全錄公司 (XRX) 2011 Q2 法說會逐字稿

Good morning and welcome to the Xerox Corporation second-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'll get started on slide three. This is a reminder of the strategy that we are executing on to transform our business. As I've said before, many people talk about transformation, and we're actually doing it. Through these four priorities, we mark our progress and measure our results.

First, capturing the sizable opportunity from scaling our services business. You'll see this quarter that we grew our services revenue by 6% with very strong performance in both document outsourcing and business process outsourcing. Our pipeline grew 21%, and we continue to benefit from revenue synergies through cross-selling with the ACS.

Second, maintaining our leadership in document technology. We continue to hold the number one revenue market share position overall and in color, and we are launching new products that solidify our strong leadership.

This quarter revenue and installs were impacted by the supply constraints stemming from the earthquake in Japan. We are on track to reduce backlog while meeting new demand in the third quarter.

Third, continue to improve the efficiency of our business operations, running a lean and flexible annuity-based business. This served us particularly well in Q2. Our disciplined approach to expense management offset the incremental supply chain costs and helped drive strong bottom-line results. By executing well on these first three priorities, we are delivering on the fourth, expanding earnings and returning cash to shareholders. Adjusted earnings per share were up 13% in Q2.

So we're well positioned for a solid second half of 2011. We plan to invest more in acquisitions that further scale our services and expand our distributions. We will resume our share repurchase program during the third quarter, and we are increasing our expectations for full-year earnings.

As with most businesses, we face headwinds or tailwinds during any 90-day period. Our success is determined by how agile we can be to effectively manage complex challenges while staying focused on our priorities. Considering the Q2 costs and revenue headwinds related to Japan, I am pleased with our progress and confident in the direction that we are heading in for the rest of the year.

Now let's take a look at Q2 results.

Our performance in the quarter reflects progress in our services-led, technology-driven business, and our sharp focus on operational improvement. We delivered adjusted EPS of $0.27. As I mentioned, that's up 13% from a year ago.

On a GAAP basis, earnings were $0.22 per share. This includes $0.05, primarily from the amortization of intangibles.

Revenue was up 2% aided by the strong euro. Technology revenue was flat, and services revenue increased 6%. As we discussed during our Q1 earnings call, supply constraints resulting from the earthquake in Japan did increase our costs and impact install activity and revenue in our technology business. I'll provide a more detailed update in a moment, but can tell you that we're already seeing significant improvements, and we expect to be back to normal operations in the fourth quarter. Our effective expense management helped to offset the incremental costs incurred from the supply chain challenges, so we are able to maintain steady margins in the quarter. Operating margin of 10.4% was up 0.3 point. Gross margins of 33.4% is within our range and reflects the result of more revenue coming from services.

We generated $347 million in operating cash flow during Q2. We faced some unique challenges relative to cash usage during the first half of the year, including cash needs from ramping new contract signings and incremental cash required to support the supply chain constraints.

As a result, we are lowering our full-year guidance for operating cash flow to $2 billion to $2.3 billion. Our second half of the year is typically stronger for cash generation, so our plans stay the same for $1 billion in available cash to be used toward modestly sized acquisitions and about $700 million in share repurchase. Considering our expectations for significant year-over-year cash improvement in 2012, we remain confident in our guidance for next year of $2.6 billion to $2.9 billion in cash from operations.

Our CFO, Luca Maestri, will provide more detail on cash flow and our financials in a moment. Then Luca and I will both take your questions. Let's turn to slide five.

Before we go into more detail on the results, here's the status on the supply chain issues. The Q2 impact was expected and created a backlog for orders taken in the quarter, orders that we will be filling during the balance of the year. We're working very closely with our colleagues in Japan to accelerate production and ensure we are meeting our customers' needs. That means alternate sourcing for components and materials, often at a higher cost, and it means more expensive distribution methods like airfreight to expedite shipping.

We're pleased with Fuji Xerox's operational management during this challenging time. As you'll see in the Q2 results, our equity income from FX was better than expected. It's difficult to project if this will continue since FX is still working through the uncertainties in their business and in their geographies. We continue to expect that production levels will be back on track over the next couple of months, and that will resume normal supply chain operations later in Q3 and into Q4. We maintain a 24/7 focus on managing the situation in Japan and throughout our supply chain. I'm confident that the worst is behind us, so we can focus intently now on reducing backlog and meeting new demand.

Let's turn to slide six for a more detailed review of Q2 revenue.

Here you will see the relatively even revenue contributions from our services and technology business. We expect the services percentage will continue to grow as we invest more in broadening our outsourcing portfolio and expanding our offerings globally. This growth strategy results in more long-term contracts that benefit our annuity stream, which is now 84% of total revenue.

Total revenue of $5.6 billion was up 2% or down 1% in constant currency. Equipment sales, as I said, were largely impacted by the supply constraints. With a series of recent product launches and a supply chain recovery, we expect improved equipment sales in the second half of the year.

As Luca will share with you, our new products are very well received in the marketplace and fill a need for affordable and more productive color printing in offices and print shops.

Please turn to slide seven for a review of key metrics in our technology business.

The metrics on this slide will look very familiar to you. We reported on them for a while, reflecting our strategic focus on moving black-and-white pages to color devices. You'll see strong progress this quarter with color MIF growth of 15% and color page growth of 8%. Digital page trends are the same on a quarter-over-quarter basis, no change, and continue to reflect declines into these transactional black-and-white pages.

It is important to note that our MIF metrics exclude printers, excludes our business in developing markets, and products sold through global imaging systems. And page counts include only estimates in those three areas.

That said, as we execute on our strategy to expand indirect channels to increase our global imaging business and to grow document outsourcing, we increasingly have less ability to accurately measure all the pages printed on Xerox systems and the number of machines in the field. So going forward, you'll see us report less on MIF and pages; instead, we will provide more context on in-store activity and revenue growth.

More important to our annuity stream is our growth in services. The multiyear contracts for our outsourcing business deliver strong recurring revenue. In Q2 services revenue was up 6% or 4% in constant currency. Our leadership in managed print services contributed to 10% growth in our document outsourcing business, and the breadth of our offerings in business process outsourcing resulted in 9% BPO growth. Strength in both of these areas offset a decline this quarter in IT outsourcing. Luca will share more details in a moment.

I'm often asked if the pressures on government spending are impacting our business, especially in the BPO space. We are exceptionally well positioned with federal, state, and local governments around the world. Revenue from our government contracts often fluctuates based on usage patterns. For example, in Q2 growth in transportation services helped offset the lower volumes from unemployment claims. This is another benefit of having a diverse portfolio in BPO. It gives us flexibility to manage through the changing dynamics in government spending. So our government business does go through cycles, but net-net, we view our strong hold in this space as a key asset of our business today and going forward.

In the quarter signings for Xerox's services totaled $3.5 billion, up more than 15% from last quarter and down 10% on a trailing 12-month basis. This decline was due to the cyclical nature of contract signings and longer lead times for large multi-year deals, some of which were completed this month.

Our pipeline remains very strong, up 21%, and helping to fuel our healthy annuity stream for the long term.

So summing up the quarter, I would characterize it as a good overall progress quarter, especially considering the unprecedented supply chain challenges. We have effectively executed on all of our key priorities just scaling our services business through our expertise in managed print services and BPO; strengthening our leadership in document technology through expanded distribution and innovation that accelerates the adoption of color; effectively managing our global operations; and generating cash that we can return shareholder value through stock buyback and dividends.

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. This was a challenging quarter in some respects, given the impact from Japan, but eventually we were successful in offsetting the constraint to revenues and delivered strong EPS. This is encouraging as we look forward to a Q3 where we should see recovering technology and acceleration in services.

Revenue growth was 2% in Q2 at actual currency with a 3 point benefit from currency. Services drove the growth and was up 6%, while technology was flat. In the second half, we expect revenue to be within our 3% to 5% guidance range.

Operating margin in the quarter was 10.4%, up 0.3 year over year and up over 1 point from Q1. We saw sequential improvement also in gross margin; however, year over year gross margin was impacted by the mix of business, by the ramp of new service contracts, and incremental supply chain costs related to Japan. This impact was more than offset by disciplined expense management. RD&E and SAG ratios improved significantly due to restructuring synergies and improved bad debt trends. We remain on track for our full year objectives of $270 million of restructuring savings and over $120 million of cost synergies.

Equity income in the quarter was $34 million, which slightly exceeded our expectations and reflects the restructuring benefits of Fuji Xerox, more than offsetting the disruption from the tsunami. The $34 million includes $4 million in Fuji Xerox restructuring costs, which we are not adjusting out this year.

Adjusted EPS was $0.27 and grew 13% year over year. The only adjustments to reported EPS were the amortization of intangibles and the loss on early extinguishment of liability from the redemption of the trust preferred securities that we mentioned during the Q1 call. As a result, GAAP EPS was up 38% year over year.

Let us now move to the technology segment on slide nine. Technology revenue up $2.5 billion was flat at actual currency and down 4% at constant currency due in large part to the impact of Japan on product availability. Segment margin of 11.8% was up over a point year on year and continues to reflect the benefits from restructuring and synergy savings.

Entry installed performance is weighted heavily towards developing markets and, as I indicated during the Q1 call, faced a difficult compare in Q2 given the 56% installed growth that we had during Q2 of 2010. The recent product launches should drive improvement in this product segment during the second half. Midrange growth continued despite being the product segment most impacted by the Japan shortages. This performance reflects our very competitive color portfolio, which was further strengthened by the launch of our latest ColorQube family of products in Q2, and we expect this favorable trend to continue as we start to address our backlog situation in Q3.

In high-end we saw mixed performance. iGen4 had a very strong quarter, reflecting demand from new features. The 800/1000 color press also showed good growth, but not enough to offset declines in the entry production color space. We have a product gap in this category which we anticipate will be helped by a series of product actions, the first of which is the recent launch of the new 8080 product line.

In summary, good progress on costs and expenses offsetting impacts from Japan to drive operating profit growth of 10%.

Moving onto services, slide 10, services revenue was up 6% with BPO up 9% and document outsourcing up 10%. ITO revenue was down 10%. BPO's 9% growth was driven by recent acquisitions, as well as human resources and healthcare payer services and by increases in customer care and transportation volumes. This growth more than offset declines in government services, lower unemployment claims volume as an example, and the timing of contract runoff and ramp. BPO signings were at $1.8 billion, which is lower year on year, but up over 40% sequentially, and we have good prospects and high expectations for BPO signings in Q3, which has started on a strong note.

ITO revenue declined 10%, driven by lower third-party hardware and software sales and lower recording revenue as we have not yet seen the contract ramp from recent strong signings.

Document outsourcing had a very good quarter with revenue up 10% thanks to the ramp of the new signings and improving page volumes. Signings of $1.4 billion were also strong with both renewals and new business up double digits. Overall signings declined 10% on a trailing 12-month basis but grew over 15% sequentially. The trailing 12-months calculation includes the 10-year, $1.6 billion California Medicaid deal we signed in Q1 of 2010, as well as the Texas Medicaid renewal that occurred in Q2 of 2010 for close to $1 billion.

We continue to see strong growth in our services pipeline, up 21% including synergies. And this is, of course, a positive indicator for future signings. Segment margin of 12.1% was up 1.8 points sequentially but down 0.5 point year on year, reflecting impacts from contract startup cost and lower volumes in some government transaction areas.

In summary, overall solid performance in services with expectations for improvement both in signings and in ITO during Q3.

With that, I now move to the balance sheet slide. As we communicated during Q1 earnings, we called our 2027 trust preferred securities in Q2, and we refinanced this amount by a very successful bond offering at a lower cost. The securities carried an 8% coupon, and this action will reduce interest expense. Our Q2 ending debt balance increased to $9.3 billion, but to be clear, our interest-bearing liabilities remain unchanged as the trust preferreds used to be reported as a separate balance sheet line.

The vast majority of our debt is, as you know, in support of our financing business. Of the $9.3 billion debt balance, $6.3 billion can be associated with the financing of Xerox equipment for our customers. The finance debt is calculated assuming a 7 to 1 leverage of our finance assets of $7.2 billion, and these finance assets represent committed revenue streams from our customers.

We have a debt payment in August, which will get us to our year-end debt balance of $8.6 billion. And with the majority of our debt supporting our financing business, we have a strong capital structure in place, allowing us to return value to shareholders starting in Q3.

Slide 12 provides further detail on our cash performance. Cash from operations of $347 million improved over Q1, but fell short of our expectations. Performance was driven by earnings of $327 million, and working capital was a slight contribution to cash flow.

Pension and restructuring outflows, as well as Capex of $135 million, were in line with plans. While the second half of the year is seasonally our strongest, we are reducing our full-year operating cash flow forecast to a range of $2 billion to $2.3 billion to reflect our lower first-half performance and some headwinds that are unique to this year.

First, we are achieving growth in services in a slightly different way than we had anticipated due in part to the mix of business and the combination of contract runoffs and revenue ramp. For instance, we're currently ramping multiple Medicaid and transportation contracts, which require major upfront costs before they produce significant revenue or cash. We are also supporting ACS's investment in several new services platforms, and we are seeing new signings with higher startup cash requirements.

We are also affected by the situation in Japan. In Q2 we have absorbed incremental cost and cash outflows related to air shipments, sourcing from alternative suppliers, as well as pre-purchasing raw materials. This will continue into Q3. The higher than normal inventory backlogs and the shift of revenue toward the end of the year also caused a negative impact on cash.

As Ursula said earlier, this adjustment to 2011 guidance does not change our 2012 cash from operations guidance of $2.6 billion to $2.9 billion, as we will have year-on-year improvement from lower pension funding, lower restructuring payments, and higher net income. The guidance adjustment also does not impact the $1 billion of available cash for share repurchase and acquisitions. Let me walk through the math.

CapEx forecast for the year is now slightly lower at $500 million. This estimate is in line with the $246 million that we spent in the first half. Debt reduction and dividend assumptions remained the same at $600 million and $300 million, respectively. The remainder of the available cash is coming from our year-end cash balance. Cash from operations at the end of 2010 came in ahead of expectations, and we exited the year with a cash balance of $1.2 billion. We do not require a cash balance at this level and can make this excess cash available for share repurchases. This gets us to approximately $1 billion of available cash, consistent with our prior guidance of buying back $700 million of stock in 2011.

In conclusion, we continue to execute on the strategy Ursula outlined in the beginning. We grew earnings by 13% through a combination of services growth, operating margin improvement, and lower interest expense, and we are focused on leveraging our annuity-based business model to drive cash flow and return value to shareholders with the share repurchase program beginning this quarter.

With that, back to Ursula.

Thanks, Luca. Let me quickly wrap up so that we can get to your questions.

Xerox is now the world's largest enterprise for business process and document management. Our expanded offerings, our broad distribution channels, our global scale, renowned brand, and innovations give us a differentiated advantage in the marketplace. We're leveraging this competitive position by taking a services-led, technology-driven approach to growing our business. And we continue to operate efficiently, maintaining steady margins and increasing earnings despite the recent Japan impact on cost and revenue. Our capital strategy contributes to our bottom-line results and positions us well to continue delivering shareholder value through dividends and beginning in quarter three, share repurchase.

We're on track to deliver solid results in the second half, and we're increasing our full-year guidance. Full-year expectations for adjusted EPS have been raised to $1.07 to $1.12 per share. For the third quarter, we expect to deliver adjusted earnings of $0.24 to $0.26 per share.

And with that, I thank you again for joining us today, and now let's open it up for questions.

(Operator Instructions). Benjamin Reitzes, Barclays Capital.

Thanks. Can you talk about what gives you confidence that you can generate so much cash in the second half to still hit your lowered estimate? You've got to do close to $2 billion in cash flow from operations in the back half of the year, the high billions at least. How do you get there?

As you know, second half is seasonally strong. If you go back and look at past years, you see that we generated very significant amount of cash during the second half. Look at the, for example, in 2010, cash generation. Earnings are stronger. We expect working capital to be favorable, and those are going to be the primary drivers. So we are fairly confident that we are going to get to that range.

And then what is the savings from the interest expense, the lower interest expense? If you are going to buy over the next year and a half, $1.7 billion in stock, what happens to the interest and other expense? Does it stay the same, or are there real savings there?

Interest expense are going to be significantly down this year because we've taken debt down, and we are refinancing at better rates. For example, with the refinancing of the trust preferreds, we will be generating on an annual basis about $20 million savings; about $11 million of that will have an impact during 2011. So we will continue to see reduced interest cost as we go into 2012 as well.

The share repurchase will come from available cash, and we do not expect any requirements to increase debt for that.

Yes, and you're not earning much on that, I'm sure.

Okay. Are you still committed to buying back $1 billion next year, even though you have lower cash flow than expected this year?

Our buying back for next year, we talked about having $2 billion of cash available, and we've actually said 70%. So it is probably going to be a higher amount.

Yes, a higher amount than the $1 billion, and we are still committed to the share repurchase, starting this quarter, flowing through the fourth quarter all the way into 2012.

And my final question is just around changing metrics around the pages and machines in field, etc. So I think at your analyst day you said, well, pages are going to decline, but we have higher value pages so we can still grow. So I guess I just want to ask, big picture, is that still true?

And then secondarily, I wanted to ask about just in terms of what metrics -- you want us to focus on MIF and how are we going to use that to really understand the growth of technology? Thanks.

Thanks for the question. On the changing metrics, I think I gave a little bit of color on what's happening. It's actually good news for our business. It is implementing the strategy that we laid out. We have a great channel in global imaging, and we are moving more and more accounts over to global imaging for them to form and grow. We have a growing reseller business where we acquire distribution and move them onto Xerox technologies. We have growing businesses in DMO -- you get the message that literally we're moving our distribution channels to a broader set of channels.

The good news about that is that we get more activity; the bad news about that is that we don't get all of the visibility that we would have gotten if we sold them directly through our channels. And while -- I'm not trying to hide anything, we're just trying to not estimate on estimate on estimate and get ourselves into a level of inaccuracy.

So what we're trying to do and what we will do on a go-forward basis is to tell you in detail the activity levels that we achieve and the split of that activity level between black-and-white and color, and we can tell you that because we see that throughout our chain, and we will talk about revenue. And revenue split by black-and-white and color will also give an indication of how we're performing in our metrics.

So installs or activity and revenue are the places that we will focus as much energy as we can to give as much visibility as we can. This is not to try to hide anything. It's literally just that our business is actually growing in ways that we don't have deep visibility into the pages or to MIF. I hope I answered --

Thank you.

Ananda Baruah, Brean Murray.

Thanks, guys, for taking the question. Congrats on navigating a challenging environment out there -- lots of moving parts.

I guess the first question is, can you give us some sense of the slope of the return in business as you work through the Japanese supply constraints, and do you think -- is it your opinion that we will exit this year, enter next year with the Japanese supply chain issues behind us?

The answer is we started to see improvement at the tail end of last quarter, and we're starting to see it at the beginning of this quarter. This is not an inexpensive way to do business. Two things will happen in the rest of the year. One is we have a backlog that has built up. We are staying in contact with those customers, obviously, making sure that we keep the orders on hold, and as the supply chain loosens up, as Fuji Xerox production continues to ramp and we get them here, generally still in third quarter by flying them here, so the cost will still be high. As we get them here, we will be able to not only alleviate some of the backlog, but we will also be able to fulfill new demands. And that's the mix that we have to do.

As we go into the fourth quarter, the production should be at regular levels, and we should be tailing out of, still having some, but tailing out of shipping things here by air.

Now there's a lot of ancillary cost around that that we don't talk about. It's really complicated, as you said, to manage this. We have parts that we have to move around in an unusual way. We have people that we have to move around in an unusual way. I think that by fourth quarter we should be done with a lot of the big noise. We should be into a fairly normal operation in the first half of next year for sure. We should be on a regular business as usual basis.

Ursula, that's helpful. Thanks. And I guess just a follow-up to that, is there any chance that if you don't see demand come back to the degree that you think it will that there's some sort of counterbalance on the cost side that would serve as a tailwind to top income dollars. So, for example, if demand doesn't materialize, you don't need to airfreight certain things out. So you get a bit of a counterbalance there, or is that not the right way to think about it?

Not the right way to think about it. Let me be clear -- demand is not the problem here. Demand is not the problem. We always have demand problems, as you know. That's what we do. We sell things. People just call them up and get them from us.

But this is not a demand issue. This is a supply issue. So we are responding to assuring that we don't keep customers hanging on for too long after they've already told us they want to buy something and given us an order. And that's where the costs are coming in. If the orders don't come in, we don't incur the costs. But the orders are coming in, so we are incurring the costs.

No, understood. Thanks a lot.

Shannon Cross, Cross Research.

Thank you very much. My first question is just about revenue expectations for the second half of the year. Historically you see seasonal weakness in third quarter, but it sounds like maybe that won't necessarily be the case this year given the backlog that you had in second quarter. So if you could just talk about how we should think about revenue in the various segments as we look at the second half, basically?

We expect revenue growth for the second half to be within our guidance range of 3% to 5%. And in terms of the dynamics of the two segments, technology, 1% to 3%; services, over 6%.

But when we think about the backlog, it seems as if you could have done better in terms of revenue in second quarter clearly because you weren't able to ship the products. So how --

Shannon, if I can just -- I'm sorry for interrupting you, but if you looked on our normal business seasonality, we would have lower revenue in quarter three than we have in quarter two. It's usually our lightest quarter.

This year, because of some of the reasons that you brought up exactly, will probably -- we will have higher revenue in quarter three than we had in quarter two. So we will definitely see some of that recovery. In quarter three from quarter two, we will see improvement in technology revenue in quarter three, for sure.

Great. That's what I thought was probably the case.

And then can you talk a bit about on the BPO signings, if we think of sort of net of the large contracts that you had in the prior year period, what was the growth there? Are there any large contracts pending, just how you see the pipeline for BPO?

Let me start with the signings, and then we'll talk about pipeline. You're right. We had two what we call mega deals that affect the metrics. It's the California Medicaid, which it was a new signing last year, and Texas Medicaid, which is a renewal from last year.

If you exclude from the calculation -- we don't want to exclude it because, of course, it's a good business for us. But if you exclude the two megadeals in the metric, then we would show signings growth of 9%. The pipeline in BPO right now is very strong. We talked about a total services pipeline of over 20% growth, and BPO is in the same range. And we've got a lot of good prospects, particularly in the commercial area, particularly on the commercial segment.

Great. And then my last question is just with regard to end demand -- what you're hearing from your customers, thoughts about Europe -- just any color you can give, given some of the questions that are out there with regard to the macro events that are going on. And it seems as if enterprise is holding in there, but I'm curious as to what you're hearing.

We are seeing enterprise -- start with your last comment -- we are seeing enterprise hold up. It's interesting. Europe is not -- we're not impacted by some of the situations in Europe yet, but we are very cautious about this. The trends here are not and the noise from this part of the world is not getting better. So we are operating really tight to the cuff to make sure that we don't get ahead of ourselves. Meaning that we know we are not going to be oblivious to the continued weakness, economic weakness in Europe. So we're not seeing it yet, but we'll see how it goes.

US enterprise is good. There is no fundamental change. We are seeing slowing of decisions, particularly in the government sector, which doesn't surprise anyone, and volumes down in some parts of our government business. Luca referred to unemployment benefits, which are down, primarily because people are rolling off the rolls, not necessarily because they are getting jobs.

So government we see -- it's still a great business for us, still strong, local, state and federal, but it goes up and down depending on the contracts that we see.

Technology business, it is going along as normal. We don't see a lot of changes anywhere in the world. We do see weakness, which we saw last quarter in the Middle East, but we're just dealing with that as the normal outcome of a business and strength in Russia. Normal flows there.

And I know you don't sell into China, but through Fuji Xerox and what you've done there, as well as India, any comments on what you're seeing there?

We do sell into India, and we are particularly pleased with some of our services success in India. That's where we're focusing a lot of our energy, particularly document outsourcing services. We've engaged -- with a significantly deeper and more pointed focus since the beginning of this year, and we're seeing some success there. And Luca, why don't you talk about China?

So China in general, Asia-Pacific was a good region for Fuji Xerox during Q2. Of course, they got significant issues in Japan, and the issues in Japan will continue into Q3. Particularly they are going to have power shortages during the summer. So yes, their Asia-Pacific and China business have helped offset some of the domestic situation.

Great. Thank you very much.

Keith Bachman, Bank of Montreal.

Thank you very much. Ursula, is there any way to normalize what revenues would have been if you could have gotten normal fulfillment, just what would revenue growth have been in either in total or however you want to answer it?

Yes, we think that at a minimum we were impacted by about 3 percentage points, at a minimum in technology. It didn't really affect any growth in technology at a minimum.

Now, the reason why we haven't gotten into this and trying to do a big mathematical thing is because, when something like this happens, you do a lot of things. One of them is redirect your salesforce, and you make them because we have a supply shortage that is significantly less effective than they would have been normally. So we don't spend a lot of time actually trying to figure that out.

What we're preparing to do is to assure that we have, which is what we're doing, the supply that is needed to backfill -- to fulfill all of the backlog and to take on new demand. But yes, we definitely suffered to the at least 3%. That's what we know -- the orders that we know that we couldn't --.

Luca, when you gave the revenue targets for September, just to be clear, were those in constant currency or as you think they will be reported with the help of FX?

Yes, good question. Sorry, I didn't mention it before. 3% to 5% we're saying right now for the second half of the year, we say constant currency. And, of course, if the rates stay where they are right now, there could be an uplift of another point or so from currency.

Then fair enough. And then on ITO was certainly a little lower than we were thinking. How does that track as we get into the second half of the year?

Better. ITL was not a strong point for us in the quarter. Interestingly enough, we had some really good, very good signings in ITO in the quarter, but we had a little bit higher than normal set of losses. And some of those we knew. We knew that we would be coming down in some of the ITO business because they were ramping down, not because we lost them, but because they were not going to be there anymore.

What we see in signings, as I said, is signing projections are good, and the contract ramps for some of the things that we won look good. In quarter three we must, we will include -- improve our ITO business. As you know, we talked about MGM and Allscripts, two very, very, very large ITO bids that we won, which is very encouraging.

BPO still stays like an engine in document outsourcing as well, and ITO should improve in the third quarter and fourth quarter.

And then my last one is very strong expense management, very nice job. How does SAG and R&D track as we look at Q3 specifically? Because it looked like headcount stayed about the same, and yet your expenses were down materially from the March quarter or from last year, however you want to look at it.

So I think what we did in Q2, we really wanted to protect the quarter, and we took a lot of actions. And it came out right. At the same time, we want to balance this for the rest of the year with the idea we want to continue to invest in the business, brand investment, people investment, and we want to grow the business. So I would say that probably some of the performance that you've seen in Q2 will not repeat in the second half on the expense side.

Right. So I would assume that translates to OpEx goes up sequentially from Q2.

Not necessarily. Not necessarily.

Slightly.

Slightly. So yes, I think we have a really good pulse on our cost and expense in the businesses, as you know, and if you've been following us.

The balance here is, as Luca said, it is really important. We have an anomaly in quarter two that will carry on from quarter three.

What we had to balance, we had to do this in expenses; we had to do this in cash. We didn't want to actually make a quarter and rob the business for the future, so we had to invest in people. We continue to invest in people. We continue to invest in our brand. We are continuing to invest in the BPO and ITO business to make sure that we can grow that. And to make sure that we could do that, we took some extraordinary actions on cost. But not so much that they would actually -- they're not so wild that we can't keep some of them going.

Thanks very much, guys. I will cede the floor.

Deepak Sitaraman, Credit Suisse.

Thanks very much. Ursula, on services your 6% plus growth outlook appears to be at the higher end of the 4% to 7% guidance range you have talked about in the past. So assuming that the DO and the ITO pieces of it grow in the mid-single digits on a full-year basis, that obviously implies very strong double-digit full-year growth for BPO. First of all, I guess can you just clarify how much of that is coming from acquisition? And secondly, I think you mentioned commercial as being strong, but any other color you can share on verticals or even geographies that are driving strength when you look out, would be very helpful.

Yes, I'll have Luca start on this one, and then I will dive in after a few --.

So in BPO clearly we are expecting to continue to grow very robustly. A good chunk of the increase comes from acquisition. You were asking the question, out of the 9% I would say 5 points this quarter were from recent acquisitions. So obviously -- and this is part of our model -- we continue to make acquisitions in the BPO space to fuel this growth. It is the growth engine really for us. And also on the services side, so you should expect to see growth rates that are above the range that we've given for the services segment overall.

And then as far as color on the mix, you were right. Commercial was stronger than government. The mix of commercial is in our sweet spot, the spot that we participate in and to say, well, all of the customer care, some of the healthcare sides of the business in transportation, for sure. We had strong signings across the board, and we were able to have some of those signings, over 15 of them in Europe -- outside of the United States.

So we're starting to see the expansion that the strategy calls for, which is to have every line of business contribute to growth and to accelerate that growth by going outside of the United States, and we are doing both of those.

The notable difference is in certain segments of the government where we're seeing two dynamics. One is volumes being a little bit lower. We talked about unemployment as one. Clearly -- obviously people can understand that, but transactions like that. But also for our new business that we're seeing coming that we're pursuing, longer times to get to closure of a deal. Meaning we're participating very well, and we are often down selected, but we have to do a lot of work with state and federal governments to get the thing actually signed.

Not perfect but very, very good that we are in the throes of the last deals, and they will eventually come. It's just taking a little bit longer.

So commercial, good; healthcare, good; transportation, customer care good; federal, okay, but a little bit slower than I would like it to be. And then ITO, as we said, we had a weakness in the second quarter that will definitely be remediated in the third given the ramps that we're going to see from the signings that we already have.

That's really helpful. I guess if I could just ask one more, you've noted a couple of times today just expectations for a very solid second half. Yet when we look at your revised EPS guidance for the year, you've taken the full-year guidance up roughly by the amount of the second-quarter beat. I guess should we read into that as conservatism, or is there anything else you are trying to signal in terms of visibility or some other uncertainty that's being factored into that guidance?

I'm definitely not trying to signal conservatism. I probably shouldn't be chuckling at that. It's hard to get through these quarters, as you probably know. We have headwinds for sure that we're working our way through from a slowdown in the economy -- there's no doubt that is -- we're navigating well, but we don't see a big tail wind from the economic forces around the world, anywhere.

We still see headwinds from Japan. We are balancing that headwind with all of the things that we're doing to run the business. And I think that the guidance that we've given for the second half is prudent, very prudent given all that we're trying to do and all we're trying to balance.

I think you're right. I think we are quite bullish on revenue. We definitely see some pressure on margins. Japan being a case in point because, of course, all the incremental costs that come with that. But in general because of the uncertainty that you see around the world -- in Europe, in government, the supply chain -- where we sense some pressure on margin and, therefore, we balance these things, and that's the way we ended up with the revised guidance.

Thank you very much.

Richard Gardner, Citigroup.

Thank you. I wanted to go back to Japan and the cost side of the equation there. I know that most of your product coming out of Japan typically goes on a boat, and you probably had sufficient product to handle demand during the first half of Q2. I guess the question is, should we expect air freight and other logistics-related cost to actually go up in the third quarter as you try to work down the backlog, or do you expect those costs to go sequentially?

Air freight will definitely go up in quarter three. It will definitely go up in quarter three. I think you understand why. You produce -- we could put everything on a boat, but then customers would definitely not be pleased with us because they have been waiting for a while.

So what we're doing is balancing towards the heavy side, particularly in quarter three, the first portion of quarter three, a large amount of our supply coming by air. Because now they have made it, and in order to get it here in reasonable time, to come by air.

As we get to quarter four, tail end of quarter three and quarter four, we start to put more and more things on the boat. And the timing should be able to work to have a normal supply gap -- order to install gap for clients. If it turns out the way that we are predicting and the way that we have people all over the place in Japan, including our guys there, we should be into normal air ship in the fourth quarter. But the third quarter we will definitely be heavier into air ship than even we were in the second quarter.

And then the logical follow-up, Ursula, is how much of the incremental cost is associated with air freight? And if we take a look at total cost associated with the tragedy there, will they be up or down sequentially in Q3?

They will be up in Q3. They will be up in Q3. No doubt about it. And total cost, we just haven't really given it out. Part of the reason is we haven't really stepped back yet and added it all up. I mean we're adding it up as it goes. And we will work that with our partners around the world, etc., etc. But quarter three is going to be a little bit more expensive. It's comprehended in the numbers that we've given you for sure, but yes, not much more to say.

Freight is an important element of the incremental cost, but we set up alternative suppliers. We prepurchased materials. So there's many different costs that come into the equation, and clearly air freight is an expensive proposition.

So thank you, Rich.

Actually, could I ask one more question?

No. Yes.

Thank you. A little bit of a longer-term question, on ACS you are taking down your cash flow guidance this year in part due to the fact that you've got more new business this year than you had expected and less renewal. You've also talked about a big opportunity for ACS longer-term beings expanding that business into Europe. And a question that I get a lot from investors is whether there's going to be another surprise in terms of cash flow or expense guidance next year as you ramp up investments in infrastructure to handle that expansion of ACS into Europe, leveraging Xerox's presence there. I would love to get your thoughts on that.

So clearly expanding into a new market requires some use of capital. At the same time, we are present in Europe. We are going to try to go-to-market with a model that really leverages the existing Xerox infrastructure that already is present in Europe. There is going to be some use of capital. But we are comprehending that into our numbers.

As we look at 2012 cash, really there are some drivers that are outside of the ongoing operations that will provide us some positive factors. I mean we are going to be spending less on pensions. We are going to be spending less on restructuring. So we feel that we certainly are going to generate more cash next year.

ACS already today, even though most of their business is US-based today, they already have a global delivery model. So it's not that we need to go and invest on the delivery model. It's more like the salesforce end of the business.

Thank you, Rich. Next question, please.

Bill Shope, Goldman Sachs.

Thanks. I have a question, I guess digging a bit more into the cash flow, which I know you've had a lot of questions on already. But I recognize that you guys are pretty confident in the second half, and that lends to confidence in the new target. But on the off chance there's a low probability event that you do have some incremental unexpected pressure on cash flow in the second half, how should we think about the risk to the buyback program? How much buffer room do you have in terms of that cash flow target coming down and in terms of maybe pulling from other areas of capital management to maintain the current share buyback target if unexpected events occur on the cash flow line?

We considered the share buyback a key priority for the second half. So obviously, we're going to be very focused on getting to an available cash of $1 billion. The $300 million on acquisitions I would say is a number that is on the low end of the range that we've given previously, and we feel that it is part of our growth model. So we need to continue to spend on acquisitions. But there is a number of items on the profit and loss and in the cash flow that we are going to be working very hard. And as we think about priorities, we know that we need to deliver on the buyback.

Great. And then one final question. You had mentioned earlier that you had longer lead times on signing and multiyear services contracts. Can you give us a little more color on how you're thinking about this as a near-term dynamic or a longer-term dynamic? And if it is a longer-term dynamic, what do you think is driving that? Is this an industry-wide phenomenon, or is this something that's endemic to Xerox specifically?

I don't think it is endemic to Xerox at all. I think the bigger the contract -- and this is when I talk about longer cycles for signing, generally in government and generally big things. These are not fall off the lot contracts. So it's definitely associated with -- it's an industry-wide phenomenon. It's associated with some of the uncertainty in government. This changes -- you get new people sitting in different chairs, that kind of stuff, and due to the fact that they're big.

I would not -- this should not be considered like a problem. It clearly is -- fix is a word -- it gives you some ups and downs in quarters, but they do sign. They do sign. They have to sign because the work has to get done, and generally if they sign, we win. So I am confident in this part of the business getting back to normal. I don't think it's something I think you said endemic or systematic.

Thanks. That's very helpful. Thank you.

Thank you. Next question, please.

Chris Whitmore, Deutsche Bank.

Thanks very much. I also had a cash flow question or two. Of the $350 million of cash flow reduction in the guidance for the year, how much is related to the supply chain and how much is related to the services business?

I would say it's 60%/40% -- 60% services, 40% Japan.

And does that upfront capital commitment -- I guess I'm trying to understand why that wouldn't continue as you try and grow that business going forward. Have you changed any of the terms and conditions you are willing to take on in trying to close some of these contracts? And to sustain growth -- why wouldn't you continue to need to deploy that capital?

Some of the increased cash requirements are coming from the fact that our renewals are maybe slightly less than we would like, and hopefully that trend will not continue going forward.

Secondly, we have a number of investments going on right now for services platforms -- think of these Medicaid platform, which we call enterprise, and then we have got another platform called eligibility again related to government services. These are investments that once they are made we are going to leverage throughout a number of business lines, and so we do not feel they are going to be a recurring drain on cash.

But clearly, we have always said it all along, if you want to grow, working capital probably is not going to be the source of cash that it has been for Xerox in 2009, 2010.

My last question, I wanted to come back to this question around page growth. Last year, for all of last year, equipment sales grew around 9%, and now that's continuing to translate into, what, about 4%, 5% declines in page volume. What does it take to get that page volume to turn up?

Part of the reason why we're actually thinking about this is because we absolutely do see activity growth, color growth, etc., all of the things that we spoke about. There's a lot of stuff going through different methodologies that we don't naturally capture. As I said, global imaging growing like a weed. The pages that are captured -- the equipment that goes into global imaging and the pages that come through there, the best that we can do is estimate them. DMO continuing to grow. The best we can do is estimate them.

And then competitive devices that we have when we win document outsourcing deals, we don't count them at all. So we just can't be as accurate as we once were in this area. I think that we are seeing in this bad time sequential flatness. So we're seeing no change, which if you think about it, based on what happened in the second quarter of this year, is actually a good sign, a good indicator. A bigger mix toward color. From the things that we can even count, a stability in pages, and then the places that we don't count of significant growth in activity. So I actually -- particularly in global imaging and in DMO. So I actually am feeling better about pages than I have in the past.

And so what does it take to turn them? I think we are doing all it takes, which is selling more, installing the right types of devices, etc. protecting the base like we can, etc.

Thank you.

We will take a final question. Thank you.

Mark Moskowitz, JPMorgan.

A couple of questions here real quickly. Luca, could you talk a little bit more about how investors should think about the contribution to earnings from revenue growth and mix longer-term? Obviously, share buyback is going to help out here in the near to mid-term, and you guys have some incremental OpEx activities. But when do we really get the benefit from revenue growth and mix?

For which year?

Let's do 2012 to start.

So we talked about revenue growth next year of, say, 4% to 6%. We think that that growth should translate into earnings. Mix is going to be primarily towards services, which carry slightly better margins than technology, so that should be a positive as well.

Go ahead.

Go ahead, Ursula.

No, please continue and then I'll bring it all together at the end. Go for it.

I was going to ask, just in terms of -- your confidence today seems a little less than usual, Ursula, regarding the color business. Can you guys just talk a little more about maybe clarifying what happened in color in terms of the high-end deterioration, how much was tougher compares versus supply constraints versus other?

I am actually just the opposite on the color business. We have unbelievable activity levels given the supply constraint that we had in midrange color. So in the office color space, we are "growing like a weed." We are doing very, very well. At the very high end of color, the iGen space, very big page front colors, iGen space and the 8100, the color press series, very, very strong performance.

We had, I talked about this last quarter as well, we have a gap in the high end of the entry production space. We have a gap that we are filling. We just launched a product called the 8080, and we have more offerings to come that will help us regain our position in this space. I actually feel extremely confident about color.

And interestingly enough, I am very confident about black-and-white. The only problem with black-and-white is this is not growing. But our share position is very strong. If a deal comes up, we win more than three-quarters of the time. So I'm strong there, confident there. It's just that that portion is not growing. I spend a lot of time on color. We spend a lot of time on color, and we are all over it. We are the number one color shareholder. We're the number one revenue shareholder, etc.

So I don't want you to walk away from this call with a statement that I'm not confident about it. It's just the opposite. I'm actually very confident about it. And as supply comes, I think we'll be fine here, totally fine here.

Thank you.

Thank you all for joining us today, and I will see you in the field -- myself and Luca. Thank you very much.

Thank you for joining today's conference call. You may now disconnect.