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Xerox (NYSE:XRX)

Q1 2011 Earnings Call

April 21, 2011 10:00 am ET

Executives

Ursula Burns - Chairman and Chief Executive Officer

Luca Maestri - Chief Financial Officer and Executive Vice President

Analysts

Deepak Sitaraman - Crédit Suisse AG

Keith Bachman - BMO Capital Markets U.S.

Benjamin Reitzes - Barclays Capital

Richard Gardner - Citigroup Inc

Shannon Cross - Cross Research

Ananda Baruah - Brean Murray, Carret & Co., LLC

Douglas Ireland - JMP Securities LLC

Operator

Good morning, and welcome to the Xerox Corp. First Quarter 2011 Earnings Release Conference Call hosted by Ursula Burns, Chairman of the Board and Chief Executive Officer. She is joined by Luca Maestri, Executive Vice President and Chief Financial Officer.

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

Ursula Burns

Good morning, and thanks for joining us today. We'll get started on Slide 3. Our results in the quarter reflect progress in scaling our Services business, while maintaining our leadership in document technology.

Steady revenue growth and our sharp focus on operational improvements resulted in a 28% increase in adjusted earnings. This is the last quarter that we need to report on a pro forma basis. You'll recall that we closed on the ACS acquisition in February of 2010. So going forward, we have the benefit of a full year of ACS results in our year-over-year comparison.

Our first quarter pro forma revenue increased 2%. We delivered Q1 adjusted EPS of $0.23, which was above our guidance. On a GAAP basis, earnings were $0.19 per share. This includes $0.04 from the amortization of intangibles.

Cost and expense management remains a strength of ours, leading to a Q1 operating margin of 9.1%, a year-over-year improvement of close to 1 point. Gross margin of 33% is within our range and reflects the results of more revenue coming from services and the continued impact of currency.

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

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

So let's turn to Slide 4. In the past year, we transformed not only our business into a leading player in the services base but also our business model with growth largely driven from an increasing annuity stream. 85% of our total revenue comes from annuity, and annuity was up 3% in Q1 or 2% in constant currency. Total revenue of nearly $5.5 billion was up 15%. On a pro forma basis, it was up 2% in constant currency.

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

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

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

As important, we continue to grow our distribution network, including 4 recent acquisitions that expand our assets to small and mid-sized businesses. 3 are in the U.S. and 1 in the U.K. In our Services business, Signings totaled $3 billion and were up 3% on a trailing 12-month basis. Keep in mind that the trailing 12-month and year-over-year compares can easily be skewed by big deals. That's the nature of

a services business and was the case this quarter.

In Q1 of 2010, you recall that we signed the $1.6 billion 10-year California Medicaid contract. The size and duration of the deal creates a tough compare for this year.

That said, I am very pleased with the success of our Signings this quarter. It's $3 billion of revenue that benefits us over the length of multi-year contracts. And many of the wins were the result of cross-selling with ACS.

Notable deals in the quarter include a $200 million contract to manage IT services for MGM Resorts International, reducing document devices from 2,700 to less than 900 through managed print services for the workforce provider, Kelly Services.

Managing clinical and technology applications for clients who use Allscripts for most hosting services. Since Allscripts is the most used solution for electronic health records, this is a significant deal, valued at $500 million over the next 10 years and reflects increasing demand from healthcare providers for IT support.

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

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

In summary, our progress in Services and Technology reflects our differentiation in the marketplace and the benefits of our diverse portfolio. We continue to hold the #1 revenue market share position for document technology and the breadth of our services offerings as well as our global account relationships give us a competitive advantage. So it was a good start to the year.

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

We do business with a number of other partners and vendors in Japan, and we're working with them on a daily basis to comprehend the impact on our supply chain. Our #1 priority is fulfilling customer orders and maintaining the uptime of their Xerox systems. That means alternative sourcing for components and materials often at a higher cost, and it means more expensive distribution methods like airfreight to avoid the long delays in many ports. As a result, we're seeing increased supply chain costs, but we are focused first on our customer needs.

Our employees in Japan and our colleagues in Fuji Xerox are doing an incredible job managing the complexities of this very challenging situation. We were extremely grateful for their perseverance and tremendous support. Based on our analysis of the situation, we expect to see some product constraints toward the middle of the second quarter, impacting the pace of install for Xerox and Fuji Xerox. And we don't expect to see a full recovery until later this year.

So from a financial perspective, there are potential Q2 headwinds in 3 areas: Equity income from our 25% ownership of Fuji Xerox; supply chain costs; and equipment sale revenue due to possible product constraints. Considering there is still much uncertainty, we're providing a broader range than usual for our earnings expectations in the second quarter. We expect that over the course of the year, we will minimize the impact on cost and revenue.

Therefore, we remain fully committed to delivering on our full year expectations. We maintain a 24/7 focus on managing the situation in Japan, and I do feel that we're in a better position than most. Above all, we're doing what we can to help our colleagues in Japan recover and rebuild.

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

Luca Maestri

Thank you, Ursula, and good morning, everyone. As Ursula said, we are reasonably pleased with the overall results for the quarter and continue to see opportunity for further improvement ahead of us.

Revenue growth on a pro forma basis was 2% in Q1, which was good performance but under our full year range of 3% to 5%. We expect to accelerate revenue growth as we move through the year because of our significant signings in 2010 and as we begin to realize greater synergy revenues. Therefore, we remain confident in our ability to be in the 3% to 5% range for the full year.

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

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

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

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

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

Overall, good performance despite some headwinds in the entry category caused by lower installs and equipment revenue. Entry for performance is weighted heavily towards the developing markets. The results in Q1 were in part affected by disruption in the Middle East. Looking forward, we anticipate trends to improve although Q2 will face a difficult compare given the 56% install growth that we had during Q2 of 2010. On the product side, we are in the midst of a refresh of our lower end, multi-function product lines, which we expect will have entry performance.

Mid-range continues to show very good growth, thanks to a strong Color portfolio, which delivers industry-leading quality, productivity and price value. The product line will also be strengthened by new product announcements in Q2. In high-end, the Color Press 800/1000 continues to perform well and is the driver of our Color install growth. As we go through the year, we will have more product launches such as the already announced inkjet production system that will build up on our leadership in the segment.

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

Moving on to Services on Page 9. Services revenue was up 40%, or 5% on a pro forma basis. Growth was driven by BPO, which was up 8%, and Document Outsourcing, up 4%, with good sequential improvement. ITO revenue was up 1%.

BPO's 8% growth had strong contributions from HR services, from customer care volumes and new business ramping transportation. This growth more than offset declines in government services associated with lower unemployment claims volume and contract run-off.

BPO signings were $1.25 billion with good momentum across all lines of business. ITO had very strong signings, which more than doubled year-on-year, and also had strong pipeline growth. We expect this positive trend in ITO to continue as new contracts ramp during the year. Document Outsourcing also had a very good quarter with strong signings up 42% year-on-year in addition to the revenue growth of 4%.

Overall, signings grew 3% on a trailing 12-month basis, which represents a deceleration given the 10-year $1.6 billion California Medicaid deal that we signed in Q1 of last year. In total, our Services pipeline was up 29%, including synergies. Segment margin of 10.3% was up 7/10 of a point and reflected the positive contribution from restructuring and synergy savings.

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

With that, let us move to the cash flow slide on Page 10. Cash from operations is seasonally weakest for us in Q1. And this quarter was further impacted by the timing of accounts payable. The accounts payable timing will work itself out through the year, and we remain committed to achieve $2.5 billion in operating cash flow for the year. Earnings contributed $289 million to cash flow, a strong performance but not enough to offset working capital usage of $584 million.

Let me make a few comments on working capital. The accounts receivable movement is in line with prior Q1 performance and reflects the tremendous effort that is made each Q4 to drive collections. DSOs actually improved year-on-year, reflecting our focus on cash generation. Inventory performance is also in line with our expectations and reflects the building back of inventory after the high Q4 sales period.

Accounts payable was a greater use of cash than normal but broadly expected given our seasonal timing of payments. CapEx was $111 million for the quarter, and we're well positioned relative to our full year outlook of $600 million. That was flat for the quarter, and our cash balance was $1 billion.

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

In our second quarter, we expect to report a $34 million pretax charge as a discreet item, which represents $24 million of non-cash, carrying value adjustments and a $10 million cash premium.

We are raising our year-end debt target by $650 million, the face amount of this security to $8.6 billion. Just to be clear, through this transaction, our liabilities remain unchanged and this action has no impact on the level of available cash or on the timing of cash deployment. We also remain committed to maintaining a solid investment-grade rating.

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

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

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

Back to you, Ursula.

Ursula Burns

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

We're a full year into our acquisition of ACS and fully realizing the benefits of being the world's largest enterprise for business process and document management. We continue to expand our offerings through products and services that give our clients more flexible choices and give us a competitive advantage while strengthening our annuity stream.

We continue to expand our distribution channels, reaching more and more customers, especially small and mid-sized businesses, on a global basis. And we continue to operate our business effectively and efficiently, helping to offset margin pressures from revenue mix and currency.

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

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

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Shannon Cross with Cross Research.

Shannon Cross - Cross Research

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

Ursula Burns

Yes, I think that what we're seeing from page trends is the continuation of the trends that we saw in the beginning all through 2010 and 2009. So with a little bit of a hiccup in this quarter driven a little bit by the Middle East. So this is what is happening. In black-and-white, particularly high-end production pages, we continue to see a decline of those pages. That's pretty much what we expect, and it's kind of in our business model and our business thinking today. That decline has not significantly accelerated but it is definitely continuing. It's a big piece of our page volume. At the same time, seeing a pickup, an increase in color pages and we're seeing an increase in average price per page because as we mix towards color, the price per page actually trends upwards, which is good. We're seeing an increased importance of the low end of our business, so the printing trends in small and medium mid-sized businesses. And we're responding to that by increasing our product intensity there and our distribution there, primarily through acquisitions. And so -- and then overriding that, we had a pretty big stall in activity and therefore, in pages in the Middle East, which we expect to come back as that region settles down, which it is beginning to do. So as we work our way through 2011, we'll see continued growth in color, continued growth in average price per page, a decline in high-end black-and-white pages and a stabilization in the growth in the low end pages, which will bring our trends pretty much in line with what we expect them to be.

Shannon Cross - Cross Research

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

Ursula Burns

Let me start with the other regions and I'll end with Japan. In the developing markets, which was a high-growth area for us, it remains a growth area for us. We, as you know, had difficulty. We and everybody else had difficulty in the Middle East area. It's a pretty big -- it's a good area for us. We're strong there. We have high share there, and we were impacted by the downturn. We didn't lose position in that marketplace. So as their economy improves, we'll participate in that area, so no problems there. From the DMO perspective as well as developing markets, Russia is a big area for us and we had huge growth in Russia in 2010, end of 2009. And we're seeing that this quarter actually slow a little bit, but we don't expect that to be a continuous trend. I think that DMO, excluding the Middle East, will continue to be a growth area for us, so pretty good. Those territories are pretty good. Europe, we talked to you before about Europe responding better than the headlines would anticipate that they would respond. So our position in Europe from a market share perspective, the penetration of color products, from our services penetration, the winning of deals, all that is very good. Europe as you know is a lower margin region for us and we're focused on continuing to win across-the-board technology and services and continuing to focus on our cost and expense in that area so that we can have a continued good business model, but Europe is strong. U.S., I have to say, has a little bit better output than it had in the previous quarters. Our equipment sales revenue in the United States is definitely picking up across the board. We're strengthening in all segments, primarily driven by the fact that we have increased penetration in performance in the low end of the business and we continue our strength in the high-end, particularly at color. We do have a product gap right below the very high-end in color, right above the mid and in color that we will fill in the second half of the year that should help us to even turn that around a bit, particularly on the post-sales side. But U.S., better than it was in the past, still a little bit tepid but improving for us. Japan, it's hard to tell, Shannon. And I'm not trying to be evasive at all. We are in constant contact. When I say constant, it's like annoyingly constant, you probably saw the people in Japan. With them on how they are doing. And their transparency is cloudy, so our transparency is cloudy as well. What I can say is that our post-sale stream, which is very important, it is 85% of the total revenue, and on the equipment side, 70% plus of the revenue. That is not impacted at all. The first thing that we focus on is to make sure that we can get that supply stream assured so that we don't have any customers who've already bought the technology down or waiting for us. We have that pretty well secured in both Japan and in the U.S. The part that was affected for Fuji Xerox was at a high business area for them or for anybody it seems like at all. The big issues are how they supply to the rest of Japan and to the rest of the United States and the rest of the world, particularly the United States. So in Japan, we're seeing not a lot of transparency. We were able get through the first quarter well, both Xerox, Fuji Xerox. We're pretty sure we'll be able to get through for equipment the first half of the second quarter. We think we'll have some problems in the second half of the second quarter. But we're also pretty confident that we'll be able to work through those throughout the year. So without having detailed transparency to all that's happening in Fuji Xerox, I'm confident that we'll be able to manage it on a Xerox income perspective. Fuji Xerox, it depends. I think that they're coming up. They're doing okay. They're dealing with that rolling power outages, all of these things kind of contribute to the uncertainty. But if they perform, which we expect that they will like they did in the first quarter, our first quarter, we will be able to make it through the first to the rest of the year, I think, without any hiccup on an overall basis from a year perspective. And if you think about what happened there, it's kind of an amazing statement. As I said when I was speaking earlier, I think that we are definitely better positioned than most. I'm pretty sure of that even though we haven't seen what the other Japanese competitors or manufacturers are saying about their results.

Shannon Cross - Cross Research

Great. Yes, I think next week will be interesting, when Canada and others report, so thank you. And then, Luca, if you could possibly just talk about sort of your initial thoughts on what you've seen at Xerox, opportunities, I mean you've been there a few months now. It would be great to get your take on it.

Luca Maestri

Sure. I think probably the word that summarizes my thoughts is execution. When I look at some of the commitments that we've made, when we need to execute on those commitments from an operational standpoint, we are in the midst of a large restructuring program, which we have announced but we need to execute now. We are doing a very important synergy activity with the combination of ACS and Xerox and both on the revenue and on the cost side. And we've got a number of new products that we need to launch on costs, on time, on quality. And then we've got a lot of financial commitments, right? We've talked about EPS growth. We've talked about cash generation. We've talked about debt repayment and of course the share buyback, right? And those are commitments that we are fully committed, too, and we will execute again. And then from an overall business perspective, when you look a bit longer term, the key for us is revenue growth and it needs to be profitable. And that's why we're so focused on this revenue opportunities that we've got with the combination of Xerox and ACS. And then that's why we continue to be focused on acquisitions. And that's why we continue to be focused on refreshing our product portfolio. And international growth is important for us, and that's why we are focusing on places where traditionally we're not as focused as we are today.

Shannon Cross - Cross Research

Great, thank you very much.

Operator

Thank you. Our next question comes from the line of Ben Reitzes with Barclays.

Benjamin Reitzes - Barclays Capital

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

Luca Maestri

What really happened, my purpose was to simplify the chart and really what should matter to investors is cash from operations, which has always been $2.5 billion. The number has not changed and it's not changing. At a certain point, we talked at kind of a subset of cash from operations. We talked about cash from core operations, so $2.8 billion, and then we said that there would be a use of $300 million from the growth of our finance asset portfolio, right? But cash from operations is what matters. It's $2.5 billion. It was always $2.5 billion. And then how debt translates into available cash. Debt also has not changed, it's $1 billion to $1.2 billion. And you just go from the $2.5 billion of cash from operations, then we've got our CapEx of about $600 million, then we talked about debt reduction of $600 million and dividends of $300 million, right? So that's the math, nothing has changed. We just kind of simplified the chart and really, the metric that matters to us is cash from operations.

Benjamin Reitzes - Barclays Capital

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

Luca Maestri

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

Benjamin Reitzes - Barclays Capital

Okay, then I got it, right, I misspoke. Okay, I got it. So nothing has changed, 100%. And the net cash flow is still same and you just simplified it. Now Ursula and Luca, a question for you. When you mentioned the cash flow in your speech, Ursula, you said that it was strong and it was a big focus and it's absolutely coming back. When you mentioned what you're going to use it for, you said acquisition. But in your slide, it says majority going to share repurchases. I assume you meant the majority going to share repurchases and then a minority going to acquisitions. I just want to be clear on that.

Ursula Burns

Yes, I'd say if you -- I think I said exactly what you just said, which is that we'll have $1 billion to $1.2 billion. We'll use 70% of that with the majority of that for share repurchase, and we'll then make acquisitions. On this cash statement, on this cash discussion, $2.8 billion to $2.5 billion to $1 billion to $1.2 billion, 70% of the $1 billion to $1.2 billion for share repurchase and acquisitions. The vast majority of the $1 billion to $1.2 billion is share repurchase. Nothing has changed, nothing has changed.

Benjamin Reitzes - Barclays Capital

And it can start in August, right?

Ursula Burns

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

Benjamin Reitzes - Barclays Capital

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

Luca Maestri

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

Benjamin Reitzes - Barclays Capital

Thank You.

Operator

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

Richard Gardner - Citigroup Inc

Okay, great, thanks. Ursula and with Luca, I was hoping that you might be able to give us some idea of how to think about gross margin here over the next quarter or two, given the puts and takes that you've talked about during your prepared comments. On the one hand, it seems like you're going to have some extra cost associated with air freighting equipment and expediting stuff out of Japan. On the other hand, currency is moving back in the right direction, and my understanding is that you typically go back and renegotiate your supply contracts with Fuji Xerox with a 1- to 2-quarter lag and recoup some of the negative impact of currency over time. So how should we think about gross margins over the next quarter or two?

Luca Maestri

I would say this quarter was affected by half a point was currency, right? And then the rest was a this shift of our mix of revenues towards services that carries lower gross margin. Going forward, I would say that we should be seeing an improving trend on gross margins. You're absolutely right. I think freight will be a headwind because of the situation in Japan. But using today's rates, the currency headwind is mitigating significantly. There is a lot of volatility in FX these days. So every day is a different story. But as a trend, currency should be much less of a headwind. And typically -- I mean Q1 is the weakest quarter that we have, right? So with a bit more activity, that will have gross margins as well. So those are the big valuables there. But we said all along, 33% to 35%, we believe that we're going to be in that range for the year.

Ursula Burns

And Richard, if I just may on Fuji Xerox contract, we do generally -- we continually negotiate with Fuji Xerox and hedge currency with them and so on. But Fuji Xerox today is a little different than they were 12 months ago, obviously. So they're scrambling. I don't expect that we'll have massive shifts in cost to Fuji Xerox that will help us mitigate this headwind. With that, I think that we'll still be in the 33% to 35% range that we talked about.

Richard Gardner - Citigroup Inc

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

Ursula Burns

No, I think that -- first of all, I think that we should wait another -- I have to wait another quarter to see more data. This quarter, while the results were very solid for the company, we had some interesting signals this quarter or interesting inputs that I don't consider normal. I'd like to be able to see our way through those a bit before I make a prediction or update my prediction. So without an update of prediction, I would say that black-and-white pages will not accelerate significantly, the decline of them, and that color pages will not accelerate significantly from the way that we were thinking about them in the past. So I think that we'll get through this first half of the year and maybe the first three quarters of the year and be able to see that, not a lot from how we look at the business has changed substantially. The Middle East and Japan and the effect of that on how we can fulfill needs and how customers buy, et cetera, is something that I want to see a little bit more clearly. So I'd wait a quarter to when color pages continue to grow. I think that's good on digital pages in general. Color pages are now about a quarter of the pages that we generate. It's 30% of the MIF. I think that will continue to grow. Our total digital MIF is growing so I think that there's nothing that would say that it would fundamentally change, but I think we need another quarter to see how this all works out.

Richard Gardner - Citigroup Inc

Okay, all right. Thank you.

Operator

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

Keith Bachman - BMO Capital Markets U.S.

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

Ursula Burns

Thanks for the question. So for the long -- for 2012, our focus, 2011, 2012 is going to be on buying back shares. So most of the capital that we get for 2011, obviously, we'll start it maybe this year. In 2012, we have a pretty good chunk to go in buying back shares. So for the near term, that's the focus, obviously. But we generate more cash than we need to use in buying back shares. So clearly, after that, we'll continue on our M&A cycle. We're doing that today. We bought 5 to 6 companies so far this year. So we'll continue doing that. And then we will clearly -- I think tail-end of this year, start speaking to the Board and the Board and us will start considering what the heck we do with the dividend. So that progress will continue 2011, 2012. And as we get beyond that, we'll have to see. I mean we'll continue to generate a significant amount of cash to be in dollars plus and we'll have to invest it and we'll buy back shares in a reasonable sense. But after a while, we get to kind of renew our energy on that one so we'll switch to M&A and to dividend. As far as allocations towards core and our core business, technology business and the services business, we are -- our technology business CapEx is fairly well-defined. It's around $300 million, plus or minus a little bit, and I don't see a significant shift, growth or significant decline in that. So I think that as we move forward on CapEx, the way that you can think about it and the way you should think about it on capital allocation in general is more and more will go toward services. Our R&D is going to shift more and more towards our services. Our acquisitions, clearly, are more in the services space, et cetera, et cetera. So you'll see a shift in our capital allocations towards the growth in services. But we will not walk away from the technology business until it's worthwhile to do that.

Luca Maestri

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

Ursula Burns

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

Keith Bachman - BMO Capital Markets U.S.

Right. I guess I'm surprised to see you continue to invest more in the distribution space, given what I think is just tremendous opportunities on the other side, the services space, specifically.

Ursula Burns

Yes, I got you. I mean, if I were you, I'd be really nervous if we didn't try to figure out a way to cover more of the small and mid-sized business growth around the world. I mean, that would be walking away from "easy money. " Our big GAAP, we cover the high end market place very well with our technology and our distribution. We do it extremely well. But as you know, that part of the market is not growing as quickly as the small and mid-sized business and it is significantly more focused on margin lowering activities than the small and mid-sized businesses. So what our distribution expansion is all around covering a place where our share is probably half as much as our share in the high end of the business. So the reason we are continuing to invest is because it's business-smart to do. I mean the technology that we have applies there just as well as it does at the high end. And don't misinterpret my comments. I'm not saying that I'm going to not invest in services. I'm shifting quite a bit to services and expanding our investments there. I just don't believe it's prudent. We don't believe it is prudent to walk away from this very lucrative Technology segment way before you have to.

Keith Bachman - BMO Capital Markets U.S.

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

Ursula Burns

I think it's probably throughout the year tending upwards. Tending upwards.Yes, because our revenue in the third and fourth quarter in particular is growing, will grow. It will grow at a pace higher than it did in the first quarter and then it will in the second quarter. So as our revenue grows, our OpEx will have to grow to support that growth.

Keith Bachman - BMO Capital Markets U.S.

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

Operator

Thank you. Our next question comes from the line of Ananda Baruah with Brean Murray.

Ananda Baruah - Brean Murray, Carret & Co., LLC

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

Ursula Burns

I'll start and Luca can jump in if he has anything to add. First of all, most important metric is revenue, and we're really pleased with our overall revenue growth. The combination of new business signings, which is really important, so you get new businesses that adds on to the revenue you have, and annuity revenue that we have that we will continue to get, we have and will continue to get from already committed signed contracts is exciting there. And you saw the growth in revenue there, BPO up 8%; Document Outsourcing, a really good rebound, up 4%; and ITO, up 1%, after a strong first quarter of about 5% growth. So across the board, we're happy with revenue. That comes because we signed things previously. And if you could -- the way that you should think about the signings is that we had -- as I said and I'll say again, we had uptick in ITO signings that was fairly dramatic, doubled our signings in ITO. We had an uptick in Document Outsourcing signings that was very dramatic, year-on-year increases, upwards of 40%. So it will continue to drive revenue. Our signings are very good. BPO signings were very strong. We have to think about the fact that we signed $1.6 billion 10-year contracts in -- this is a rich man's problem to explain. You have a signing like California Medicaid and then I have to explain the fact that it's not going as much. I have no problem with that. And so signings in BPO and ITO and Document Outsourcing are all good. The pipeline of signings is mixed very well. The pipeline is mixed very well so signings on a go-forward should be good across the board, ITO, BPO and Document Outsourcing, and our synergies pipeline is up 29%, which includes synergies signings. So I think if you look at signings across the board, we are very pleased with them. We continue to win in all the segments that we focus on. There'll be compares that are difficult in certain quarters because we did greater the previous quarter but net-net pure dollars doing extremely well.

Ananda Baruah - Brean Murray, Carret & Co., LLC

And I guess -- Ursula, I appreciate that. That's helpful. I guess because signings is something, I think, that you folks are going to increasingly become focused on. Is there any way that we can think of what a normalized signings growth would be? Or over time, should we think of the signings growth approximating the revenue growth? I mean, just so that when we see it move around, or should we expect it to move around, because of the nature of the verticals that ACS is attached to and maybe they're more prone to make a deal? I guess, should we expect the kind of movement that we've seen the last few quarters? Is that normal just so that we know it's normal? Or should we expect some kind of approximation eventually to revenue growth?

Luca Maestri

Ananda, I think you know well that signings is not a perfect metric, right? There is a lot of variability within the numbers, right? Think about the fact that we participate in so many verticals and the duration of these contracts can be extremely different. you go from a 3- to 5-year contract. And then in our Transportation business, sometimes we talk about a 50-year contract, right? So obviously, when you sign a very long-term-contract, then you skew the numbers, right? So you need to expect some time of volatility there. Think of our ITO business this quarter. It was up more than 100%, right? Obviously, it has several factors. It's very difficult to give you a normalized rate. Of course, you know in the very, very, very long term, you should approximate revenue growth, but particularly when you talk about quarter comparisons, it's going to be moving up and down a lot.

Ursula Burns

Next question, please. thanks, Ananda.

Operator

Thank you. Our next question comes from the line of Doug Ireland with JMP Securities.

Douglas Ireland - JMP Securities LLC

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

Ursula Burns

We're really pleased with our government business. It's about -- it's a big piece of our BPO businesses. As you know, it's about 40% of the BPO, ITO business. And if you remove transportation, it's a little bit lower than that. So we're pleased with it is something that we focus on assuring that we win. Now have we seen impact? As more people are employed, the less unemployment there is so we have definitely seen volume declines, lower volume in our service of the government from an unemployment perspective. And we've seen a little bit of lower volumes or a little bit lower revenue as some of the contracts that we won are now ending. Not ending that we lost them, they're ending because they ended. The service is done. But the way that we manage this business is that we actually mix it across the board. So while that's going down, slightly, we have to actually increase and we have increased our signings and our revenue on the commercial side. The answer is yes, a little bit, but not any way that would have me consider government being anything but a very, very lucrative and extremely important portion of our business. But yes, we've seen some downward turns there but not significant.

Douglas Ireland - JMP Securities LLC

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

Ursula Burns

Yes, so I think that you should look at it from a purely financial perspective. And obviously, the next step right before, the revenue and profit potential of the business is you have to get share. So let me back up. Big thing here is color. If you didn't have a black-and-white business. Suppose there was no history in black-and-white, everyone in the world who is competing today would be competing to get a position in this color page market because it is lucrative, because it is growing. So our investment here is in distribution, in R&D, and it's pointed heavily towards color across the spectrum, low to high. That's it. At the same time, we have a black-and-white business that we still have to service. It's not growing but it throws off cash and it's reasonably profitable. So the way that we look at it is running after the part of the business that is growing and that is profitable and that's exciting and keeping hold of for as long as is reasonable, the part of the business that customers still want but at a lowering demand rate. So that's the shift that we're making here. And in order to service that, we need to actually have distribution. We have to have products that serves the customer's needs. You shouldn't think about investing a whole lot of money in black-and-white R&D or black-and-white manufacturing because that's not what we're doing. Most of our investments in R&D and one of the ways that we can make this shift and in some ways downturn in R&D is by focusing our energies on the parts of the business that are growing.

Douglas Ireland - JMP Securities LLC

Thank you.

Ursula Burns

Your next question, please.

Operator

Thank you. Our next question comes from the line of Deepak Sitaraman with Crédit Suisse.

Deepak Sitaraman - Crédit Suisse AG

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

Ursula Burns

And so our sales cycle -- I'll do this relatively quickly and then this will be the last question for the group. Sales cycles, I think what you can think about is not a significant change in trends from previous discussions that I've had but let me remind what they were. For the different segments of our business in the BPO space and in the BPO space if you think about government, the sales cycles are generally long, when I say long, year, a year, a year plus, kind of sales cycle. The deals are generally larger. And our win rate in these long sales cycles, large deals is very good. We have over half the states, for example, in Medicaid, et cetera. So you'll see long sales cycles, difficult challenging sales cycles, that you have to stick with and that we can -- that we win. And it's actually a good business. It's a difficult one but a very good business. In some of the ITO space, the sales cycles are shorter, so significantly shorter, a quarter or less well. And the deals are smaller, obviously. We have two that we signed this year, this first quarter that are longer and bigger than historically but generally, ITO has some walk in takeover deals and they have some shorter cycle deals. So you see the spectrum of them. Document Outsourcing is definitely in between those two, not short, not as long as some of the healthcare, BPO type deals. But they're in the middle of it. So you see them across the board, different durations of selling before you actually win. And the alignment between how long it takes to sell and the size of the deal is pretty much one-to-one, with the long sales cycle the deals generally a lot bigger. Pricing, what we see is that the goal in pricing for new deals is generally attractive, very attractive. It remains attractive through the contract. Renewals are generally at a lower pricing than the old -- than the first time in for sure almost everywhere. And what we find is that what supports this lower pricing is our intimacy and knowledge and the customer's intimacy and knowledge of us. So we can actually still extract good margins, equal margins or improving margins the longer we are with the customer because we actually know how to actually streamline the operations we give to them. One of the things that we do, for example, is to never make the margins get too high, too high because the customers would actually feel disappointed and think that we are actually not sharing the benefits adequately with them. So whenever we get a really wide margin spread, we would go to a customer and renegotiate it before the contract was up. So margins, pricing on a new deal is lower than pricing on the old or the renewed deals, lower than pricing on the old deal margin should be the same, and if we're really good at how we manage it a little bit of growth in the margins portion. And then, Luca?

Luca Maestri

Yes. So from a ramp-up perspective, keep in mind, we've got a very, very diversified portfolio of services, right? So a lot depends on the mix of the portfolio in places like ITO or customer care. The ramp up is fairly quick in other places within BPO or transportation, for example. We're talking about much longer ramp up periods, up to 18 months. And also, the profitability of the different lines of business is different. So the net outcome of this is very influenced by mix. We do expect -- you were asking about how do we think about gross margins for the Services business for the rest of the year. We do expect the margin to be more or less where we are right now, maybe a slight improvement because we continue to work on, both on the restructuring initiatives and also on synergies, also on the services side. It's not only in technology. So flat to slightly up for the year.

Ursula Burns

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

Operator

Thank you for joining today's Xerox First Quarter 2011 Earnings Announcement Conference Call. You may now disconnect.

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