Xerox Holdings Corporation (XRX) Q4 2010 Earnings Report, Transcript and Summary

Good morning, and welcome to the Xerox Corp. Fourth Quarter 2010 Earnings Release Conference Call, hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Larry Zimmerman, Vice Chairman and Chief Financial Officer. During this call, Xerox executives will refer to slides that are available on the web at www.xerox.com/investor. [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. Before we review our results, let me take a moment to comment on another set of news of the day, Larry Zimmerman's retirement and the appointment of Luca Maestri as our new CFO. To be candid, this is a bittersweet moment for me and for many of us at Xerox. It's not easy thinking of Xerox without Larry, and it's impossible to thank him enough for all he's done. In his nine years as our Chief Financial Officer, he has made contributions that far exceed the role that any CFO plays. He is truly respected, not only for his exceptional financial management, but also as a trusted business partner. Larry retires at the top of his game after helping us create a financially strong and growing, global enterprise with a sustainable and successful future. In building this solid foundation, he's paved the way for his successor. For that, we are grateful and we are fortunate. Next month, Larry hands the CFO role to Luca Maestri. Luca brings to Xerox two decades of international experience and a successful track record of leading large finance operations. Through his most recent position of CFO of Nokia Siemens Network and his 20 years in financial and operational leadership roles with General Motors, Luca's experience extends across several geographies and sales channels, and his expertise reflects the balance between disciplined financial management and business expansion. They are skills that complement the strength of our leadership team and the experience our company can benefit from in this transformative time. So while Larry will stay with us as Vice Chairman through April 1, and he knows I'll be counting on his counsel during that time, this is his last official earnings release. Luca is here with us today to observe, but he doesn't officially join the company until February 16. And while the CFO is changing, certain things always remain the same. First and foremost, delivering value for our shareholders through consistent revenue growth, disciplined cost controls and strong operating cash. We'd adjust that in Q4. So let's move on to our results. You'll hear from Larry in a bit to cover our financials, and then Larry and I will both take your questions. We'll get started on Slide 3. We closed the year strong with steady revenue growth and excellent cash generation, reflecting the strength of our business model and the benefits of our expanded technology and service offerings. For this quarter, we're still reporting not only GAAP earnings but also adjusted EPS. We're also reporting on a pro forma basis, which assumes that ACS was in our 2009 results. Our fourth quarter pro forma revenue was up 2%, or 3% in constant currency. We delivered Q4 adjusted EPS of $0.29, on track with our guidance and bringing us to $0.94 for the full year. On a GAAP basis, earnings were $0.12 per share. This includes restructuring and intangibles. We took a restructuring charge of $273 million in the quarter, a bit more than we initially planned. And as we shared with you last quarter, the restructuring gives us more flexibility in our business so we can continue improving operating margins while maintaining investments to drive growth. So where there was restructuring opportunity in Q4, we pursued it. Cash from operations was $1.3 billion, contributing to a very strong $2.7 billion in full year operating cash and free cash flow of $2.2 billion. With that, we also reduced debt by $1.9 billion from the time of the ACS acquisitions last February. Cost and expense management continues to be an operational strength of ours, leading to a Q4 operating margin of 10.4%, a year-over-year improvement of one point. So a good quarter and a solid way to end the year. And let's turn to Slide 4. As you see here, our revenue remains almost equally split between Technology and Services. This gives us a steady mix of annuity that comes from both segments. It's always worth repeating that in Technology, we generate recurring revenue through service and supplies, and multiyear outsourcing contracts are the source of strong annuity from our Services business. Total revenue of nearly $6 billion was up 42%. On a pro forma basis, it was up 3% in constant currency. Annuity revenue on a pro forma basis was up 3%. Equipment sales were up 6%, a growth rate that is more in line with normalized levels considering that the economy began slowly improving in the fourth quarter of last year. For the full year, we grew equipment sales 10% in constant currency, reflecting strong demand for our new products and expanded global coverage, both of which positions us extraordinarily well as the economy improves and businesses start to invest back in technology. During the year, we launched 21 products, with an emphasis on broadening our color portfolio for both production and office markets. As a result, we made more progress in growing color pages, an important contributor to our annuity stream. Slide 5 shows some of the key metrics in this area, where we saw solid sequential year-over-year progress. In our Technology business, we monitor page growth and machines in the field or MIF. More MIF leads to more pages. More pages generate more revenue from supplies and technical service, both of which flow through to our annuity stream. For Q4, we saw continued growth in MIF, supported by a 6% increase in installed Xerox equipment. And through our innovation and leadership in color printing, we continue to drive an increasing share in MIF and in pages. Total revenue grew 6% in the quarter, 8% for the full year. Big contributors to these growth rates are the Xerox Color 800 and 1000 series, and the ColorQube family of multifunctional systems, which uses our proprietary solid ink technology. With solid ink we're able to significantly lower the cost of color printing, making it a more viable option for businesses of all size. That's why we're growing our line of ColorQube systems, scaling our solid ink investments to make color printing as affordable as black-and-white. And we did see a pickup in usage trends during Q4, leading improvements in digital pages and color page growth. As color continues to replace black-and-white printing in office and production environments, color pages grew 11% on a year-over-year basis. We saw this as a good sign, helping to offset declines in black-and-white pages. We've stated before that more transactional pages are logically moving off-line, like bill statements, and more of the marketing focus pages are moving to color, so our strategy remains the same. We're focusing our investments on creating more color pages through affordable office color printing and more advanced digital production printing. In the Services side of our business, signings were $3.6 billion. On a trailing 12-month basis, we grew signings 13%. And it represents some very large wins from Louisiana, where we were awarded a contract to upgrade and significantly expand the state's customer service center for their Department of Children and Family Services to Zürich, where we won a multimillion dollar deal to convert the city's bus fares into electronic payment systems managed by ACS. Our growth in Services was driven by an 11% increase in revenue from our BPO offerings and 5% revenue growth from IT outsourcing, solid results that reflect our competitively advantaged portfolio, as well as the progress that we're making on cross-selling with ACS and expanding our relationships with global accounts. Our efforts in this area led to a 23% increase in our total pipelines, strong opportunity that we're aggressively pursuing for 2011 signings. In 2010, our total revenue was $21.6 billion. More than 80% of this is an annuity revenue. By combining our strengths in Services and the sale of more Xerox technology, we're fueling this annuity stream, which positions us well for more growth this year and for the long term. And it's a good place for me to turn it over to Larry. Larry?

Thank you, Ursula, and good morning. As Ursula commented, we are pleased with fourth quarter results as well as total 2010. We exceeded the commitments we made in October of 2009 at the time of the ACS acquisition announcement. Our 2011 guidance will also exceed those commitments. This was a year of returning to revenue growth, expanding operating margin and earnings, coupled with really good balance sheet performance. We strengthened our hand significantly with the ACS acquisition, which is performing at a very high level. We also strengthened our business model with significant restructuring to align our business for the future. We believe we can build on these achievements going forward and deliver significant shareholder returns. Now let's go to Slide 6, our Technology segment. Technology revenue was flat and up 1% at constant currency and represents $2.8 billion, or 48% of our business, with a segment margin of 11.7%. Overall, good performance with good installs and equipment growth at more sustainable levels, given a tougher prior year compare. Post-sale metrics improved with sequential page growth beyond normal seasonal levels, a good sign for future quarters. Supplies revenue was flat year-over-year at constant currency as fourth quarter 2009 revenue benefited from improving supplies inventories. Strong operating margin despite currency and mix impacting gross margin. Entry, mid-range and high-end also a continued strong growth in color fueled by our strong color portfolio. In 2010, we launched a number of key products, including in the high end, the Color Press 800/1000, which continued to perform extremely well, driving production color demand in an otherwise pressured graphic arts environment. In mid-range, we recently launched multiple products that have leadership quality, productivity and price value. In 2011, we will continue to enhance our mid-range color portfolio. And in entry, we just launched the ColorQube 8570/8870, which refreshes our popular solid ink desktop platform. And we have more plans for solid ink in 2011 as we build on this proprietary technology. With revenue growth of 3% at constant currency for the year and a segment margin over 10%, the Technology segment showed solid performance in 2010, which we expect will continue into 2011. Next slide. The Services segment is comprised of three lines of business: Business Process Outsourcing, Document Outsourcing and Information Technology Outsourcing. Revenue mix for the quarter was about 54% Business Process Outsourcing, 33% Document Outsourcing and 13% IT Outsourcing. On a pro forma basis, total revenue improved and grew 6% at constant currency, driven by BPO, which was up 11% and ITO, which was up 5%. BPO growth was solid across all areas and reflected good new business ramp, as well as increased volumes in the areas such as healthcare, payer and customer care. ITO growth of 5% was driven by new business. We expect continued positive contributions from ITO, given new contract ramping and a strong pipeline. Document Outsourcing was flat at constant currency and benefited from underlying improvement in page volumes and exhibited strong signings of $1 billion. Operating margin of 12% is up half a point and reflects higher revenues, effective portfolio management, as well as savings from restructuring and synergies. Indicators for future revenues remain positive. New business signings were at their second highest level going back to 2007 and grew approximately 10% year-over-year on a trailing 12-month basis. Total signings of $3.6 billion grew 13%, driven by BPO and Document Outsourcing. On a year-over-year basis, we grew our total services pipeline by 23%, including synergies. With a synergy pipeline of over $5 billion, we are pleased with our ability to generate new opportunities for our services offerings. So positive results in both Technology and Services segments. Slide 8. Revenue growth was 3% at constant currency for the fourth quarter and full year. Good growth, or improvement, in all parts of our business. Full year gross profit margin of 34.4% is above the midpoint of our 33% to 35% business model range. This was accomplished while absorbing the negative impact on cost caused by the strengthening of the Japanese yen to the dollar and yen. About a $45 million headwind in the fourth quarter and $60 million in the full year. Using current rates for 2011, we would expect about a $50 million negative effect, which is more weighted towards the first half. With approximately half of our business in services, our focus is on operating margin expansion. Our operating income on a pro forma basis grew $69 million in Q4 and $271 million for the year. This drove a full year margin of 9.6%, which is a one-point improvement over 2009. We finished the year with adjusted EPS in fourth quarter of $0.29, high end of our range, and $0.94 for this year. We continue to differentiate between GAAP earnings and adjusted earnings for guidance and for actuals reporting, in order to give you transparency into the fundamentals of the business. As a reminder, 2010 earnings on an adjusted basis exclude amortization of intangibles; restructuring and asset impairment costs; acquisition-related costs, including direct transaction costs and specifically defined integration costs; and any discrete unusual items. We had $273 million of restructuring in Q4, $83 million above our third quarter estimate. The restructuring supports exiting certain businesses and accelerating the shifts in our business model through more indirect channels, optimizing the infrastructure and services and centralizing support functions, achievement across synergies, such as continued outsourcing to ACS of some back-office functions. The restructuring from 2010 will save us approximately $270 million in 2011 and more than offsets currency and cost headwinds going forward, as well as investments in the business. In 2011, we do not anticipate any further significant restructuring and plan for adjusted earnings to exclude only amortization of intangibles and any discrete unusual items. Next slide. We had a strong cash flow from operations in Q4 of $1.3 billion and $2.7 billion for full year, about $100 million above our $2.6 billion guidance. It was driven by earnings and very good working capital performance, $685 million fourth quarter and $348 million full year source of cash. CapEx was $519 million full year, resulting in $2.2 billion free cash flow, $200 million above our $2 billion guidance. Debt decreased $889 million in fourth quarter and $1.9 billion since the ACS acquisition last February. This performance positions us well to deliver $1 billion to $1.2 billion of available cash in the second half of 2011. One last point. With the strong activity growth this year, our finance receivables and equipment on operating lease grew. And we're at $235 million use of cash in fourth quarter and $159 million used for the full year. This is important, as it is not an actual use of cash because we leverage these assets 7:1. So in an environment of financial asset growth, core cash flow, cash from ops before financial assets is more relevant. In 2011, we expect the financial assets to grow, driven by equipment activity and revenue growth, as well as from an expansion of leasing activities to support Global Imaging. As a result, we will focus on core cash flow and core cash flow less CapEx as our free cash flow measurement. Next slide. Slide 10 expands on our guidance for 2011. We remain on track to reduce debt by mid year to $8 billion, which will put us at a steady-state leverage ratio of approximately 2.3 on total debt and 0.6 on core. Achieving this leverage will allow us to have $1 billion to $1.2 billion of available cash in 2011, and $2 billion by 2012 to return to shareholders. We remain committed to using over 70% of this towards share repurchase, beginning in the second half of 2011. To achieve our $1 billion to $1.2 billion of available cash in 2011, we will need to generate $2.8 billion of core cash flow and $2.2 billion of free core cash flow. Within cash flow, there are a few points I'd like to make relative to the individual lines. Earnings are expected to grow by 15% and drive cash flow. Pension funding will be higher as we account for a lower discount rate and a requirement to move to quarterly contributions. We estimate contributions of approximately $500 million in 2011. Looking beyond 2011, we expect contributions to reduce approximately to $350 million in 2012 and then below $300 million going forward. Lastly, we are planning for working capital to be a use of cash as we continue to see revenue growth. The positive results on revenue in 2011, for both Technology and Services, positions us to achieve 3% to 5% revenue growth in 2011. We are also confident that our actions on costs, coupled with our revenue growth, can drive a point improvement in operating margin. Our EPS guidance is $1.05 to $1.10. So in summary, I can retire with confidence in the future of Xerox. First, I have utmost respect for Ursula and the senior management team. Second, we have an incredibly strong strategy that will sustain Xerox for the long term. Third, we have an advantaged market position in technology and services. And finally, we benefit from a business model that will deliver earnings expansion and cash generation. So it's the right time for me to retire and it's the right time for Luca to step in, bringing to Xerox extensive global experience and a complementary set of operation and financial skills. My thanks to the investment community for your interest and investment in Xerox. I am confident you will continue to be rewarded. And now back to Ursula.

Thank you, Larry. We started 2010 with the acquisition of Affiliated Computer Services. It transformed our company into the world's leading enterprise for business process and document management. And we closed the year with results that reflect the benefit of our expanded services and competitive technology, as well as the strength of our business model. In 2010, we grew adjusted earnings, increased revenue, improved operating margins and generated $2.7 billion in operating cash. We delivered on our commitments across-the-board. And by doing so, we generated greater value for shareholders. We have momentum and have every expectation that we will build on it in 2011. We start the new year as one company, with our total Xerox performance reflecting the combined strength of our Technology and Services businesses. For our customers, that means relying on one reliable source for the back-office support that gives them more freedom to focus on their core business, their real business. Our 2011 priorities keep us on track to expand earnings and continue building shareholder value. We won't compromise our leadership position in document technology. Through investments in innovation and expanded distribution, we'll increase install activity and equipment sales with a focus on driving more color pages that help boost our annuity stream. We'll continue to grow our services business by leveraging our brand, our global scale, innovation and world-class delivery platforms to win multimillion dollar deals for Business Process, IT and Document Outsourcing. We remain diligent in our cost and expense management, capturing key cost synergies from the acquisition and driving efficiencies through the enterprise. Generating significant cash flow remains paramount to how we run our business. This year, we expect $1 billion to $1.2 billion in available cash. And while reducing debt, delivering dividends and buying back stock. I am confident we have the right strategy, the competitive strength, the skilled leadership team and a disciplined focus on execution to build on our progress in 2010. And I expect a strong start to 2011. So for the first quarter, our expectations are for adjusted earnings of $0.20 to $0.22 per share and full year adjusted EPS of $1.05 to $1.10. With that, I thank you again for joining us today. And let's open it up to questions from Larry and me.

[Operator Instructions] Our first question comes from the line of Ben Reitzes with Barclays Capital.

Two main questions today, and I'm going to address this to Ursula but, obviously, Larry and maybe even Luca can chime in. But the number one thing is, and you mentioned it is, with Larry leaving, Larry obviously shepherded a major buyback program six, seven years ago that was very good to shareholders for a few years. And we know how Larry feels about buybacks, and I think there are some concerns that, with the change, whether there's any change to that philosophy on returning cash to shareholders. So Ursula, you know now that it's going to be yours and Luca's, if you can talk about timing of the buyback and pace and your philosophy and whether anything can change with Larry not being there, that would be appreciated.

Larry's commitment to share buyback is Xerox's commitment to share buyback and mine, as well. So while Larry is phenomenal, we'll all miss him and love him, the good news is that he acts and speaks on behalf of our company, on behalf of the strategy that the corporation has put in place that I lead and that I am committed to. So he wasn't out on a limb all by himself. And we will continue on the strategy that we laid out: Services and Technology, generating cash, using that cash to buy back shares, doing that in the timing that we have always spoken about, which is in the middle of this year. None of that has changed. None of that has deviated at all. Delivering the results, buying back the shares, paying back our debt, buying back the shares and using cash for acquisitions, as well. So net-net, change is always hard. This one is particularly hard, but you should not be concerned and our shareholders should not be concerned about a change in strategy because Larry is leaving.

That's your 70% or 75% of available cash was going to be for buyback, and that's for Luca's as well?

That's right. 70% or 75% of available cash for share buyback starting in the second half of 2011. And, as I said, that's the mantra and the march that we will be on.

With the quarter, we've gone through all the numbers with the revenues in line with the street and the EPS. In terms of the guidance, there's obviously the -- you had never given quarterly guidance before for 2011. But obviously, Ursula, you know it's $0.01 or $0.02 below the street. Is it just because of the timing of these currency hits? And in terms of smoothing it out, how do you see like the earnings playing out by quarter for the year? Is there nothing to read into with the 1Q guide? Is it just a progression of gross margin throughout the year? And if you can just talk about the distribution of earnings throughout the year, that would be great.

I'll let Larry start on the answer and then I'll jump in.

I think, first of all, I think the consensus on the street is $0.22, so we're at $0.20 to $0.22. And I think the first quarter is consistent with making a whole year, our guidance for the full year. I think it just recognizes the headwind of transaction currency. Transaction currency, if you look at it quarter-by-quarter, it has a big effect. And we're saying that it's about -- it's a great stay where they are now, it's about a $50 million effect in 2011. And a good portion of that, more than half we say, so I don't know, $30 million for arguments sake here, is what's going to hit you in the first quarter. The restructuring that we did in the fourth quarter, to try and take to offset any kind of headwinds that we have, obviously doesn't have that kind of magnitude effect in the first quarter. So you have a little bit of mismatch there. And I think that does put a little pressure on gross profit margin in the first quarter. However, it really doesn't take away from the full year performance because we've positioned our business model here to deliver. So I think it's consistent. I think it's right on. There's no hidden messages there. And I think we'll definitely hit or exceed our guidance.

Let me just kind of pull it together a little bit, exactly what Larry said but with an overriding statement. If you look at the two sides of our business, our Technology and our Services side and you look at the fourth quarter, look at all of 2010, the progression through the quarters, the fourth quarter and what we're out looking for 2011. You will see continued progress along the strategy, expanding distribution, growing our technology line, growing our machines in the field, our pages, our color pages. That's the plan here and that's what's coming out. That's what's happening. And I think in the first quarter we recognized. We have recognized that currency throughout 2010 had a negative impact on us and it will continue our outlook, as that will continue through 2011. And the first quarter just recognizes the fact that a lot of that will happen at the beginning of the year, not at the end of the year. There's no other message here except for that. And we're taking the restructuring to make sure that we're in line and able to perform.

Our next question comes from the line of Shannon Cross with Cross Research. Shannon Cross - Weeden & Co. Research: My first question is with regards to the Services business. If you can talk just a little bit about, essentially, what you're seeing with the $5 billion pipeline or I guess it was $3.5 billion, $2.5 billion last quarter. So in terms of the revenue synergies, how are things closing? What type of deals are you doing? Just any more color you can give us on sort of how the revenues are working on that side?

So first of all, let me start at the higher level. We're really pleased with the three lines of business that we have in services. We saw a good quarter across-the-board. Excellent signings in both Business Process and IT outsourcing but also a very, very good signings quarter in Document Outsourcing. I think it's important to see the distribution and we're seeing it. It's good. And we believe that, that is caused almost solely by the fact that we have these two very strong companies together now as one. And we're able to leverage that. I'm going to skip to a little bit farther ahead. In the future, we're going to kind of stop talking about synergy as distinctly as we do because we're finding that we're putting a lot of work into trying to distinguish what the synergy siding and what's not. And all we're looking at -- all I'm looking at now is whether revenue is growing. If the revenue is growing, the signing controls are growing and the pipeline is growing, then I am pleased. It turned out for this quarter, all three of those things are happening. On a trailing 12-month basis, signings are up, new business signings are up, which is extremely good and the pipeline is growing, and the synergies are over $5 billion. I think, I kind of wrapped it all around. We see excellent, excellent uptake. This acquisition is doing what we thought it would do, even a little bit faster. We signed 50 deals in 2010, with more than we had even planned. Interestingly enough, those deals have revenues a little bit lower than we thought. We thought we would get fewer deals at bigger revenue, but what we're doing is getting a lot more deals at slightly less revenue. And we'll be able to get into those accounts and then grow our position in those accounts in this whole penetrate and then radiate strategy that we have. So we're very pleased with the signings in quarter four, the new business in particular. We're very pleased with the suite of business and all the metrics are tending in the right direction. Shannon Cross - Weeden & Co. Research: And then can you talk, whether it's Ursula or Larry, about the gross margins? I mean, clearly currency was a big impact during the quarter, a couple of pennies, and going forward. But can you talk maybe more about sort of the underlying trends? What are the puts and takes we should think about in terms of the gross margin, the restructuring charges that you took and the movements you made? Sort of how, again, I guess this flow through more towards the second half of the year, but just any more color you can give us on how you're thinking about gross margin?

I would say first of all, Shannon, that with the content of our Services business, this really becomes an operating margin story and is not as much -- I'm not saying we wouldn't look at gross profit margin, obviously, we would. But it's an operating margin story and it's a question of whether you can expand margins here or not, which we're confident we can. I mean, we obviously did it all the year and we expect to have another point next year. So we are doing all the things here that expand operating margin. And within that, we're trying to just do a balance of gross profit margin. Gross profit margin, since the currency changed in 2008, is over a $200 million cost increase. If you want to look at it as just cost. And I think if you look at the gross profit margins, the Xerox team has done a great job of offsetting that and maintaining our gross profit margin within the 33% or 35% range. Now in this fourth quarter, we probably had, I think it was $45 million of -- so it's like 7/10 of a point or something effect of transaction currency. And we offset it on other lines so that the operating margin still improved a point. And, again, as we look at 2011, we're expecting about a $50 million hit. Maybe the currencies will help us and if they do, then we'll report that back. But right now, it looks like a negative headwind of $50 million, $30 million of which is in the first quarter. But we are still committed to be in the 33% to 35% range. And more importantly, we're committed to increase the operating margin by a point. So gross profit margin varies but we have our act together to make sure that we deliver the earnings associated with that. Shannon Cross - Weeden & Co. Research: And then just one last question, Larry, since we still have you for this call. I'm just curious, if you look back over the last year, I'm just curious, is this sort of what the biggest surprise is, both positive and negative had been for you? And just sort of if can you position us in on your thoughts as you're sort of leaving the company. I think your perspective would be helpful.

Well, I think -- I wouldn't say it's a surprise but I'm really, really thrilled that ACS acquisition has fit so well into our company. They are performing well. They love being part of our company. We love having them. Our management team is unbelievably excited about the way we can address customers in the marketplace now with all, I mean literally, all the infrastructure you need, BPO, ITO, Document Outsourcing, technology better than anybody else's. And I kind of drank the water here, we all know that, but that's the best thing. We put together these numbers sort of predicting the future back in the summer before we announced ACS. And we were trying to be fair, we weren't trying to be real conservative or anything. And we actually glued the doors off of all of them. We did really well. So I wouldn't say it's a surprise but I am really happy. That's why it turns out this is a good point, because it's done so well. The currencies, I think, are something that -- at least, I pray to the currency gods that we would get a break here, and the yen would weaken to the dollar and the euro. That's a recurring dream and maybe one day it will happen. Things tend to go one way against you, and then when you least expect it, it'll go the other way. I think the currency has been hard work. But again, I think we hit the numbers on it. So I'm just proud to be part of the team here who delivered on what we said, and I think the numbers going forward are going to be -- the investment community is going to like them.

I'll just add one thing, even though you didn't ask me and I'm not leaving. I'll throw it in anyway. So I agree with Larry, totally. I mean ACS, we had great aspirations and dreams about it and it's coming through well. How we're working together. How we're dealing with customers. That's all good. Interestingly enough, Global Imaging, which is one that is now just a part of us, had a phenomenal year. Again, we managed that operation like we thought we should, like we said we should. And we're doing it and they're delivering. So there's a lot of parts of the business that are doing well. Our developing markets operations has picked up quite a bit. So I think that we're moving the company along in a strong, balanced way. I think that's the way that I would -- that's something that actually pleased me the most in 2010, even though you didn't ask me.

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

I wanted to ask about cost synergy realization in the fourth quarter, as well as your outlook for 2011. Your targets were $100 million to $150 million for cost synergies related to ACS in 2010 and, I think, at $140 million from the restructuring. I'd just like to get, Ursula, your assessment of how you did versus those targets and/or Larry? And then what we should expect in terms of additional cost savings, both from the restructuring actions that you're announcing today as well as ACS merger synergies going into 2011 and 2012? If you're willing to go out that far.

Let me hit the synergies and then I'll turn it over to Larry. The cost synergies for 2010, were well within the range that we had predicted that we would be in. We said $100 million to $150 million, and we are solidly there. We are across-the-board pleased with how we've performed. As Larry said, we laid this thing out such a long time ago. I can't even remember the buckets anymore, but we delivered across-the-board -- I obviously can't remember the buckets, Rich. But we delivered across-the-board and delivered over $100 million. In 2011, we expected to get in the range of about $120 million or more. And well on the path to get to the $375 million that we said we'd get to in year three. So the way that you should think about the cost synergies from the acquisition are that we are knocking them down on a year-by-year basis with very little risk, like no risk that we will miss any of them. So strong performance there in the categories that we said that we wanted them to be in.

I think on a restructuring basis for 2010, we have said about $140 million of pretax savings, and that's about the number we got. And that's how we got operating margin improvement in the face of pressure on gross profit margin. So I think we did good things there. And then because we added restructuring, additional restructuring in the fourth quarter, our expectation is to get about $270 million of, again, pretax savings. And that's the headwinds, again, from any pressure on gross profit margin and the currency, which I said a couple of times was $50 million. So these restructuring are targeted to places that will help us on all lines of our income statement. And they're delivering the way we expected and they're helping us get our results in the face of some, of tough currency situation.

It also allows us to invest, I mean, reinvesting in our people in 2010. And then continuing in 2011, we had a fairly significant investment in marketing in a new brand campaign. And we need to be able to do that to make these investments to grow the company. And that's one of the reasons why synergies and restructuring, both of those two things together, and the savings that come from that are so important to us.

Maybe a little more specific question on that. It looks like given your 3% of 5% revenue growth guidance and assuming that gross margins don't go up next year because of mix and currency, that operating expense dollars actually need to be down pretty nicely year-over-year in order to achieve 100 basis point improvement in operating margins. And I just wanted to confirm that, that is indeed what you think you can achieve next year?

I don't think there's a big minus effect. I think with the revenue growth that if you can maintain gross profit margin -- gross profit margin that's a different subject, but when you grow revenue, you maintain gross profit margin, we will be able to expand.

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

I actually have a reconciliation question. Number one. Normally, gross margins are up a little bit anywhere from 20 to 100 basis points from Q3 to Q4. Secondly, as I look at the last conference call, as we talked about Q4, there really wasn't a significant discussion surrounding gross margins. And then third, as I look at the yen-U.S. dollar rate, most of the variants happened prior to, call it September to October. For mid-October, the yen-euro has actually been within a more normalized trading range. It certainly had some volatility but nowhere near where the volatility occurred for the prior, call it nine months. So I'm just trying to understand, putting all that together, gross margins were actually flat sequentially from Q3 to Q4. How do I reconcile all those data points? Because it looks like gross margin, frankly, was a little bit disappointing. I'm not sure I can really fully explain it with the yen-dollar exchange rate.

Well, I think it's a couple of things, Keith. First of all, I don't think the seasonality of gross profit margin is the same when you add ACS into our business. We did have a pretty good bump in the fourth quarter, Xerox without ACS. I think when you add ACS in the Services business, the gross profit margin story is different on a seasonality basis. And secondly, I think that currency definitely, I mean, we know the arithmetic by when we got the cost, by what the rates were year-to-year, and so it definitely cost us almost a point, 7/10 I said. So there is pretty good accuracy on that, as far as the reconciliation. And the rest of it is associated with the other services business with a much lower gross profit margin on average than the company that had BPO grow 11% and ITO grow 5%. And so you just do the arithmetic and the average of that, and that lowers the gross profit margin but they have -- that same businesses have a higher operating margin and therefore, again in arithmetic, you get growth there. So I'm sure that Jim staff, here, can give you a detail.

Could you, to follow from Rich's question, could you be more specific and what numbers you're thinking about, say for Q1? And then also implicit in '11, how we should be thinking about the range of gross margin, including the FX impact?

We're expecting the gross profit margin to be between 33% and 35%.

I was hoping to get a little more specific, particularly on Q1.

Well, if you can tell me all the revenue mixes of the products, I can give you an exact answer. But our commitment is $0.20 to $0.22, $1.05 to $1.10 gross profit margin, between 33% and 35% and an improvement of one point on operating.

And the third quarter, the first half, we believe to be a little bit more pressured than the second half because the currency impacts are more in the first half than the second. But I do believe it's important, as Larry said, we actually, for the fourth quarter of 2010, your premise was not exactly accurate and the staff will take you through that. First quarter of 2011 and the first half of 2011, we were going to fight to make sure that we can hold the total operating margin -- the operating margin will increase for sure but the gross margin, the 33% to 35% range. And I'm confident we'll be able to do that.

Our next question comes from the line of Ananda Baruah with Brean Murray. Ananda Baruah - Brean Murray, Carret & Co., LLC: Question, I guess, just on sort of tone of business, both in Services and, maybe, some in hardware too. Have you've noticed the tone, I guess, amongst your BPO customers and their willingness to look at spending, I guess, incremental dollars a little more than they had as we had moved through 2010? I guess I'll just leave it there and I have a follow-up as well.

I think that from the Services side, I think that the tone is positive and improving. And I think that it shows up in our metrics. It shows up in signings but, more importantly, in the pipeline and how the pipeline is growing for us across-the-board, including Document Outsourcing, by the way, which had a phenomenal fourth quarter signings rate, which was kind of a record for us. But I think that what customers were saying, large enterprise customers, governments, mid-sized customers are, as well, is that they understand the value proposition of this services bundle that we offer. And that we've kind of proven to them with examples from different industries that we show to them that we can actually pull it off, and they need to help in managing their infrastructure and reducing their costs. And it's showing up in our signings and our pipeline numbers. So it's a positive trend that we're seeing. Ananda Baruah - Brean Murray, Carret & Co., LLC: So this is sort of, I guess, the cyclical aspect to it, the kind of recovery aspect. But just in general, you feel that the tone has picked up as well?

Yes. I think that there is, obviously, some of the tone improvement is a little bit of recovery in the economy. But I think independent of that, even before the economy was recovering, when we saw that Services grew better, faster than Technology. And we're continuing to see that. So independent of a recovery, I think that we'll see that this business continues to be attractive from a client perspective. Attractive line of business for us to get engaged with them on. Ananda Baruah - Brean Murray, Carret & Co., LLC: And I guess just going over to the traditional Xerox business. A lot of your install momentum was really good this quarter again. I guess, could you just comment on what you're seeing, other than sort of the new product cycles as being the driver of that? Do you see maybe a little bit more secular strength embedded in the installs as we've moved through the year then, I don't know, then maybe you may have expected as we enter into fall? And then just on the supply side, I think there is a comment related to Document Outsourcing but would just like to get your thoughts on general supplies, trends and I guess what you're seeing out there from customers on supplies?

I think the first part of the question was on what I'm seeing from a technology standpoint in secular strengths, weaknesses, et cetera. I mean, we think that we know were happening are continuing to happen. That is a color significantly more attractive investment line from our customer's perspective than black-and-white. That, at the high end of black-and-white, while there is still a large business there, that business is under pressure from a growth perspective. And because many pages, especially in the transaction portion of the business, are moving away from being printed and being viewed, et cetera. Those trends have not changed. Color strength, high end, black-and-white transactional printing under pressure. We invest our money to make sure that we can actually capitalize on that strength. We invested both in technology, in color, but also very importantly in distribution. We just brushed over on Global Imaging a minute ago but they had a phenomenal quarter, and year actually, as well, and that actually bodes well for us. We've expanded distribution in Europe as well. So we're seeing across-the-board, in the areas that we would expect growth to happen. We're see across-the-board growth. The lower end of our portfolio, as we expand distribution to serve those customers. Color, as we continue to invest in both distribution and technology. Geographically, I think we're seeing positive news from all geographies, kind of face-to-face. We are seeing it in DMO from the beginning of the year. We are seeing Europe being -- I actually would expect for no significant bad news in Europe, actually pretty managed performance there. And we saw an uptick in the fourth quarter in the U.S. So from a geographic standpoint, that's how it's going. And from a line of business standpoint, government is strong, large enterprise is improving and small and medium business is the strongest. Ananda Baruah - Brean Murray, Carret & Co., LLC: Larry, given the sort of the yen headwinds and sort of at least all the conversations around the push and the pulls on the risk margins. Did they have you guys try a little bit more to see what you can do in terms of collaboration with Fuji Xerox to maybe push to more R&D their way? Is there anything you guys can do in areas like that to sort of uplift some OpEx?

I'll take it, Ananda. The answer is not to offload OpEx only. I mean, that's not the way that we approach it. But the fundamental question is a good one, which is we have enough range with Fuji Xerox and we work continuously. And this year no different than any other year. This quarter no different than any other quarter. We try to optimize the investment that Fuji Xerox and Xerox make so that we minimize duplication, so that we can drive cross competitiveness, so that we can actually work significantly more efficient business model between the two of us. So the fact of the matter is that we will continue to push that vector there. We'll drive them on cost competitiveness, fixed focus for us, synergies or any kind of collaboration we can have in R&D. Big focus for us, as well. And there is obviously more to begotten there. It's not perfect so we're working it.

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

Question on growth expectations for the Services business next year. What's the key driver of that 4% to 7% target? Is that growth in existing contracts or new contracts coming on to the business model?

I'll take it and then Larry can chime in. It's both. From the BPO and ITO side, for sure, and growth in existing contract. Usage probably to improve in the fourth quarter in our Document Outsourcing services line. And that trend is a good trend from the revenue perspective. So it's both from signing new deals and from improving usage on the deals that we already have.

So when I look at gross margins in the Services business, that was a little light versus my expectation and it's been down the past couple of quarters. Is that decline in gross margin trend going to continue as you layer on these new contracts? Is that a headwind on the gross margin line? And are you restructuring below that in order to meet the operating margin targets?

No. I think, again, the way we're approaching this in total is from an operating margin standpoint because there are some things that you find in the Services business that the focus isn't the same on our gross profit margin as it is in the Technology business where you're selling a piece of hardware. So again, I think our expectation is not declines in gross profit margin. We're thinking gross profit margins will stay where they are and we're thinking within any particular quarter. They are between 33% and 35%, depending on a lot of variables, not the least of which is the mix of the business, the mix of the products, the mix of the geography, on which Services business. So other than calling out the pressure caused by the currency, just year-to-year comparisons, that has the biggest quarterly effects. And when we have it, it takes it down more than you would expect. And when we don't have it, we're back to a higher range like you saw at the beginning of 2010. So again, every line, you have to be cost competitive here, and we're working on currency as a cost issue. So if it's up $200 million since the yen strengthened big time in the fourth quarter of 2008, we're just plowing ahead like this is a cost problem. But we think it's all manageable within this 33% to 35%. And again, one point of operating margin improvement'

And just one point to add is that our operating margin big focus, as you know, and, historically, we had a gross margin focus, we still do on our Technology business. But we don't report gross margin on the Services business. So there's no way to really actually answer the question accurately that you answered, Chris, I'm sorry. But operating margin integrated for the business and, historically, we looked at gross margin for the Technology business.

Our next question comes from the line of Douglas Ireland with JMP Securities.

I was wondering, one of the fastest-growing areas you've identified in the BPO business is around healthcare. And I was just wondering if the current uncertainty around the government's plans has had any impact in your forecast for that area.

Not really. I mean, we obviously pay a lot of attention to this and actually, not only by watching from afar, but engaging with the government where appropriate and when appropriate and formulating a path forward for them on health, IM or any kind of automation or information automation of the healthcare system. We haven't really seen an impact from a business perspective based on the uncertainty. There are certain things that we count on happening. I mean, we count on people needing access to healthcare. We count on the fact that the information infrastructure that we currently have in this country, and lots of other countries, as well, is inefficient and ineffective, and needs to be improved. It doesn't matter who is in what office. Those two facts are for sure and known, and that's what we're riding. We were riding this wave of different news for fundamental improvement and all the debates actually -- don't include the debate around this, around those two points. So we're seeing good news from the focus on healthcare. I think we have time for one more question.

Our final question comes from the line of Mark Moskowitz with JPMorgan. Mark Moskowitz - JP Morgan Chase & Co: I wanted to get a sense more on the gross margins. A lot has been discussed as far as FX. I guess, I can't really understand, or investors can't really understand, how come currency continues to be an issue with you given your hedging and consistent hedging? Is there really a cost issue or structural issue we need to be aware of, as well? And then the second question is more around the revenue profile. If the services, the synergies really take off, should we start to anticipate gross margins maybe being at the low end or even maybe being below the low end of the 33% or 35% range but actually up margins holding steady because of the mix?

Yes, so on the currency and hedging. The fact of the matter for Xerox, or any company, when the currency changes, notwithstanding hedging, hedging is a very short-term idea that protects you against changes. So there's an exchange rate, you have a normal pattern of buying 25% of your forecast, 50% of your forecast so it's got a very short-lived protection. The fact that a currency changes significantly, 30%, takes your cost up. That's what it does. And as soon as you start hedging after the fact of that, you can protect your balance sheet so you don't have to pay in a different exchange rate than you put it on your books for. But the hedging doesn't protect Xerox or anybody, it's just a short-term kind of balancing of it. So when you look at exchange rate changes, I mean, those changes have to be comprehended as cost impacts and you have to take significant cost actions or expense actions, which we've done in the business to offset them. And as I said, it's about a $200 million cost hit. And we can spread that by quarter, we've looked at it over and over again. And that's really been the impact. And if you look at the pattern of gross profit margins, we've done a good job, if I don't say so myself, of managing within even with taking a $200 million cost hit, which is -- it is profound because if you average at the break the other way here, it's going to roll to the bottom line. So that's just the fact that. I mean, you can ask any CFO in any company who has to deal with changing exchange rates on a transaction cost basis, I think you'll get the same answer.

The gross profit margin, given the fact that we may actually go in services faster.

Yes. I think that, that's the story of operating margin, because you're growing the business that has a lower, much lower gross profit margin than the technology business and you're growing it much faster, and so that puts pressure on your gross profit margin, which, by the way, we don't just accept. We try to offset. However, they have a higher operating margin. And so when you get down to the operating margin line, you're actually get helped by it and it drives the profit and then expands earnings. So the model works here. Again, I think it's important to look at gross profit margin. I'm not saying it isn't, but I think you have to put it in the context of a business that's 50% services, higher operating margin, lower gross profit margin. And when you show that kind of expansion of margins, it's pretty damn good.

So thanks for your time and for your interest. And please enjoy the rest of the day.

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