to just talking about the backlog, what you -- how you feel about business going in. I know you said things are slowing in terms of the decisions, but anything you can give us into what plays into the decision making of your customers right now?

Well, I mean, I think what we said was that certainly color remains quite good and certainly the hot products, 700 and iGen, we are seeing very healthy backlogs on. We also talked about services signings up in the fourth quarter, and fourth quarter last year was really strong, so we are very, very pleased with that.

And so overall I think, although there's no question time to decision is a major headwind in terms of the hurdle rates for decisions these days, we think we are winning more than our fair share and clearly feel good about where Xerox is positioned in that.

The strength of the services business in this economy is a very big deal. Our enterprise print services offerings are absolutely driving a lot of our services contracts right now. So I think we have segments, color particularly, that are strong and services which are strong, which are offsetting a little bit of the weakness in the black and white world.

One additional add here, Shannon, is that our product introduction cadence for 2009 will continue to be strong, as strong as it was in 2008, so we believe that that positions us well as well.

I think we have time for one more question.

We have a follow-up from the line of Richard Gardner. You may proceed.

Thank you for taking the follow-up. Anne, I was just hoping and maybe Ursula that you could give us some sense of what the pattern is for renewals on the business that's coming up for renewal this year. Are the renewal rates pretty much in line with your historical experience or better or worse? Thank you.

I think there's no disproportionate, by the way, amount of the business that is up for renewal. It's a very, very even cadence in terms of the way that the business renewals occur. We are quite pleased with regard to our ratio of renewals. They are very, very high and continue to be high. We have no indicators that that business is at all at risk.

I would add we have even added, I think, on the incentive side for our field organization to focus on what we call same account revenue growth because we really think it's hugely important to get a larger share of wallet. So we have some help from the incentive compensation side, both ensuring we protect our base as well as grow it, particularly in the services area. So --

The only add I would have is on -- I talked about the new product introductions. We put these out primarily because they add additional value to our customers and that will help move decisions along for them to trade from the current base that they have to a better product, lower cost, more functionality, et cetera. And our renewals in color in particular are something that we are very, very pleased with. When we get a customer who buys a color system, their ability to rebuy from us, especially when we give them new functionality or better price, is very good.

Okay. And then maybe as one quick follow-up. Could you talk at all about where your customers are on current average toner usage versus the minimums that they are contractually required to take? In other words, should we be worried that customers a quarter or two ago had been using well above the contractual minimum and are trending back down toward the contractual minimum and a big impact on post sale as a result of that over the next quarter or two?

Well, we have talked about this before, that a large portion -- the majority of our contracts have minimums established. The best way for us to really get a sense of where we are is really pages. And so from that standpoint, I would say although page growth decelerated a little bit, it was up from third quarter to fourth quarter. So we saw a seasonal uptick in pages, so as you think about it, it has -- that would suggest that certainly minimums are not being breached and not even getting close in terms of the way the contracts are written.

Okay. Thank you, Anne.

Thank you. Thanks, everybody, for participating today. We appreciate your involvement this morning. Take care.

This concludes today's presentation. You may now disconnect. Good day.