Xerox Q3 2007 Earnings Call Transcript

Xerox Corporation (XRX)

Q3 2007 Earnings Call

October 19, 2007 10:00 am ET

Executives

Anne M. Mulcahy - Chairman of the Board, Chief Executive Officer

Ursula M. Burns - President, Director

Lawrence A. Zimmerman - Chief Financial Officer, Executive Vice President

Analysts

Jay Vleeschhouwer - Merrill Lynch

Bill Shope - J.P. Morgan

Caroline Sabbagha - Lehman Brothers

Benjamin A. Reitzes - UBS Warburg

Matthew Troy - Citigroup

Chris Whitmore - Deutsche Bank

Shannon Cross - Cross Research

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Xerox Corporation 2007 earnings release conference call, hosted by Anne Mulcahy, Chairman and Chief Executive Officer. She is joined by Ursula Burns, President, and Lawrence Zimmerman, Executive Vice President and Chief Financial Officer.

During this call, Ms. Mulcahy, Ms. Burns, and Mr. Zimmerman, will refer to slides which are available on the Xerox investor websites, at www.xerox.com/investor.

At the request of Xerox Corporation, today’s conference call will be tape-recorded. Taping and rebroadcasting of this call are prohibited without express permission of Xerox. After the presentation, there will be a question-and-answer session. (Operator Instructions)

During this call, Ms. Mulcahy, Ms. Burns, and Mr. Zimmerman will make comments that contain forward-looking statements, which may, 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. Mulcahy. Ms. Mulcahy, you may begin.

Anne M. Mulcahy

Thank you and good morning, everyone. Thanks for joining us today. If you could turn to slide 4, we’ll provide you a summary of our Q3 performance.

As you can see by our performance this quarter, our strategy is on track, the business model is generating double-digit, bottom line results. We delivered EPS of $0.27, slightly higher than our expectations and a 17% improvement over our adjusted results from Q3 last year.

We feel good about our progress this quarter and believe we are well-positioned to deliver another year of solid earnings expansion.

We now expect full year earnings per share to be in the range of $1.18 to $1.20. Total revenue, which includes the benefits of our acquisitions, was up 12% this quarter to $4.3 billion. During the quarter, post-sale revenue, which accounts for more than 70% of our total revenue, grew by 11%.

Currency gave us about a three point benefit. In a moment, I’ll provide more detail on the revenue picture with and without the inclusion of Global Imaging.

Highlights in the quarter include a 13% increase in color revenue. Color now accounts for 39% of our overall revenue and more than 50% of our equipment revenue comes from the sale of color systems.

Color was the heavy hitter across the board with an up-tick in iGen3 install and a 69% increase in installs of our color multi-function devices.

We maintained gross margins at 40.1%. Selling, administrative and general expenses were 25.4% of revenue, just slightly better than last year. We ended the quarter with $286 million in cash from operations. We purchased $212 million worth of shares, bringing our total share buy-back to $2 billion since we launched the program two years ago.

Just last week, we closed on the purchase of Advectis for $32 million. Advectis’ technology created the electronic loan folders, streamlining the mortgage process for lenders and brokers. Not unlike our acquisition of Amici last year for the legal market, Advectis increases our presence in an important, document-heavy industry and strengthens our services business.

Ursula Burns and Larry Zimmerman are with me this morning. We’ll all take your questions in a bit, but first I would like to review our revenue picture and then Larry will talk more about our financials, so please turn to the next slide.

So here’s a look at our revenue trends, noting that the year-over-year compare in actual and constant currency. The adjusted column on this chart assumes that Global’s revenues for Q306 is included in our results for the same period. Again, total revenue was up 12% in the quarter to $4.3 billion.

When we adjust the compare for Global Imaging, revenue was up 4% with two points of positive currency.

The leverage from post sale continues to be significant. It was up 11% in the quarter. That’s an increase of $314 million with Global. Adjusting for Global and the benefits in currency, we’re quite pleased that the trend in post-sale continues to be favorable, increasing 3% in Q3.

This was our first complete quarter with Global Imaging. As expected, Global is transitioning into selling and servicing more Xerox systems, while continuing its strong support of other vendors’ products.

Global’s results were on par with our expectations for the quarter, especially considering the effects of the transition and the time invested for Global sales and service reps to learn more about our offerings.

During the third quarter, Xerox benefited from 38 new office and production products launched this year, as well as broader distribution to small and mid-sized businesses through the Global acquisition.

Equipment sales were up 14% over the prior year, or flat on an adjusted basis, including a 2% benefit from currency.

A greater proportion of our contracts, including some of our services deals, is recognized as operating leases and not as equipment sale revenue.

This revenue shift cost us two points of equipment sales in Q3, heavily weighted in the production end of our business.

While we don’t see the revenue in equipment sales, it flows through to post-sale revenue over time and we’ll see the benefit of this operating lease trend in our post-sale as we deliver steady annuity growth.

With Global and our core business, we are competing aggressively to increase placements of Xerox systems through new products and expanded distribution, and bolstering growth through Xerox's consulting and managed services.

Services deals fueled an 8% increase in post-sale from services to the third quarter of this year. Large services deals typically have a long lead time, and several big wins hit us in Q3 rather than later this year.

In fact, we recently signed a $93 million contract with the U.S. Navy to provide equipment and services for its entire fleet, and an $82 million multi-year outsourcing deal with EuroPart, Europe’s largest auto parts distributor. We are managing all of their office and production printing, as well as customer service centers.

At the same time, color continued to give us a big boost to our annuities, so if you turn to slide 6, we’ll take a look.

With color, the power is always in the pages. Right now, Xerox office and production systems are on pace to produce more than 40 billion color pages this year. That is about 10 billion more than last year. We are miles ahead of our competitors on color pages and pages remain the best source of annuity and profit growth.

Color page volume was up again this quarter, growing 32% and now representing 13% of total pages -- three points more than Q3 of 2006.

Revenue from color this quarter was up 13%, 10% on constant currency. Post-sale from color was up 17% in the quarter. That’s without factoring in any benefit from Global Imaging. The solid results reflect steady demand for Xerox office color MSDs and production color systems.

Last month, we unveiled an industry first, bringing the price of printing a color page down to that of black and white. We launched our Phaser Solid Ink Printer in MFD that breaks the price barrier for customers who need affordable, quality color systems and use them a lot to get business done, like realtors, designers, and contractors.

With the advancements in our solid ink technology, a realtor can print a postcard of a new listing in full color for the same price as printing it in black and white, but with 10 times the impact.

It’s a strategy that’s opening new doors and plays to the significant advancements we’ve made in our proprietary solid ink technology, and there’s more to come.

This launch also included two additions to our series of color laser multi-function systems. We’ve introduced 17 more color products this year alone, building on what is already the industry’s broadest portfolio of color printing technology.

So if you will turn to slide seven, we’ll review our production business. Total production revenue grew 6%, including a four point benefit from currency. Post-sale was up 7%. More of our production customers are shifting to operating leases, as mentioned earlier. We saw a four-point impact from the shift on production equipment sale revenue. Again, the benefit of operating leases is that the revenue flows through to post-sale over time.

I am really pleased with the demand for new products launched earlier this year, like the Nuvera 288 production systems. The mix of products sold in this space is balancing out, with continuous feed in the Nuvera 288 helping to offset declines in other higher end black-and-white production and light production. And we expect the decline in light production will improve with the recent launch of the Xerox 4112 and 4127.

Overall, we remain very well-positioned as the market continues to shift to highlight color ink full color, and that’s what we heard at Graphex the last month. I know some of you were there, too. Ursula was there meeting with customers and partners who continue to post huge gains in growing their digital printing business. The show was a success for Xerox, highlighting the breadth of our products, workflow, and services offerings, and generating multi-million dollar orders, including multiple orders for iGen3s right from the show floor.

We continue to see strong demand for our iGen3 systems, both in our revenue and install figures. Production color install activity was up 14% this quarter.

So regardless of what our customers are buying, high-end or light production, color or monochrome, we continue to benefit from the profitability and production across the board.

As you know, we typically exclude our developing market operations from our production and office revenue results, since DMO is a separate reporting segment, but with DMO’s expanding growth, I think it is important to show the leverage from our strengthened business in areas like Russia, Central Europe, and more.

Production equipment sell revenue from DMO was up 16% in Q3, and that’s largely due to more iGen3 and DocuColor sales.

So if you will turn to slide 8, we’ll take a look at the office. With the benefit of Global Imaging in our results, total office revenue was up 14% in the quarter and 11% in constant currency. Our competitive play to install more and more Xerox units helps to boost post-sale, which was up 12% in the quarter.

The addition of Global Imaging led to the 18% lift in equipment sales. Global also continues to branch out, making two more acquisitions this quarter that expand our reach to small and mid-sized businesses.

Even without the benefit of Global, we saw an improving trend in office equipment sales, reflecting a better mix of products sold and a ramp-up from the office product launches this year.

Install activity for segments three through five multi-function devices, which are designed for workgroup and mid-sized offices, increased 8%. Demand for our desktop devices in the segments one and two market drove up activity 9%, and we saw a 69% increase in installs of our color multi-function systems. Installs of color printers, a much smaller part of the total, were down due to declines in our OEM business.

We’ve introduced 25 more office products this year, from solid ink advancements to a complete refresh of our black and white work center MSE family, and more color laser based systems.

It has been a strong launch year for the company, along with competitive pricing, breaking down cost barriers of color, and expanding distribution, and we are seeing positive traction from this aggressive growth strategy.

The same holds true in our developing markets business, with office equipment sales up 7% in the quarter. So if you will turn to slide 9, we can provide more details on DMO’s results.

Revenue from our development markets operations was up 12% with post-sale up 13% and equipment sale revenue up 9%. While office printers and multi-function devices are standard plays in DMO, we are seeing stronger sales of production systems this year.

Commercial printers in countries like Russia and in Central and Eastern Europe are building their businesses on the advantages of digital, and we’ll have a large showing at next week’s IPEC’s South Asia event, where Xerox's leadership in digital printing is gaining ground in India.

Not unlike businesses in more developed countries, our customers in DMO are seeking cost-effective ways to simplify the way they do work and demand for our outsourcing and consulting services is forging valuable partnerships with clients and providing a boost to DMO post-sale results.

So here’s a quick wrap-up on the revenue front; annuity, acquisitions, color, services, and activity were the drivers of growth. No surprises; just steady, increased improvement across the board and the benefits on the top line were supported by a close eye on managing costs and expanding earnings. So that’s a good place for me to hand it over to Larry. He has more to share on the dynamics of our post-sale results and a review of our financials. I’ll be back to wrap up and discuss Q4 expectations and then Larry, Ursula, and I will take your questions. Larry.

Lawrence A. Zimmerman

Thank you, Anne and good morning. Our third quarter performance delivered on our commitment of sustained enhancement of shareholder value. Adjusted EPS growth of 17%, 18% year-to-date, $320 million core cash flow, $820 million year-to-date.

The fundamentals of our business model are strong. Equipment installs had strong growth, annuity revenue growth is driving total revenue growth, there is a balance between gross profit margin and expense levels -- all of which yielded expanded earnings and good cash generation. The quarter and year-to-date results position us well to deliver on the full year. Slide 11.

Our business model is driven by annuity and our leading indicators continue on a positive trend. Keep in mind that the machines in the field, MIF, and page numbers do not include printers, our development market segment, or Global Imaging Systems, which would only improve the results.

Looking first at the top left, digital revenue was up 7%, 4% at constant currency; MIF was up 7%, while digital pages were flat. This digital performance was driven by color growth of 18% revenue, 34% MIF, and 30% pages, combined with the positive influence of color on price per page.

This remains a huge opportunity going forward, as color only represents 16% of the MIF and 12% of the pages. These numbers will continue to grow and drive annuity higher.

In addition, our services annuity, another key indicator and element of our growth strategy, continues its positive growth at 8%. Black and white digital is stable, with slight declines in pages but continued growth in MIF, is a positive indicator for the future.

The last set of numbers on the bottom related to Light Lens, the analog transition to digital that has put a drag on our post-sale and is now only 2% of total annuity revenue. This positive story, coupled with the office production and DMO installs that Anne reviewed with you, reflect well on continued annuity performance. Slide 12.

The annuity scorecard points to positive post-sale on financing revenue growth. Adjusting 2006 for Global, we grew annuity revenues 6%, 3% constant currency. The trend of improvement is the key to our business model and at 3% constant currency growth, we are on track for sustained performance.

Digital and DMO annuity drove the growth. DMO has had two quarters in a row of double-digit growth. Light Lens is now only $47 million in the quarter and a one point drag on the results. So the metrics in revenue results point positively and we see annuity going forward, continuing to support our business model and cash generation. Slide 13.

Our P&L for the third quarter delivered solid earnings expansion of 17% over third quarter 2006 adjusted earnings. We’ve dealt with revenue, so let’s start with gross profit margin of 40.1, about the same as last year and in our model range. We grew gross profit dollars significantly this quarter. Expense ratios improved, with flat RD&E dollars and a decline in SAG, considering currency and Global.

This quarter, 2006 after tax -- I’m sorry, third quarter 2006 after tax adjustments were $68 million for litigation matters, $72 million restructuring, and $448 million positive tax audit settlement. With these adjustments, third quarter 2006 EPS was $0.23 versus $0.27 this year, or 17% growth. Slide 14.

Cash flow from operations was $286 million in the third quarter, $860 million year-to-date, with core cash flow of $320 million and $820 million respectively. Quarter and year-to-date results were driven by strong earnings and a cash generation from our annuity model.

This core cash flow performance is on track to reach $1.5 billion for the year, the high end of our $1.2 billion to $1.5 billion guidance range.

In the third quarter, we paid $197 million into our pension plans, $158 million in U.S. to achieve 100% funded on a current liability basis.

Accounts receivable and inventory area an opportunity in the fourth quarter, as our year-to-date results saw increased uses of cash. However, we have consistently performed well in both areas in the fourth quarter, and I expect the same results this year.

CapEx was $85 million in the third quarter, $247 million year-to-date, going to about $300 million for the year. Acquisitions represent Global and some acquisitions they made in the third quarter. Advectis, the mortgage document management services company which we just closed on, will show up in the fourth quarter.

On the financing side, we purchased $212 million of shares, $500 million year-to-date. We remain leveraged at 7-to-1 on our financing business, and core debt is $700 million, flat with last quarter. This will decrease in fourth quarter.

So overall, I am pleased with the cash results. Slide 15. Looking at year-to-date results has the advantage of smoothing some of the timing considerations of 90-day periods. Our year-to-date performance is quite good and the trends support our expectations for delivery of shareholder value to the full year.

Our revenue growth shows positive trends on both post-sale and equipment, with post-sale driving total revenue growth. A 40.3% gross profit margin is on track to deliver between 40% and 41% for the year.

Good expense management with improved expense to revenue ratios and year-to-date adjusted EPS growth of 18%. In addition to our 18% growth in EPS, we delivered $820 million cash from core operations and used $212 million for share repurchase program in third quarter, $501 million year-to-date -- $2 billion since inception of the program, with approximately $0.5 billion remaining on our current authorization.

We continue to leverage our financing business 7-to-1, and balance share repurchase and acquisition with core cash flow. We just closed on Advectis for $32 million.

I am comfortable on the cash side. Given our year-to-date performance, we will deliver $1.5 billion core cash, top of our $1.2 billion to $1.5 billion range.

So in summary, a really good 90-day period, as well as year-to-date results -- expanding earnings, delivery on cash, and key indicators pointing positively.

And now back to Anne.

Anne M. Mulcahy

Thanks, Larry. I’ll close with a real quick summary; this quarter did set the stage for a solid second half of the year, in line with our expectations and evidence of the strength of our strategy. The trends are all moving in the right direction.

Our top line growth reflects a positive mix of annuity acquisitions and activity. Our success in color and services is giving us great leverage and generates post-sale revenue. Equipment installs in key markets, especially color and office multi-function, remain strong. The 38 product launches this year alone keep us on a steady pace for continued activity growth.

We’re managing the balance sheet effectively. We’re continuing to invest in growing our business through innovation and acquisitions, and through stock buy-back, we continue to build more shareholder value.

For the fourth quarter, we expect to deliver earnings in the range of $0.39 to $0.41 per share, and for the second time this year, we have increased our earnings expectations to $1.18 to $1.20.

So thanks for listening. Ursula, Larry and I will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Jay Vleeschhouwer from Merrill Lynch. You may proceed, Jay.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good morning. My first question concerns the Global acquisition. Can you comment on the kind of revenue run-off that you have been seeing, post the de-certification by Canon and Ricoh of their new product sales through that channel? As well, the ability that you’ve had to backfill that through that network with Xerox-branded products, so talk about that transition, if you could.

On the services side, you’ve been pursuing these kinds of managed serviced deals for a long time, of course, and you cited two large wins. Has there been a fundamental change in new demand for such contracts? Or your close rate on the contracts? Or were the two you just announced somewhat anomalous?

Anne M. Mulcahy

So let’s talk about Global. As I said, we’re really pleased with the delivery of Global. Obviously it’s early days, there’s been a lot of change for them to absorb, but I have to tell you, their results are on track and this is really a heck of a management team. There has been no revenue run-off that we would find concerning or out of trend, despite the fact that obviously they’ve adjusted to the Canon and Ricoh decision.

As a matter of fact, I think in reviewing the results on the Xerox equipment that now is being delivered through Global channels, by the end of third quarter it was over 50%, which is certainly exceeding our expectations in terms of how quickly we would be able to integrate Xerox offerings into the global channel, and they’re just really bullish about the acceptance and feedback as it relates to Xerox technology.

So we are really not at all concerned that Global is not successfully integrating Xerox technology into their customers and I think we are through, quite frankly the beginning days of that transition, so it will just get better and better.

On the managed services side, I think there is a lot of deals we don’t announce because we’ve obviously got to get permission from customers to announce, so I would not view these deals as anomalies. We actually now have implemented kind of a big deal bid desk just to deal with bids that are over $20 million or $30 million in a global, very disciplined way.

I think certainly our win rate is increasing as we gain more and more experience, and I think the implementation of this global bid desk is going to be very, very helpful, but the fact is that as you close these deals, they become reference points for segments of the industry that I think are absolutely listening to the Xerox value proposition, and we’ve got demonstrated results that are reflecting enormous productivity gains and great value for lots of services customers out there. So we’re really I think building on the momentum of what this business has been delivering for the last few years.

Jay Vleeschhouwer - Merrill Lynch

Questions for Larry on the operating lease side -- can you comment on whether you think this phenomenon will grow as a percentage of new business, or might it abate in some way? It does seem to be spreading across the product line in production beyond just iGen. Is it temporary, do you think or is it just going to have to become a large piece of the business?

And then finally, back to Anne, can you comment on overall trends in your key verticals -- graphic arts, corporate, government, and how you are doing finally in some of the new production specialty applications?

Lawrence A. Zimmerman

I would say on the operating lease side, to the extent that we are being so successful in services bids and we can solve a lot of customer problems that way, that we are going to see more operating leases. I think it is definitely a part of our business.

And it is really a positive. At some point here, there is a steady state where you are getting the benefits in the post-sale side. Right now, it is just a way of explaining what is happening in equipment sales, and that’s why we bring it up. It’s really a really good point for the annuity stream and as it builds up here, it is going to pay off significantly.

So number one, I think it is going to continue; number two, I think we are going to get huge benefits in post-sale, and I think it is a good thing for the long-term.

Anne M. Mulcahy

I am going to take a general swag at the verticals. I want to turn it over to Ursula on the -- particularly the graphics art marketplace, but corporate, we’re actually feeling good about it and I know that there’s been a lot of questions, particularly on the financial services segment, but I think we are differentiated in the sense that these kind of services led solutions that provide these clients with substantial productivity and cost savings while we are building more and more value around document management services is absolutely continuing to thrive in a world where perhaps there is a lot more pressure, just on pure technology acquisition and capital-based acquisition.

So I think we are positioned well there. So we are not seeing anything in the corporate sector that we haven’t been seeing for the last three years, and that’s just that corporate clients want a real ROI on whatever investments they make from technology companies.

Government has been terrific. A lot of the big breakthrough services deals like the Department of Works and Pension in the U.K., the Navy deal that we just talked about, government now is beginning to get into the -- they want ROI from big time services approaches as well, versus just hardware acquisition. So I think we are just beginning to open up the government opportunities.

And graphic arts looks great but I’m going to let Ursula talk about it.

Ursula M. Burns

As Anne said, graphics arts does look very encouraging for us. It continues to be a strong segment. It plays extremely well and therefore, we lead with our technology here, both our color technology, which you know about. We are really pleased with our performance in the quarter, third quarter. By the way, second quarter as well on iGen3, and on our [inaudible] production color product line. iGen performance was very strong. Activity and utilization of our workflow to drive application-specific pages are up as well.

We are winning and succeeding in the photo market. We are making good in-roads in the packaging market, so the production in the commercial print market is looking very good, the graphic arts market is looking very good.

If I can also add, our black and white portion of the graphics art market is strong as well. If you look at our Nuvera EA and our Nuvera 288 systems, they are continuing to be very successful and drive applications like books and trans promo, and for applications in the commercial print market as well.

So this is a quarter, and last quarter as well, that we are very pleased, very pleased with the activity.

Jay Vleeschhouwer - Merrill Lynch

Thank you.

Operator

Thank you. And your next question will come from the line of Bill Shope from J.P. Morgan. You may proceed, Bill.

Bill Shope - J.P. Morgan

Thanks. Anne, despite the operating lease headwind, there was obviously a nice improvement in equipment sales trends versus last quarter. Could you talk about the sustainability of this improvement? And in adjusting for Global and currency, should we anticipate that this segment could start to show some positive growth in coming quarters?

Anne M. Mulcahy

I think we are pleased that it really was a nice up-tick from Q2 on the equipment sales side. As Larry said, operating lease is a little bit difficult to predict because it is going to be based on the strength of, particularly of our services business, but that’s one that we are very pleased about.

I think as we look at what really drove the up-tick in equipment sales, it was really strong color performance, so that we expect to continue. There is no question that color is the big driver on the equipment side now for growth and everywhere you look, just about, the performance was very, very good.

So is the improvement sustainable? The answer is yes, and as we think about the top line equipment sales for the full year, we certainly see it as an improving trend. Can there be some volatility quarter to quarter based upon product launches or services content? Yes, but hey, when you look at this over a few quarters, we expect this trend to improve as color becomes a bigger and bigger part of the overall equipment sale portfolio.

Bill Shope - J.P. Morgan

Final question -- are you seeing any competitive pressure or any change in the competitive landscape from Canon’s 7000 series of products?

Anne M. Mulcahy

No. I think -- well, I should say -- do we see it? Yes. There is a lot of certainly aggression in the marketplace, I think, with regard to trying to place Canon 7000, but I think we have a very entrenched, loyal customer base with our DocuColor and iGen customers. And as you can see in terms of growth rates on installs, 14%, that’s really an up-tick on installs for us. The revenue story is great, so I think we are absolutely doing very, very well, in light of competitive entries.

Ursula, you may want to add.

Ursula M. Burns

The one thing I want to add is we launched last quarter, the most recent quarter, DocuColor 8000 AP. This was a product that we worked on specifically to respond to the one application space that the Canon 7000 would have had an advantage over us, and that’s in heavyweight papers. And we’ve launched that product and it is doing very well.

So that product, along with our entire product line in the EPC space and production color space, and in the office color space, I think we are, as Anne said, very confident where we are today and definitely confident facing off against the Canon line.

Anne M. Mulcahy

By the way, if you look, the most recent data we have on market share, which was Q2 market share, production color, it’s just really great in terms of the improvements we’ve seen both sequentially and year over year.

Bill Shope - J.P. Morgan

Thank you.

Operator

Thank you very much. And your next question will come from the line of Caroline Sabbagha from Lehman Brothers. You may proceed, Carol.

Caroline Sabbagha - Lehman Brothers

Thank you. First, just a very broad question about what you are seeing regionally across the world; are you seeing any sort of slowdown in bids at all, or requests for proposals? Or is the economy continuing to operate the same level it has in the first half of the year?

Anne M. Mulcahy

I think we see the regional trends being pretty similar, and obviously you can see from the results in developing markets that that continues to be the higher source of growth and we are capitalizing on it and we will continue to do so.

But I think both in Western Europe and North America, we would characterize both our signings and our bid pipelines as being as strong as ever. Can there be -- when you are dealing with really big services deals, the reality is they do take longer to close and it’s not a transaction business, but all the indicators would say that our big deal business is going in the right direction with a pipeline that is as strong as it’s ever been.

I think we are very much aware, obviously, of the economic challenges as it relates to the debt markets and the financial services segment, but I think that our business model and our business-to-business orientation is actually keeping us in pretty good shape from feeling any real downward pressure from that.

Caroline Sabbagha - Lehman Brothers

And then, a question on Global Imaging; it looks like if you can back in to potentially some numbers, that their revenues are up in the low single digits and their equipment sales were down. I know they had an extremely tough compare versus their third quarter last year, so can you address that a little bit and talk about what you believe trend line is on the Global Imaging revenue side?

Anne M. Mulcahy

I think you characterized it correctly. On the total revenue side, I think we would view it very much on trend. And by the way, pretty good performance in light of the early days of change management that they’ve had to deal with with regard to the acquisition.

On the equipment sales side, for any of those who choose to go back and read 10-Qs, but if you look at the Global 10-Q from third quarter of last year, you would see they had an exceptionally strong performance in their network services and audio visual groups, which are a small part of the business but it was huge performance, and it created obviously a compare pressure.

If you look at their core business, we are quite pleased with their equipment sale trend on their core business, but they did have a difficult compare and as a result, it actually put pressure on our equipment sale performance in our core business and actually deteriorate the performance a bit, but underlying fundamentals are good and we continue to be very pleased with Global’s performance.

Caroline Sabbagha - Lehman Brothers

One last quick question on use of cash. You did a bigger buy-back in the quarter than I would have guessed. What is the outlook for how much you are willing to allocate for the stock buy-back for the rest of the year, and if we can look out a little bit into ’08?

Lawrence A. Zimmerman

We have $500 million that’s still authorized that we haven’t used, and I would say for the remainder of the year, we plan to be modest. I think the third quarter, we just intended -- you know, we just looked at the share price and bought back shares, so that was the motivation. We thought it was a good price to buy at. And I think we are going to continue on the trend that we said at the beginning, which is within cash flow, we’re going to buy back shares.

And the important factor too is I think by the end of the fourth quarter, we will have paid down a significant amount of our core debt, so we will be open to go right back on the trend we had before in the next year.

Caroline Sabbagha - Lehman Brothers

Thank you very much.

Operator

Thank you very much. And your next question will come from the line of Benjamin Reitzes from UBS. You may proceed, Ben.

Benjamin A. Reitzes - UBS Warburg

Thank you. A couple of questions -- I guess you got the economy question a lot. Can you just delineate between Europe and the U.S., please and talk about any differences you saw there in the quarter and into the fourth?

Anne M. Mulcahy

I don’t think we are seeing any real material difference between Europe and the U.S. at this point in terms of the markets that we serve. For us, if you look at certainly the strength in the graphic arts market, and clearly the corporate value proposition, I think it’s really important to remember that our go-to-market strategy for significant corporate sectors is now a services led business and I think where you might see some short-term pressure is more on the capital acquisition side and I think that we are less vulnerable to that than others.

I do believe that in both Europe and North America, we are not seeing a lot of pressure and clearly we are watching it very carefully, but nothing that is terribly worrisome in terms of our particular business model right now.

Benjamin A. Reitzes - UBS Warburg

Could we talk about your acquisition strategy, in light of that you are still absorbing Global? What kind of acquisitions should we expect from Xerox and what do you think of Lexmark? It’s beaten down and there’s some very bullish views out there by some, but I’m wondering if you would be able to absorb something like that, or if that would even be on the radar screen?

Anne M. Mulcahy

First of all, I think in terms of what we’re ready to digest, I mean, Larry said it. We’ll pretty much have digested Global by the end of this year, which I think was a sizable acquisition for us.

Going forward, we’re real clear -- we are going to continue to look for service verticals that are all, quite frankly, additive, top line driven kinds of competencies. We are going to look at software that actually enhances our production solutions business, and we’re going to look for distribution. Global was a big bite but there’s lots of other smaller bites out there and obviously Global continues to digest those on a business as usual fashion.

As a matter of fact, it’s interesting but their acquisition candidate pipeline has never been stronger because of the fact that they are now have Xerox, the Xerox brands behind them. They are really seeing interest from dealers that they would not have seen before.

I think that the strategy is solid and consistent and will continue and be very well-balanced within the capital deployment side.

I think our principals on acquisitions is really value creating, really good revenue synergies, where we can acquire a company and actually use it to drive incremental growth in our core business, so it is not a one-time deal, it’s not a drug that we have to keep doing because it is going to actually enhance our ability to drive core growth.

I don’t think Lexmark is an ideal candidate with that kind of view. We have tons of R&D and technology capability. We are not looking to increment that. Between Fuji Xerox and Xerox, there is nothing the Lexmark would bring to the table that would be really value-creating for us.

And from a distribution perspective, I think it’s much cheaper and in much better interest of the shareholders to go out and drive additional indirect distribution and optimize on the Global acquisition, than we would want to look for.

I think that based upon what we’ve been articulating as a strategy, it’s really not a great fit.

Benjamin A. Reitzes - UBS Warburg

Thanks for hitting it head on. It was a pretty great, complete answer. Take care.

Operator

Thank you. And your next question will come from the line of Matthew Troy from Citigroup. You may proceed, Matt.

Matthew Troy - Citigroup

I was wondering if you could comment just more broadly not on what you are seeing in the economy -- I think we all look at the same data and data points, but talk about the business model going forward to 2008? This is a much different Xerox than what we’ve seen in past recessions, and to the extent that seems to be the flavor-du-jour in terms of folks’ questions, I was wondering if you could talk about how Xerox is positioned if the economy were to go into a negative growth, or lack of growth mode.

I look at the business and I say on the enterprise side, color is a more discretionary spend. I know they reign in our ability to use color when costs are tight. And if look at the commercial print, which is a new growth market for you folks, that’s correlated to economic activity over the last 25 years to the tune of about 96%, so you potentially could be vulnerable there. But at the same time, you’ve changed your manufacturing infrastructure.

I’m wondering if you could just talk about how you think about the economy, how you think about positioning the model, and this is all just generated basically out of consolidated graphics pre-announcement yesterday, one of the largest commercial printers saying they are starting to see economic softness.

Anne M. Mulcahy

I actually think that we’ve been investing and positioning this business to win in tougher and tougher economic conditions in many ways. And that’s come from the relentless focus on productivity and competitiveness, but if look at our strategy going forward, I would say our intent is and you are -- you are seeing it already, you are going to see more of it, is to make color more and more affordable.

We’re going to make it so that people will not point to color as something that’s unaffordable, despite the toughest of economic conditions, and obviously what we’ve done now with this solid ink positioning is the beginning of a strategy, Ben, that we intend to have a much broader impact with as we go forward.

So from that perspective, I think our plans for color are to make it work and be a source of growth by really being responsive to the fact that the more affordable we make it, the better the growth prospects are.

I’ve talked about our services but if you look at our services business right now, driving 8% annuity growth, well above the corporate average, it is all playing in a world where clients have to make touch choices about how they spend their dollars and what they focus on, and I think our ability to continue to make that value proposition attractive to our clients by reducing their direct costs and allowing their resources to focus on their core business, is really compelling.

I mean, a lot of our services business now is about not acquiring technology but allowing us to host and manage everything for them, either onsite or offsite. So I think we have solutions to a problem that clients might face out in the future that are going to be very important.

And in the production business, if you are going to be a survivor in the graphic arts business, you better be in digital because there is no place else to go for growth in value. This is a case where things get weak, you separate out, quite frankly, what the sources of growth and profitability are from those that quite frankly will be deteriorating, and I think that we are well-positioned.

And when you add it all up, if the going gets tough, the business model you want is an annuity-based business model and 70% of our revenues are annuity based and with the impact of services and operating leases, that will be going up.

So hey, do we want a stronger economy, do we want the GDP to be helping propel our growth? Yes, but I think we are prepared to be a winner among the competitors with regard to the strategy that we have in place.

Matthew Troy - Citigroup

I understand that. I didn’t want to sound off alarm bells. Consolidated said both on their call and offline that they intended to continue their investment in digital. I think if you talk to any commercial printer, I would agree. It’s becoming just the ante to be in the business, increasingly.

Anne M. Mulcahy

I totally agree and I think look at the product portfolio that we are bringing to this market and I think this is going to be one of the biggest strengths we have going forward.

Matthew Troy - Citigroup

Second question would just be on again on new market opportunities; it’s been a couple of quarters since you announced a broader interest and focus on photofinishing. I was wondering if you or Ursula could talk about the learning curve there, what those discussions are like and maybe a hint or a forward-looking statement about what we might see at PMA or in 2008, specifically as it relates to your photofinishing push? Thank you.

Ursula M. Burns

You know, photofinishing is a focus area for us. In the high end of the business, we have obviously a flagship product, with expanded copy quality capabilities that allow us to participate in the photo imaging market even more deeply than we did before.

We have great examples of this, both in North America and in Europe. In North America, we partnered with Shutterfly, as you know, and in Europe we have a great partnership with MyPhotoFun, with a company called Ted Gigaprint, so we are actually moving far and moving fast there and trying to expand our footprint. And I think in the high end of the business, doing well.

At the lower end, there are applications at the lower end not as high quality as the iGen or EPC space, and we work through our partners, which is Xerox with FujiFilm, to actually participate there, using some of our office multi-function devices in partnership with FujiFilm to be a kiosk type provider. That is a new space for us, a beginning space for us, but one that we are positioned well to continue to grow, especially as we work with FujiFilm, who has a footprint and a deep knowledge there.

So our technology hardware, our technology software and their back-office understanding of how kiosk photo works will help us to be effective in that space.

So high end, I think covered, growing well, great technology implications; low end, great, working with an expert there with our technology. So we see it as a great opportunity for us going forward.

Matthew Troy - Citigroup

Certainly a strong partner with Fuji. If I think about that as a channel for you to place devices, is this still early days or are you seeing traction and placements growing to a more material number, or is really an ’08, ’09 story where we will see more from you there?

Ursula M. Burns

It is definitely still early days but I am not discouraged by the way that the market is moving in the kiosk space. At the high end space, it is not as early days and so the indicators are good there. And the real indicators are good there -- great providers of this type of distributed kind of photo applications, we are partners with some of the best providers in the world here. So in the high end of the space, it is not early days.

Matthew Troy - Citigroup

Thanks, Ursula.

Operator

Thank you very much. And your next question will come from the line of Chris Whitmore from Deutsche Bank. Chris, you may proceed.

Chris Whitmore - Deutsche Bank

Thanks very much. Larry, can you quantify either the inter-company revenue realized from backfilling the global channel or the incremental equipment margin capture from that backfill? And perhaps talk about the opportunity there going forward?

Lawrence A. Zimmerman

I don’t think -- you are talking about what we transfer through Global and what they add to our business? I mean, I think that from the standpoint of going forward, until we have a lot of product there, it is not a material difference but as the products build up, obviously it is going to help us on total dollars that we get from them. I’m not sure that’s public knowledge.

It’s just like any channel that we have. I don’t think we publish what the profitability of those particular channels are, so -- but it is going to be very profitable for us going forward, looking out in time for sure.

What was the second part of the question, or was that it?

Chris Whitmore - Deutsche Bank

I was just trying to get a feel for the manufacturing margin captured from equipment sales through that Global channel.

Lawrence A. Zimmerman

I don’t think that’s a public data number, from a channel standpoint.

Anne M. Mulcahy

But obviously it’s one of the things that we pointed to in terms of the ability to leverage the acquisition to be more than what standalone Global would have brought us. The manufacturing profit is one of the synergies that over time, will be a real help in improving actually the margin in the company.

I think we have time for one more question.

Operator

Thank you. And your last question will come from the line of Shannon Cross from Cross Research. You may proceed, Shannon.

Shannon Cross - Cross Research

Just a couple of questions; just curious -- have you seen any changes -- this sort of goes back to the economy question -- with regard to any push back of contracts from any of your customers? You know, how when things slow down, you tend to push back contracts and not sell as much product. It doesn’t appear that that was the case this quarter, but I just wanted to confirm.

Anne M. Mulcahy

When you say push back on contracts, you mean in terms of deals signed?

Shannon Cross - Cross Research

Actually lengthening out the contracts. So your salesperson goes in and says okay, fine, I know times are a little bit tough, let’s stretch out the contract another year and you benefit on the margin side because --

Anne M. Mulcahy

I see. You know, I would not say that that’s any different -- I mean, we do go and think it’s to an advantage, sometimes, if we can extend the contract for the client. It tends to be the timeframe where it is most productive for the client and what’s profitable for us, there’s no question about it.

So that’s kind of a strategy that we have in place, but I don’t think we are seeing anything that would be materially different in terms of the economic impact.

Shannon Cross - Cross Research

Okay, good, and then Larry, maybe you can talk just a little bit more in terms of the use of cash. You’ve talked about repurchase, you’ve talked about acquisitions -- any comments on dividends or any thought process with regard to looking out and how you evaluate the various uses?

Lawrence A. Zimmerman

I think as we’ve said before, and I think we’ll cover in more detail at our investor conference, we consider that in the future, Xerox will be a dividend company and it’s just a question of when that will happen.

I think going forward, you are going to see a significant amount of share buy-back. You are going to see acquisitions, as Anne outlined, probably not anywhere near the size of a Global Imaging, and then I think at some future date, we will be a dividend company and I think we will cover more detail on that when we go through it at the investor conference.

Shannon Cross - Cross Research

Okay, sounds good. I guess we’ll all see you in November.

Anne M. Mulcahy

Great. That’s my parting line, Shannon, because I wanted to thank all of you for joining us and we do hope that we see as many of you as possible at our investor conference. It is in New York on November 19th and thank you very much for your participation today.

Operator

Thank you, ladies and gentlemen, for your participation in today’s presentation. You may now disconnect and have a wonderful day.

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