全錄公司 (XRX) 2011 Q1 法說會逐字稿

Good morning and welcome to the Xerox Corporation first quarter 2011 earnings release conference call hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Luca Maestri, 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 recorded. Other recording 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 Ms. Burns. Ms. Burns, you may begin.

Good morning and thanks for joining us today. We will get started on slide 3. Our results in the quarter reflect progress in scaling our Services business while maintaining our leadership in document technology. Steady revenue growth and our sharp focus on operational improvement resulted in a 28% increase in adjusted earnings. This is the last quarter that we need to report on a pro forma basis. You will recall that we closed on the ACS acquisition in February of 2010, so going forward we have the benefit of a full year of ACS results in our year-over-year comparisons.

Our first-quarter pro forma revenue increased 2%. We delivered Q1 adjusted EPS of $0.23, which was above our guidance. On a GAAP basis earnings were $0.19 per share. This includes $0.04 from the amortization of intangibles. Cost and expense management remains a strength of ours, leading to a Q1 operating margin of 9.1%, a year-over-year improvement of close to 1 point. Gross margin of 33% is within our range and reflects the results of more revenue coming from Services and the continued impact of currency.

The first quarter is typically our lightest in the year for cash generation. Due to some seasonal effects of our business on working capital and the timing of accounts payable, we used $30 million in operating cash during the first quarter. We remain very confident in our cash flow for the balance of the year and continue to expect to deliver $2.5 billion in operating cash and $1.9 billion of free cash flow for the full year.

Our CFO, Luca Maestri, will provide more detail on cash flow and our financials in a moment. First I will review a summary of our Q1 performance and discuss how we are managing the impact on our business from the earthquake in Japan, then Luca and I will both take your questions. So let's turn to slide 4.

In the past year, we transformed not only our business into a leading player in the Services space, but also our business model, with growth largely driven from an increasing annuity stream. 85% of our total revenue comes from annuity, and annuity was up 3% in Q1 or 2% in constant currency. Total revenue of nearly $5.5 billion was up 15%. On a pro forma basis, it was up 2% in constant currency.

Equipment sales were flat in the quarter. This was not surprising considering the double-digit growth rates we saw in Q1 of last year as the economy was improving, especially in developing markets. Fast forward a year and we are facing volatility in some Middle Eastern markets, stalling previous rapid growth in this region. With a series of recent product launches and more to come in Q2, we expect to see an improvement in equipment sales later this year. For now, we are being prudent in our planning, considering potential product constraints from Japan. I'll talk more about this in a moment.

First, let's turn to slide 5 for a review of the metrics that fuel our annuities, pages, MIF, and signings. In our Technology business, we focus on color page growth and machines in the field, or MIF. Many of you know that I always provide a reminder of this equation. More MIF leads to more pages. More pages, especially color pages, generate more revenue from supplies and technical service. MIF plus pages equals more revenue flowing through to our annuity stream.

For Q1, we saw continued growth in MIF with digital up 2% and color MIF up 14%. Color is 32% of our MIF and 25% of pages. Total digital pages were down 5%, the result of declines in transactional black-and-white pages. Yet within total pages we had a 7% increase in higher-value color pages. We are focusing our investment on creating more color pages through affordable office color printing and more advanced digital production printing.

As important, we continue to grow our distribution network, including four recent acquisitions that expand our access to small and mid-size businesses. Three are in the US and one in the UK.

In our Services business, signings totaled $3 billion and were up 3% on a trailing 12-month basis. Keep in mind that the trailing 12 months and year-over-year compares can easily be skewed by big deals. That's the nature of a Services business and was the case this quarter. In Q1 of 2010, you will recall that we signed the $1.6 billion 10-year California Medicaid contract. The size and duration of the deal creates a tough compare for this year.

That said, I am very pleased with the success of our signings this quarter. It's $3 billion of revenue that benefits us over the length of multi-year contracts, and many of the wins were the result of cross-selling with ACS. Notable deals in the quarter include a $200 million contract to manage IT services for MGM Resorts International, reducing document devices from 2700 to less than 900 through managed print services for the workforce provider Kelly Services; managing clinical and Technology applications for clients who use Allscripts remote hosting services. Since Allscripts is the most used solution for electronic health records, this is a significant deal, valued at $500 million over the next 10 years and reflects increasing demand for healthcare providers -- from healthcare providers for IT support.

In addition, we are continuing to win government contracts for transaction and claims processing as well as transportation and parking services. Our growth in Services was driven by an 8% increase in revenue from our BPO offering, 4% from document outsourcing and 1% from ITO. That's strong performance across the board, along with a 29% increase in our total pipeline.

We are also scaling our Services business through acquisitions. In Q1 we announced an expansion of our call center business in Europe by acquiring Unamic, and through our acquisitions of CredenceHealth, we are strengthening our portfolio of software solutions that serve the healthcare market.

In summary, our progress in Services and Technology reflects our differentiation in the marketplace and the benefits of our diverse portfolio. We continue to hold the number-one revenue market share position for document technology, and the breadth of our Services offerings as well as our global account relationships give us a competitive advantage. So, it was a good start to the year.

Before I hand it over to Luca, let's turn to slide 6 for a review on how we are responding to and impacted by the tragic events in Japan. Most important, we are relieved to learn that our people, the Xerox employees in Japan and our colleagues from Fuji Xerox, are all safe. And since Fuji Xerox's major manufacturing and operations sites are in Tokyo and regions south and west from where the earthquake hit the hardest, our facilities were not damaged.

We do business with a number of other partners and vendors in Japan, and we are working with them on a daily basis to comprehend the impact on our supply chain. Our number-one priority is fulfilling customer orders and maintaining the uptime of their Xerox systems. That means alternative sourcing for components and materials, often at a higher cost, and it means more expensive distribution methods like air freight to avoid the long delays in many ports. As result, we are seeing increased supply chain cost. But we are focused first on our customer needs. Our employees in Japan and our colleagues in Fuji Xerox are doing an incredible job managing the complexities of this very challenging situation, and we are extremely grateful for their perseverance and tremendous support.

Based on our analysis of the situation, we expect to see some product constraints toward the middle of the second quarter impacting the pace of installs for Xerox and Fuji Xerox. And we don't expect to see a full recovery until later this year.

So from a financial perspective there are potential Q2 headwinds in three areas -- equity income from our 25% ownership of Fuji Xerox, supply chain cost and equipment sale revenue due to possible product constraints. Considering there is still much uncertainty, we're providing a broader range than usual for our earnings expectations in the second quarter. We expect that over the course of the year we will minimize the impact on cost and revenue. Therefore, we remain fully committed, we remain fully committed to delivering on our full-year expectations. We maintain a 24/7 focus on managing the situation in Japan, and I do feel that we are in a better position than most. Above all, we are doing what we can to help our colleagues in Japan recover and rebuild.

With that, let me turn it over to Luca, and I will be back to wrap up and open the call to your questions. Luca?

Thank you, Ursula, and good morning, everyone. As Ursula said, we are reasonably pleased with the overall results for the quarter and continue to see opportunity for further improvement ahead of us. Revenue growth on a pro forma basis was 2% in Q1, which was good performance but under our full-year range of 3% to 5%. We expect to accelerate revenue growth as we move through the year because of our significant signings in 2010 and as we begin to realize greater synergy revenues. Therefore, we remain confident in our ability to be in the 3% to 5% range for the full year.

Operating margin in the quarter was 9.1%, up nearly a point year on year on a pro forma basis and a very good start to the year. As anticipated, we saw currency and the mix of business impacting gross margin. But this impact was more than offset by disciplined expense management. Our D&A and SAG ratios improved quite significantly, thanks to restructuring and synergies, and we are well on track for our full-year objective of $270 million of restructuring savings and over $120 million of cost synergies.

On the gross margin front, we expect improvement over the year. We will continue to implement restructuring and synergy initiatives, and we see now reduced head wind from currency.

Equity income in the quarter was $34 million, which reflected a strong year end for Fuji Xerox. The $34 million includes $11 million in Fuji Xerox restructuring, which we did not adjust out this year. Adjusted EPS was $0.23 and grew 28% year on year. The only adjustment to reported EPS was the amortization of intangibles, and GAAP EPS of $0.19 was an improvement of $0.23 year on year.

As Ursula indicated, going forward we expect equity income to be affected by the events in Japan, especially during Q2 and Q3. We also continue to assess the direct impact on our operations, and we provide an update on this during our investor conference in May. As a result of the uncertainty from Japan, we're providing a range for Q2 EPS which is wider than usual.

Let us turn now to slide 8 for a review of our segments, starting with Technology. Technology revenue was flat in Q1 at $2.5 billion, about 46% of our business. Importantly, segment margin of 10.7% was up over a point year on year with benefits from restructuring more than offsetting the negative impact from currency.

Overall good performance, despite some head winds in the entry category caused by lower installs and equipment revenue. Entry install performance is weighted heavily towards the developing markets, and results in Q1 were in part affected by disruption in the Middle East. Looking forward, we anticipate trends to improve, although Q2 will face a difficult compare, given the 66% install growth that we had during Q2 of 2010.

On the product side we are in the midst of a refresh of our lower end multifunction product line, which we expect will help entry performance. Mid-range continues to show very good growth, thanks to our strong color portfolio, which delivers industry-leading quality, productivity and price value. The product line will also be strengthened by new product announcements in Q2.

In high end, the Color Press 800/1000 continues to perform well and is the driver of our color install growth. As we go through year, we will have more product launches, such as the already announced inkjet production system that will build upon our leadership in this segment.

In summary, solid overall performance in Technology during Q1, and we expect this will continue throughout the year.

Moving onto Services on page 9, Services revenue was up 40% or 5% on a pro forma basis. Growth was driven by BPO, which was up 8%, and document outsourcing, up 4% with good sequential improvement. ITO revenue was up 1%. BPO's 8% growth had strong contribution from HR services, from customer care volumes and new business ramp in transportation. This growth more than offset declines in government services associated with lower unemployment claims volume and contract runoff.

BPO signings were $1.25 billion with good momentum across all lines of business. ITO had very strong signings, which more than doubled year on year, and also had strong pipeline growth. We expect this positive trend in ITO to continue as new contracts ramp during the year.

Document outsourcing also had a very good quarter with strong signings up 42% year on year in addition to the revenue growth of 4%. Overall signings grew 3% on a trailing 12-month basis, which represents a deceleration, given the 10-year, $1.6 billion California Medicaid deal that we signed in Q1 of last year. In total, our Services pipeline was up 29%, including synergies.

Segment margin of 10.3% was up 0.7 points and reflected a positive contribution from restructuring and synergy savings.

In summary, positive results in both our Technology and Services segments.

With that, let us move to the cash flow slide on page 10. Cash from operations is seasonally weakest for us in Q1, and this quarter was further impacted by the timing of accounts payable. The accounts payable timing will work itself out through the year, and we remain committed to achieve $2.5 billion in operating cash flow for the year.

Earnings contributed $289 million to cash flow, strong performance but not enough to offset working capital usage of $584 million. Let me make a few comments on working capital. The accounts receivable movement is in line with prior Q1 performance and reflects the tremendous effort that is made each Q4 to drive collections. DSOs actually improved year on year, reflecting our focus on cash generation. Inventory performance is also in line with our expectations and reflects the building back of inventory after the high Q4 sales period. Accounts payable was a greater use of cash than normal, but broadly expected, given our seasonal timing of payments.

CapEx was $111 million for the quarter, and we are well positioned relative to our full-year outlook of $600 million. That was flat for the quarter, and our cash balance was $1 billion.

Slide 11 provides more detail on our debt and cash flow expectations. Beginning with debt, given our borrowing capacity and our objective to optimize funding costs, we intend to call our 2027 trust preferred securities during the second quarter. These preferred securities were issued in 1997, have a par value of $650 million and carry an 8% coupon. This action will help reduce interest expense and will be cash accretive by the end of 2011.

In our second quarter we expect to report a $34 million pre-tax charge as a discrete item, which represents $24 million of non-cash carrying value adjustments and a $10 million cash premium. We are raising our year-end debt target by $650 million, the face amount of this security, to $8.6 billion. Just to be clear, through this transaction our liabilities remain unchanged and this action has no impact on the level of available cash or on the timing of cash deployment. We also remain committed to maintaining a solid investment grade rating.

When looking at our debt balances, it is always important to keep in mind that the vast majority of our debt is in support of our financing business. We have $8.6 billion of debt, of which $6.3 billion can be associated to the financing of Xerox equipment for our customers, which assumes a 7-to-1 leverage of our finance assets of $7.2 billion. These finance assets represent a committed revenue stream from our customers.

As I said before, we remain confident in our achievement of cash from operations of $2.5 billion, and we expect to have $1 billion to $1.2 billion of available cash this year. We are fully committed to using over 70% of available cash towards share repurchases beginning in the second half.

In summary, we had a solid quarter in spite of some fairly challenging external circumstances. Our annuity-based business model and our market leadership position are strong assets which we will continue to leverage to grow earnings and return value to shareholders.

Back to you, Ursula.

Thanks, Luca. Let me quickly wrap up so that we can get to your questions. We are a full year into our acquisition of ACS and fully realizing the benefits of being the world's largest enterprise for business process and document management. We continue to expand our offerings through products and services that give our clients more flexible choices and give us a competitive advantage while strengthening our annuity stream. We continued to expand our distribution channels, reaching more and more customers, especially small and mid-sized businesses, on a global basis. And we continue to operate our business effectively and efficiently, helping to offset margin pressures from revenue mix and currency.

As result, in Q1 adjusted EPS increased 28%, revenue was up, and we improved operating margins. Generating significant cash flow is imperative to our business and a key focus for our leadership team. This year we expect $1 billion to $1.2 billion in available cash for acquisitions and to buy back stock.

For the second quarter we expect to deliver adjusted earnings of $0.23 to $0.26 per share, and we remain committed to delivering full-year adjusted earnings of $1.05 to $1.10 per share.

With that, I thank you again for joining us today and now let's open it up to your questions for Luca and me.

(Operator instructions). Shannon Cross, Cross Research.

Can you just talk a bit about what you're seeing in terms of page trends, actually sort of end usage at customers? Because you had page volume that was down 5%, yet document outsourcing was up 4%. So I'm kind of curious as to sort of where you think everything nets out in terms of what customers are doing and their willingness to print and that. And then I had a couple of follow-ups.

I think what we are seeing from page trends is a continuation of the trends that we saw in the beginning and all through 2010 and 2009, so -- with a little bit of a hiccup in this quarter, driven a little bit by the Middle East. So this is what is happening. In black-and-white, particularly high-end production pages, we continue to see a decline of those pages. That's pretty much what we expect, and it's kind of in our business model and our business thinking today. That decline has not significantly accelerated, but it is definitely continuing. It is a big piece of our page volume. We are at the same time seeing a pickup, an increase in color pages, and we are seeing an increase in average price per page, because we are -- as we mix towards color, the price per page actually trends upwards, which is good.

We're seeing an increased importance of the low end of our business, so the printing trends in small and medium, mid-sized businesses. And we are responding to that by increasing our product intensity there and our distribution there, primarily through acquisitions. And so -- and then overriding that, we had a pretty big stall in activity, and therefore in pages in the Middle East, which we expect to come back as that place, as that region settles down, which it is beginning to do.

So as we work our way through 2011, we will see continued growth in color, continued growth in average price per page, a decline in high-end black-and-white pages and a stabilization in the growth in the low-end pages, which will bring our trends pretty much in line with what we expect them to be.

Okay, great. And then, Ursula, if you could talk a little bit about geographic trends in terms of demand, what you're seeing in the various regions and any color you can shed on sort of what Fuji Xerox is seeing in terms of demand in Japan. I know it's a tough situation right now, but is some business getting back to normal? Or how should we think about that? And then also Europe and some of the other regions.

Let me start with the other regions, and I will end with Japan. In the developing markets, which was a high-growth area for us, it remains a growth area for us. We, as you know, had difficulty -- we and everybody else had difficulty in the Middle East area. It's a pretty big -- it's a good area for us; we are strong there, we have high share there and we were impacted by the downturn. We didn't lose position in that marketplace, so as the economy improves we will participate in that area, so no problems there.

From a DMO perspective as well, developing markets, Russia is a big area for us, and we had huge growth in Russia in 2010, end of 2009. And we are seeing that, this quarter, actually slow a little bit. But we don't expect that to be a continuous trend. I think that DMO, excluding the Middle East, will continue to be a growth area for us. So pretty good, those territories pretty good.

Europe -- we talked to you before about Europe responding better than the headlines would anticipate that they would respond. So our position in Europe from a market share perspective, the penetration of color products from our Services penetration, the winning of deals, all that is very good. Europe, as you know, is a lower-margin region for us, and so we are focused on continuing to win across-the-board technology in Services and continuing to focus on our cost and expense in that area so that we can have a good -- continued good business model. But Europe is strong.

US, I have to say, has a little bit better output than it had in previous quarters. Our equipment sale revenue in the United States is definitely picking up across the board. We are strengthening in all segments, primarily driven by the fact that we have increased penetration and performance in the low end of the business and we continue our strength in the high end, particularly at color.

We do have a product gap right below the very high end in color, right above the mid end in color that we will fill in the second half of the year. That should help us to even turn that around a bit, particularly on the post-sale side. But US better than it was in the past, still a little bit tepid but improving, improving for us.

Japan -- it's hard to tell, Shannon, and I'm not trying to be evasive at all. We are in constant contact -- when I say constant, it's like annoyingly constant, probably, for the people in Japan -- with them on how they are doing. And their transparency is cloudy, so our transparency is cloudy as well.

What I can say is that our post-sale stream, which is very important, it is 85% of the total revenue and on the equipment side 70% plus of the revenue -- that is not impacted at all. The first thing that we focused on is to make sure that we can get that supply stream assured so that we don't have any customers who have already bought the technology down are waiting for us. We have that pretty well secured in both Japan and in the US.

The part that was affected for Fuji Xerox was not a high business area for them, or for anybody, it seems like, at all. The big issues are how they supply to the rest of Japan and to the rest of the United States and to the rest of the world, particularly to the United States.

So in Japan, we are seeing not a lot of transparency. We were able to get through the first quarter well, both Xerox/Fuji Xerox. We are pretty sure we will be able to get through from an equipment side the first half of the second quarter. We think we will have some problems in the second half of the second quarter, but we are also pretty confident that we will be able to work through those throughout the year. And so, without having detailed transparency to all that's happening in Fuji Xerox, I'm confident that we will be able to manage it on a Xerox income perspective.

Fuji Xerox -- it depends. I think that they're coming up, they're doing okay, they are dealing with it -- rolling power outages, all these things kind of contribute to the uncertainty. But if they perform, which we expect that they will, like they did in the first quarter, our first quarter, we will be able to make it through the rest of the year, I think, without any hiccup on an overall basis from a year perspective.

And if you think about what happened there, it's kind of an amazing statement. As I said when I was speaking earlier, I think that we are definitely better positioned than most -- I'm pretty sure of that, even though we haven't seen what the other Japanese competitors or manufacturers are saying about their results.

Great. Yes -- no; I think next week will be interesting, when Canon and others report, so thank you. And then, Luca, if you could possibly just talk about your initial thoughts on what you have seen at Xerox, opportunities -- you have been there a few months now -- it would be great to get your take on it.

Sure. I think probably the word to summarize my thoughts is execution. When I look at some of the commitments that we've made, we need to execute on those commitments. From an operational standpoint, we are in the midst of a large restructuring program which we have announced but we need to execute now. We are doing a very important synergy activity with the combination of ACS and Xerox, both on the revenue and on the cost side, and we have got a number of new products that we need to launch on cost, on time, on quality.

And then we've got a lot of financial commitments, right? We talked about EPS growth, we talked about cash generation, we talked about debt repayment and, of course, the share buyback, right? And those are commitments that we are fully committed to and we will execute against.

And then, from an overall business perspective, when you look at the longer-term, the key for us is revenue growth, and it needs to be profitable. And that's why we are so focused on these revenue opportunities that we've got with the combination of Xerox and ACS, and that's why we continue to be focused on acquisitions and that's why we continue to be focused on refreshing our product portfolio. And international growth is important for us, and that's why we are focusing on places where maybe traditionally we are not as focused as we are today.

Great, thank you very much.

Ben Reitzes, Barclays.

There's two pretty important things I want to clear up. Last quarter, on your slide deck, slide 10, you said cash flow from core ops of $2.8 billion. And this time, on slide 11, you are saying $2.5 billion. Now, I think you're trying to say the same thing because there's some receivables, some from the financing division, that are floating around. And I just want you to clear that up, because I think that some folks today think that these slides don't match up and that there's $300 million less in free cash flow for the year. And I'd like you to clear that up right now.

I'll clear it up, and my purpose was to simplify the chart, and really what should matter to investors is cash from operations, which has always been $2.5 billion. The number has not changed and it is not changing.

The second point, we talked kind of as a subset of cash from operations, we talked about cash from core operations of $2.8 billion. And then we said that there would be a use of $300 million from the growth of our finance asset portfolio. Right? But cash from operations is what matters; it's $2.5 billion, it was always $2.5 billion. And then how that translates into available cash -- that also has not changed; it's $1 billion to $1.2 billion. And you just go from the $2.5 billion of cash from operations, then we've got our CapEx of about $600 million. Then we talked about debt reduction of $600 million and dividends of $300 million, right?

So that's the math. Nothing has changed. We just kind of simplified the chart. And really, the metric that matters to us is cash from operations.

Okay. And then on top of this, there's $300 million in finance receivables that will roll off that are not included here.

That's correct. We're going to -- well, no, it means that our receivables related to the finance assets are going to grow by $300 million, and therefore cash from core operations before our finance asset portfolio has to be $2.8 billion because there's going to be usage of $300 million from the finance assets.

Okay, then I got it, right; I misspoke. But when you -- okay I got it. So nothing has changed, 100%? And the --

Nothing has changed.

-- net cash flow is still the same, and you just simplified it. Now, Ursula and Luca, a question for you. When you mentioned the cash flow in your speech, Ursula, you said that it was strong and it was a big focus and it's absolutely coming back. When you mentioned what you're going to use it for, you said acquisition. But in your slide, it says majority going to share repurchases. I assume you meant the majority going to share repurchases and then a minority going to acquisitions. I just want to be clear on that.

Yes; actually, if you -- I think I said exactly what you just said, which is that we will have $1 billion to $1.2 billion, we will use 70% of that or the majority of that for share repurchase, and we will then make acquisitions. On this cash statement, on this cash discussion, $2.8 billion to $2.5 billion, to $1 billion to $1.2 billion, 70% of the $1 billion $1.2 billion for share repurchase and acquisitions; the vast majority of the $1 billion to $1.2 billion is share repurchase. Nothing has changed. Nothing has changed.

And it can start in August; right?

It can start in the second half of the year, which is what we said. You're not going to pin me down to an August -- second half of the year. On the call, I want everyone to be confident of the following things -- one, that we will generate the cash. That's what we do. We've done it for as long as I've been here, and Luca has not changed one step in that; actually, he's put additional focus on it. We will get $2.8 billion. We will use $300 million for finance receivables. We will get $2.5 billion, we will use CapEx, etc., etc., get to $1 billion to $1.2 billion. We will take 70% of that, and we will buy back shares as soon as we can start doing it. And then the rest of it we will use for acquisitions, for dividends, for whatever we can think of that's really great with the rest of the cash that we have.

And then just a nit, Luca, on modeling. Should we use a 29% tax rate going forward? And what should we model for equity income? Should it just be something around $30 million a quarter or $20 million to $30 million a quarter net of restructuring charges for Fuji Xerox? Thanks, that's it.

The guidance for the tax rate is 31% for the rest of the year. So 29% in Q1 was just an outcome, but we continue to see about 31%. And obviously, the equity income for Fuji Xerox, it's a question mark also for us, so maybe we can compare notes. But, yes, $20 million to $30 million is a good number.

Thank you.

Richard Gardner, Citigroup.

Ursula and Luca, I was hoping that you might be able to give us some idea of how to think about gross margin here over the next quarter or two, given the puts and takes that you talked about during your prepared comments. On the one hand, it seems like you're going to have some extra cost associated with air freighting equipment and expediting stuff out of Japan. On the other hand, currency is moving back in the right direction, and my understanding is that you typically go back and renegotiate your supply contracts with Fuji Xerox with a one- to two-quarter lag and recoup some of the negative impact of currency over time.

So how should we think about gross margins over the next quarter or two?

So, I would say this quarter was affected by -- half a point was currency, right? And then the rest was this shift of our mix of revenues towards Services that carries lower gross margin. Going forward, I would say that we should be seeing an improving trend on gross margins. You're absolutely right; I think freight will be a head wind because of the situation in Japan. But using today's rates, the currency head wind is mitigating significantly. There is a lot of volatility in FX these days, so every day is a different story. But as a trend, currency should be much less of a head wind.

And typically -- Q1 is the weakest quarter that we have, right? So with a bit more activity, that will help gross margins as well. So those are the big variables there.

But we said all along 33% to 35%. We believe that we are going to be in that range for the year.

And, Rich, if I just may, on Fuji Xerox contract negotiations, we do generally -- we continually negotiate with Fuji Xerox and hedge currency with them and so on. But Fuji Xerox today is a little different than they were 12 months ago, obviously. So they are scrambling. I don't expect that we will have massive shifts in cost to Fuji Xerox that will help us mitigate this head wind.

With that, I think that we will still be in the 33% to 35% range that we talked about.

Okay, great. And I guess one follow-up for you, Ursula. You referred to the fact that you did expect production of black-and-white pages to continue to decline. It looked like black-and-white pages were down high-single digits in the quarter, backing into that from the other data that you provided. Does this weaker page growth change your view at all regarding the sustainable growth rates for the core business? And do you still think that pages can grow at some point as we get deeper into an up cycle or (multiple speakers) is this the new norm for us?

No; I think that what -- first of all, I think that we should wait another -- I have to wait another quarter to see more data. This quarter, while the results were very solid for the Company, we had some interesting signals this quarter or interesting inputs that I don't consider normal, and I would like to be able to see our way through those a bit before I make a prediction or update my prediction.

So without an updated prediction, I would say that black-and-white pages will not accelerate significantly, the decline of them, and that color pages will not accelerate significantly from the way that we were thinking about them in the past. So I think that we will get through this first half of the year, maybe the first three quarters of the year, and be able to see that -- there's not a lot, from how we look at the business, that has changed substantially. The Middle East and Japan and the effect of that on how we can fulfill needs and how customers buy, etc., is something I want to see a little bit more clearly. So I would wait to quarter two.

Color pages continue to grow. I think that's good. Digital pages in general -- color pages are now about a quarter of the pages that we generate, it's 30% of the MIF; I think that will continue to grow. Our total digital MIF is growing. So I think there's nothing that would say that it would fundamentally change, but I think we need another quarter to see how this all works out.

Okay, all right, thank you.

Keith Bachman, Bank of Montreal.

Hi, Ursula, I had one for you. I wanted to broaden the capital allocation question, and that is, as you look out the next couple of years philosophically, how are you thinking about the longer-term allocation of capital between the buckets of M&A and then buybacks and dividends? And particularly within the context of M&A, trying to understand how you think about the capital allocation between, say, the core Xerox business, the previous -- the legacy business, I should say -- and then the new Services business? Because, clearly, the growth trajectory -- you are having great results on ACS, and the core Xerox business had had a little bit of trouble here with the economic cycles in Japan. But just want to understand longer-term, how do you think about that allocation process?

Thanks for the question. So for the longer -- for 2012, our focus 2011-2012, is going to be on buying back shares. So most of the capital that we get will, for 2011 -- obviously, we will start it later this year. In 2012, we have a pretty big chunk to go in buying back shares.

So for the near-term, that's the focus, obviously. But we generate more cash than we need to use in buying back shares. So clearly, after that, we will continue our M&A cycle. We're doing that today; we've bought five, six companies so far this year. So we will continue doing that. And then we will clearly, I think, tail end of this year start speaking to the Board, and the Board and us will start considering what the heck we do with the dividend. So that progress will continue 2011-2012. And as we get beyond that, we'll have to see. We will continue to generate a significant amount of cash, $2 billion-plus, and we will have to invest it. And we will buy back shares in a reasonable sense, but after a while it gets kind of -- you run out of energy on that one. So we will switch to M&A and to dividends.

As far as allocations towards core and -- our core business, the Technology business and the Services business, we are -- our Technology business CapEx is fairly well-defined. It's around $300 million, plus or minus a little bit, and it won't -- I don't see a significant shift, growth or a significant decline in that. So I think that as we move forward on CapEx, the way that you can think about it and the way you should think about it on capital allocation in general, is more and more will go towards Services.

Our R&D is going to shift more and more towards our Services. Our acquisitions clearly are more in the Services space, etc., etc. So you will see a shift in our capital allocations towards the growth in Services. But we will not walk away from the Technology business until it's worthwhile to do that.

Yes, just to add, on acquisitions, the acquisitions that we make for, call it traditional Xerox, are very much focused on distribution, right? And those acquisitions have worked very well for us, and it's very important for us to broaden our coverage both here in the US and overseas. We made -- probably the largest acquisition that we made during Q1 is a company in the UK, distribution company in the UK. Very, very important for us to continue to do that because it helps us offset some of the negative trends that you see on the technology front. So I think it's very balanced and it's not different from what we were doing in the past.

Yes, yes (multiple speakers); I guess I'm surprised -- go ahead, Ursula.

And that said, we do play -- we have an advantage that we have. Fuji Xerox, who will continue to focus more heavily on investing in the technology side from an R&D perspective than Xerox does, and Xerox will, as we go forward. So we get to play a very good, harmonized game here where we can utilize the expertise in Fuji Xerox to continue to fuel our technology R&D. We help them do that, obviously, and we will spend a little bit more time focusing on our services.

All right, (multiple speakers) but I guess I'm surprised to see you continue to invest more in the distribution space, given what I think is just tremendous opportunities on the other side, the Services space, specifically. (multiple speakers)

Yes, I'll tell you, I would be -- if I were you, I would be really nervous if we didn't try to figure out a way to cover more of the small and mid-sized business growth around the world. That would be walking away from easy, quote-unquote, easy money. Our big gap -- we cover the high-end marketplace very well with our technology and our distribution; we do it extremely well. But as you know, that part of the market is not growing as quickly as the small and mid-sized business, and it is significantly more focused on margin-lowering activities than the small to mid-sized business.

So what -- our distribution expansion is all around covering a place where our share is probably half as much as our share in the high end of the business. So the reason why we are continuing to invest is because it's business smart to do. The technology that we have applies there just as well as it does at the high end.

And don't misinterpret my comments; I'm not saying that I'm going to not invest in Services. I'm shifting quite a bit to Services and expanding our investments there. I just don't believe it's prudent, we don't believe it is prudent to walk away from this very lucrative Technology segment way before you have to.

Okay, well, thanks for that answer. I just wanted to ask about, then -- my final question is just on OpEx. As you think about absolute dollars of spend in OpEx, if I look at, say, June and September, what does that number look like? Is it flat, down, up?

I think it's probably, throughout the year, tending upwards, tending upwards.

Yes.

Because revenue -- our revenue in the third and fourth quarter, in particular, is growing, will grow. It will grow at a pace higher than it did in the first quarter and than it will in the second quarter. So as our revenue grows, our OpEx will have to grow to support that growth.

Okay, all right, well many thanks, I'll cede the floor.

Ananda Baruah, Brean Murray.

Hey, thanks, good morning, guys, and thanks for taking the question. I guess Ursula and Luca, could you maybe talk through some of the interplay that we are beginning to see between Services signings and Services revenue growth, I guess, those dynamics? Particularly as the signings of -- you know, the growth has come down to, I guess, low-single digits, where it is now, what should we expect through the year on each of those metrics? And I guess ultimately, maybe if you look towards -- I mean, maybe not 2012; I know you don't want to give guidance. But I guess, what ultimately should we think of as normalized signings growth rates when things settle in?

So I'll start and Luca can jump in if he has anything to add. So first of all, the most important metric is revenue, and we are really pleased with our overall revenue growth. The combination of new business signings, which is really important -- so you get new business that adds onto the revenue you have -- and the annuity revenue that we have that we will continue to get, we have and we'll continue to get from already committed, signed contracts is exciting there.

And you saw the growth in revenue there, BPO up 8%, document outsourcing a really good rebound, up 4%, and ITO up 1% after a strong first quarter of about 5% growth. So, across the board, we are happy with revenue. That comes because we signed things previously. And if you could -- the way that you should think about signings is that we had -- as I said, we have -- I didn't say this yet. We had uptick in ITO signings that was fairly dramatic, doubled our signings in ITO. We had an uptick in document outsourcing signings that was very dramatic, a year-on-year increase upwards of 40%.

So it will continue to drive revenue. Our signings are very good. BPO signings were very strong. I mean, you have to think about the fact that we signed a $1.6 billion 10-year contract in [2000] -- but this is a rich man's problem to explain. You have a signing like California Medicaid and then I have to explain the fact that it's not growing as much -- I have no problem with that.

So signings in BPO, in ITO and document outsourcing, all good. The pipeline of signings is mixed very well. The pipeline is mixed very well, so signings on a go-forward should be good across the board, ITO, BPO and document outsourcing. And our synergies pipeline is up, synergies -- pipeline is up 29%, which includes synergy signings.

So I think, if you look at signings across the board, we are very pleased with them. We continue to win in all the segments that we focus on. There will be compares that are difficult in certain quarters because we did (inaudible) the previous quarter. But net-net, pure dollars, doing extremely well.

And I guess -- Ursula, I appreciate that; that's helpful. I guess because signings is something, I think, that you folks are going to increasingly become focused on, is there any way that we can think of what a normalized signings growth would be? Or, over time, should we think of the signings growth approximating the revenue growth? I mean, just so that when we see it move around, or should we expect it to move around some because of the nature of the verticals that ACS is attached to, and maybe they are more prone to megadeals?

I guess, should we expect the kind of movement that we've seen the last few quarters? Is that normal, just so that we know it's normal? Or, should we expect some kind of approximation, eventually, to revenue growth?

Ananda, I think you know well, signings is not a perfect metric, right? There's a lot of variability within the numbers, right? Think about the fact that we participate in so many verticals, and the duration of these contracts can be extremely different. You go from a three- to five-year contract, and then now, a transportation business, sometimes we talk about a 50-year contract, right? So obviously, when you sign a very long-term contract, then you skew the numbers, right? So you need to expect some kind of volatility there.

Think of our ITO business this quarter; it was up more than 100%, right? Obviously, it's that type of stuff, so it's very difficult to give you a normalized rate. Of course, in the very, very, very long-term, it should approximate revenue growth. But particularly when you talk about quarter comparisons, it's going to be moving up and down a lot.

Next question, please; thanks Ananda.

Doug Ireland, JMP Securities.

I was wondering if you could talk a little bit about any impact you saw in the Services business in the budget delays and some of the uncertainty around government budgets. Has there been any impact there?

We are really pleased with our government business. It's about -- it's a big piece of our BPO business. As you know, it's about 40% of the BPO/ITO business. And if you remove transportation, it's a little bit lower than that. So we are pleased with it. It is something that we focus on assuring that we win.

Now, have we seen impact? As more people are employed, the less unemployment there is, so we have definitely seen volume declines, lower volumes in our service of the government from an unemployment perspective. And we've seen a little bit of lower volumes or a little bit lower revenue as some of the contracts that we won are now ending -- not ending that we lost them; they are ending because they ended, the service is done.

But the way that we manage this business is that we actually mix it across the board. So, while that is going down slightly, we have to actually increase, and we have increased, our signings and our revenue on the commercial side. The answer is yes, a little bit, but not any way that would have me consider government being anything but a very, very lucrative and extremely important portion of our business. But yes, we have seen some downward turn there, but not significant.

Thank you. The other question I had is a little bit more theoretical. Could you give us a sense of the assumptions you are making about the printing business that drive your investment in distribution? Are you looking at this purely from a market share gain in cutting off distribution of competitors and getting higher consideration with a same win rate? Or, are you looking at a longer-term growth opportunity? I'm just wondering what's driving that decision-making.

Yes, so I think that you should look at it from a purely financial perspective. Obviously, the step right before the revenue and profit potential of the business is, you have to get share. So let me back up.

The big thing here is color. If you didn't have a black-and-white business -- let's suppose there was no history in black-and-white -- everyone in the world who is competing today would be competing to get a position in this color page market because it is lucrative, because it is growing. So our investment here is in distribution, in R&D and it's pointed heavily towards color across the spectrum, low to high. That's it.

At the same time, we have a black-and-white business that we still have to service. It's not growing, but it throws off cash and it's reasonably profitable. So the way that we look at it is running after the part of the business that is growing and that is profitable and that's exciting and keeping hold of, for as long as is reasonable, the part of the business that customers still want but at a lowering demand rate.

So that's the shift that we are making here. And in order to service that, we need to actually have distribution, we have to have products that serve the customers' needs. You shouldn't think about us investing a whole lot of money in black-and-white R&D, or black-and-white manufacturing, because that's not what we are doing. Most of our investment is in R&D, and one of the ways that we can make this shift and in some ways downturn in R&D is by focusing our energies on the parts of the business that are growing.

Thank you.

Yes, next question, please.

Deepak Sitaraman, Credit Suisse.

Just a follow-up to an earlier question on deal trends in the Services business, especially for BPO and ITO -- can you give us some color on what you are seeing in terms of sales cycles, and also in the pricing environment? And then just as a follow-up for Luca, also in Services, can you help us think about margin progression as we go through the year? Specifically, as you ramp some of the new Services revenue opportunities, how should we be thinking about the lag between when you start recognizing those revenues versus the up-front costs associated with that? Thanks very much.

So our sales cycle -- I'll do this relatively quickly, and then this will be the last question for the group. Sales cycles -- I think what you can think about is not a significant change in trend from previous discussions that I've had. But let me remind what they were. For very -- the different segments of our business in the BPO space -- and in the BPO space, if you think about government, the sales cycles are generally long. When I say long, year, a year, a year-plus kind of sales cycles. The deals are generally larger. And our win rate in these long sales cycles/large deals is very good. We have over half the states, for example, in Medicaid, etc., etc. So you will see long sales cycles, difficult, challenging sales cycles that you have to stick with and that we can -- that we win. And it's actually a good business; it's a difficult one, but a very good business.

In some of the ITO spaces, the sales cycles are shorter, so -- significantly shorter, you know, a quarter or less, and the deals are smaller, obviously. We have two that we signed this year, this first quarter, that are longer and bigger than any historically. But, generally, ITO has some walk-in takeover deals and they have some shorter cycle deals. So you see the spectrum of them. Document outsourcing is definitely in between those two -- not short, not as long as some of the healthcare BPO-type deals, but they are in the middle of it.

So you see them across the board, you know, different durations of selling before you actually win. And the alignment between how long it takes to sell and the size of the deal is pretty much 1-to-1. With a long sales cycle, the deal is generally a lot bigger.

Pricing, what we see is that the go-in pricing for a new deal is generally attractive, very attractive; it remains attractive through the contract. Renewals are generally at a lower pricing than the old -- than the first time in, for sure, almost everywhere. And what we find is that what supports this lower pricing is our intimacy and knowledge and the customer's intimacy and knowledge of us. So we can actually still extract good margins, equal margins or improving margins the longer we are with a customer, because we actually know how to actually streamline the operations we give to them. One of the things that we do, for example, is to never make the margins get too high because the customers would actually feel disappointed and think that we are actually not sharing the benefits adequately with them. So whenever we get a really wide margin spread, we would go to a customer and renegotiate it before the contract was up.

So margins, pricing on a new deal is lower than pricing on the old -- on a renewed deal is lower than pricing on the old deal. Margins should be the same. And if we are really good at how we manage it, a little bit of growth in the margin portion. And then, Luca?

Yes, so, from a ramp-up perspective, keep in mind we've got a very, very diversified portfolio of Services, right? So a lot depends on the mix of the portfolio. In places like ITO or customer care, the ramp-up is fairly quick. In other places, within BPO or transportation, for example, we are talking about much longer ramp-up periods, up to 18 months. And also, the profitability of the different lines of business is different. So the net outcome of this is very influenced by mix.

We do expect -- you were asking about, okay, how do we think about gross margins for the Services business for the rest of the year? We do expect the margin to be more or less where we are right now, maybe a slight improvement because we continue to work on -- both on restructuring initiatives, and also on synergies also on the Services side; it's not only related to Technology. So flat to slightly up for the year.

Okay, thanks to all of you for your time and for the good questions and for your interest. I look forward to seeing you in May, on May 10 at the investor conference. Please enjoy the rest of the day. Thank you.

Thank you for joining today's Xerox first quarter 2011 earnings announcement conference call. You may now disconnect.