Anne Mulcahy - Chairman, CEO Lawrence Zimmerman - CFO, SVP

Shannon Cross - Cross Research Matthew Troy - Citigroup Jay Vleeschhouwer - Merrill Lynch Ben Reitzes - UBS Keith Bachman - Banc of America Jack Kelly - Goldman Sachs Carol Sabbagha - Lehman Brothers

Good morning, ladies and gentlemen, and welcome to the Xerox Corporation first quarter 2006 earnings release conference call hosted by Anne Mulcahy, Chairman and Chief Executive Officer. She is joined by Lawrence Zimmerman, Senior Vice President and Chief Financial Officer. During this call Ms. Mulcahy and Mr. Zimmerman will refer to slides which are available on the Xerox investor website at www.Xerox.com/investor. At the request of Xerox Corporation today's meeting 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 the meeting Ms. Mulcahy and Mr. Zimmerman will make comments that constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements reflect management's current beliefs and expectations and are subject to a number a factors that may cause actual results to differ materially. Information concerning these factors is included in the Company's 2005 Form 10-K filed with the SEC. The Company assumes no obligation to update any forward-looking statements as a result of new information or future events or developments. At this time I would like to turn the meeting over to Ms. Mulcahy. Ms. Mulcahy, you may begin.

Thank you and good morning to everyone; thanks for joining us today. If you'll turn to slide 4 you'll see a summary of our Q1 results. We delivered earnings per share of $0.20 and net income of $200 million; EPS was at the low end of our expectations and our gross margin was down 1.6 points. So clearly I'm disappointed our gross profit decline. Our issue in the quarter came down to three main areas. First, we made some aggressive pricing investments in office black and white, specifically segment 3 through 5. The strategy worked in accelerating activity for our new work center systems, but it did cost us about half a point on gross margin. While we had planned for this, we had expected to offset the impact in other areas . Second, increased labor for technical and managed services cost about another half a point. In short, we ramped up contract labor to ensure customer satisfaction during our transition to a flexible service force and we had some start-up costs on new managed services contracts. We know both issues are well under control and that our labor costs will be better aligned next quarter. Third, during the first quarter of last year we disclosed a sizable licensing deal that generated a non-repeatable benefit to gross margin. In addition, there were a series of non-recurring costs that made it difficult for us to offset the challenges in these three areas. So in total, it was a mix of operational issues that we could have managed better and non-operational items that all hit in first quarter. These certainly are not intended to be excuses, but to assure you that we understand the issues and they are being addressed. In other words, the issues we face this quarter are within our control. We have consistently demonstrated excellent execution in this area and are confident we'll be back on track next quarter and I do expect gross margin will improve in Q2. On revenue, currency continued to have an impact in the quarter. Total revenue was down 2% and flat on a constant currency basis. Wholesale and financing revenue, which represents 75% of our total revenue, was down 1% and increased 1% in constant currency. This steady positive trend tells me that the business model is working and it was a highlight in the quarter. More on that, equipment sales and good news on color in a moment. Our tax rate came down significantly in first quarter as a result of a favorable outcome from an ongoing tax audit and as you can see here, it was another positive quarter in balance sheet performance with a lot of activity. Larry will fill you in on this a little later, but first I'd like to spend a few minutes on revenue and activity and, of course, I'll wrap up with thoughts on Q2 before we take your questions. So if you will turn to slide 5, here's a look at our revenue trends noting the year-over-year compare in both actual and constant currency. Total revenue in the quarter was down 2% and flat excluding the currency impact. On a constant currency basis, equipment revenue was down 2%. This is primarily due to price and mix pressures, a dynamic you'll see more clearly in a moment when I talk about install rates. Our product launches from last year, especially the DocuColor 240/250 and the refresh of the Work Center line of multifunction systems, continues to fuel the accelerated pace of install activity. We continue to generate about two-thirds of our equipment sales from products we've launched in the last two years. It's clear that the revenue dynamics are shifting. As we discussed last quarter, equipment sales will provide less leverage due to mix as well as the strength of our services-led enterprise wins which are annuity contracts. We've talked a lot about the significance of our post-sale revenue and will continue to do so as post-sale lifts total revenue. Adjusting for currency you'll see a steady improvement in post-sale, up 1% in the first quarter. The drag from older Light Lens products was offset this quarter by good news in post-sale from Digital, growth in color pages and a continuing benefit now from our developing markets. So turn to slide 6 for a closer look. On this chart you'll see the strong leverage of post-sale revenue from our digital products, up 5% in constant currency and continuing a positive trend. Light Lens and SOHO declined at the consistent rate. As we discussed in the past, this is becoming a smaller and smaller percentage of total revenue, having less of a negative affect on the total. In Q1 Light Lens cost us 2 points on post-sale versus a 4-point impact last year. Improved results in developing markets up 5% in post-sale, again a highlight. The year-over-year compare on post-sale is skewed by a swing in licensing revenue. In first quarter of last year we had $29 million in licensing revenue. Without the licensing compare, our post-sale revenue was up 2% this quarter in constant currency. That's solid growth from our operations. Color is a key driver with post-sale from color up 12%; good news as we strengthen our leadership position and invest in color technology. As important, we're building momentum with our overall services business which delivered a 2% post-sale gain. In first quarter alone we increased contract signings for Xerox global services by more than 25%. Like in AOL, where Xerox was selected to staff an on-site managed imaging center; and at Enterprise Rent-a-Car where Xerox manages the global printing and distribution of their invoices and training materials, and scans and stores their key documents for secure access over their network. It's these annuity-based deals that give me confidence in our growth strategy. Services wins plus strong install activity will generate continued positive trends in post-sale. So if you'll turn to slide 7 for a look at our Q1 install rates. Activity remained strong in several key areas of the business. The total refresh of our office portfolio including new Work Center multi-function devices and DocuColor systems lead to 18% install growth in office black and white and 53% growth in color. When I review the office segment you'll see that activity in segments 3 to 5 was particularly strong this quarter. In production publishing we continue to see trade-off to light production especially with the success of the Xerox 4110 system. We've launched three new light production products this year that will strengthen our leadership in this market. Our challenge is in black and white high-end production. At IPEX earlier this month we announced the new finishing features on our Nuvera line and we expect this will begin to pickup the high-end production install pace. I'll speak more on this in a moment. We have more launches coming this quarter and we'll continue to innovate, capture share and win the deals that fuel long-term gains So if you'll turn to slide 8 to see how color influences this model. As you know, Xerox has the industry's broadest portfolio of color systems for production in office environments of any size and the benefit is in the pages. 41% color page growth in the quarter supports the 15% increase in color post-sale at constant currency. This significant increase in pages shows the leverage of production color pages on the total. In fact, 7.1 billion pages were printed this quarter alone on Xerox color systems. Some of our competitors don't print that much in a year. So we're advantaged by providing the technology that drives high volumes of pages. With color revenue per page about 5X greater than black and white, its clear that color provides significant leverage our annuity revenue growth. The success of our DocuColor systems for office and production environments contributed to 11% in color equipment sales at constant currency. Total color revenue was up 14% in constant currency. We did see a slowdown this quarter in sales of desktop color printers, primarily in our OEM products. Without the impact from color printers our color revenue was actually up 19% this quarter in constant currency. So our leadership in color is changing the profile of our revenue with color now representing 33% of our total revenue; that's up 8 points from two years ago. So if you'll turn to slide 9 for a look at our production business. Total production revenue, which was flat in constant currency, was largely impacted by declines in sales and activity of our high-end productions systems. We know that the graphic arts market, particularly in the U.S., was waiting for more options on the Xerox Nuvera production system. The new finishing module we launched earlier this month responds to this need, offering customers the tools they need to produce bound books and other digital printing applications. In light production, continued strong demand for the Xerox 4110 increased installs by 35%. Earlier this year, we launched the Xerox 4590 copier/printer. At IPEX, where Xerox had the strongest presence of any digital printing company, we introduced the 4590 and 4110 products as enterprise printing systems that can produce more applications like short-run publishing of booklets to transactional applications for invoices. For production color, again the success of the DocuColor 240/250 continues to exceed expectations. This product, along with strong sales of the DocuColor 7000 and 8000 series, fueled a 92% increase in production color activity and a 14% increase in production color revenue. Coming off a very strong Q4 for iGen3 we saw some slowdown in iGen3 installs during Q1. This was expected, and largely due to delays in Europe in anticipation of the April IPEX event which creates a shift for iGen demand to the second quarter. At IPEX we launched the Xerox iGen3 90 digital production press which brings the power and quality of the iGen at a lower price point. I can tell you from being at the show and meeting with many customers that I'm quite confident in the steady pace of iGen3 installs for the balance of the year. We will make more news during second quarter in this space as we strengthen our leadership and aggressively target opportunities to win. So now if you'd turn to slide 10 for a review of our office business. Our total office revenue was up 1% in constant currency, including 3% growth in digital. For our segment 3 to 5 Work Center products we made pricing investments of 9%, the high end of the range that we've talked about in the past. Our strategy is simple: we're taking an early, aggressive attack at the market to drive major placements of these new multi-function systems. We're winning the big fleet deals and increasing activity in segments 3 through 5 with install rates up 25% this quarter. These installs generate post-sale revenue and a strong yield on post-sale profit. So while it cost us half a point on margin this quarter, the return on the pricing investment is significant and supports a healthy annuity stream. In fact, the rate of activity for the new Work Center family could have well exceeded 25% resulting in stronger equipment sale performance. Demand for these products outpaced supply in the first quarter. So now we're quickly filling the backlog of orders and have ramped up production to keep pace with the accelerated demand. We'll get some of that benefit in the second quarter, so it's a good problem to have. Revenue from office color grew 11% in constant currency with installs of office color multi-function devices up 53%. These solid growth rates are largely driven by the office version of the DocuColor 240/250 which we launched last year. As previously mentioned, the pace of growth in desktop color printers slowed this quarter, primarily due to a decline in OEM printers. We continued to deliver solid install growth for Xerox branded printers and we're certainly not resting on our laurels in the office space; you'll see news from Xerox this quarter to broaden our portfolio in the competitive office market. So now if you'll turn to slide 11. The results in our developing markets are continuing to improve. Revenue was up 6%, with equipment sales up 8% and post-sale and financing up 5%. Much of the growth is from continued success in Eurasia and Central and Eastern Europe where the trend remains exceptionally strong. We made steady progress in Latin America, in line with our expectations, as the two-tiered distribution model boosts results. The developing markets have turned the corner and we expect that the positive trends we've been seeing will continue. So now I'd like to turn it over to Larry for the financial review; then I'll be back to wrap up and share what we expect for the second quarter. And then, of course, Larry and I would be pleased to take your questions.

Thank you, Ann and good morning. As Ann covered with you, our earnings performance, specifically cost management, did not meet our expectations for this 90-day period. We understand cost, we understand cost management and specific actions are in place to improve as we work through the second quarter. Our full-year earnings expectations are unchanged and we remain confident that we will deliver. To put the cost issue in perspective, we manage more than $2.2 billion of costs each quarter. This quarter we should have done about $40 million better and next quarter we will. During every 90-day cycle there are pluses and minuses. We saw a mix of both this quarter and definitely some areas within our control where we should have done better. What's most encouraging is that the positive signs in the quarter point to a successful year. First annuity performance and growth. It's happening as we planned; constant currency growth of 1% and the underlying trend is even better. As Ann explained, without the licensing compare, post-sale grew 2% at constant currency and digital and DMO grew 5%; all positive signs in a positive trend. Second, our balance sheet continues to strengthen. We continue to throw off cash, invest in our business, rebalance secured and unsecured debt and buyback shares; all adding shareholder value. Slide 13. Now let's start with revenue, which Ann talked a lot about. The purpose of this chart is to reinforce that as our annuity revenue grows it drives total revenue growth. As you see here, the last four quarters are all roughly half a point of growth at constant currency. This picture will consistently improve as page volumes grow and we continue to build up the installed base as Light Lens becomes a smaller percent of the total. Again, it cost us about 2 points in post-sale this quarter, half of the hit of last year. So in summary, total revenue grew 3 points better than last year, largely due to the reduced impact of Light Lens and improved performance in digital and DMO. Slide 14. On our P&L summary, our expense to revenue ratios in R&D and SAG remain essentially flat. G&A spending did improve $26 million, with 60% of the reduction in G&A. As we've discussed, cost was the primary issue in the quarter and drove a 1.6 point decline in our total gross profit margin. The equipment sale margin decline drove about 0.5 point of the 1.6 point decline and was driven by price and product mix. This was on track with our expectations. The post-sale margin decline drove the 1.1 points equating to a $40 million cost issue. Half of this decline is due to nonrecurring issues, the other half, as Ann discussed, is where we should have done better. The majority of this cost issue came from higher labor costs in technical and managed services. The increase in technical service resources resulted from the transition we started last year in the U.S. to a flexible service model. To ensure that our customers were well served during the transition, we increased the use of contract workers. This activity served its purpose of effectively maintaining customer satisfaction, but did result in incremental spending. The transition to a more flexible service model is now largely behind us, so the resource issue has been and continues to be addressed with further reductions expected in the second quarter. In the managed services area we staffed up considerably to handle the start-up of some major contracts. The revenue now coming in on this business is offsetting the start-up costs and the labor resources have been stabilized. So we are confident that the technical and managed services costs will be brought down to the appropriate level in the second quarter and for the balance of the year. Our tax rate was 22.6%, lower than the 34% expected. This quarter we resolved certain tax issues related to our ongoing 1999 to 2003 IRS audit which resulted in a $24 million benefit. We expect to finalize this audit in 2006. EPS was $0.20 a share, flat to last year. Slide 15. In Q1 we threw off cash consistent with earnings, invested in our business and continued to rebalance secured and unsecured debt. Cash flow was about $150 million, consistent with meeting the high end of the range of $1.2 billion to $1.5 billion for the year. Cash from investing included $44 million of capital investments. Cash from financing was driven by a $285 million net secured debt repayment, a $100 million payment for the redemption of deferred preferred shares, share repurchase of $238 million and $689 million in proceeds from our bond offering. We ended the quarter with $1.8 billion in cash and short term investments. Since quarter end we have used $300 million to pay off our 2003 credit facility and made a $226 million contribution to our U.S. pension plan. These actions strengthen the Company and move us toward achieving an investment grade rating structure. The next slide provides a bit more detail, slide 15. As you can see, there was a lot of positive activity in our treasury organization as we continue to optimize our balance sheet. We issued $700 million of senior notes due 2016 at an attractive 6.4% rate. The proceeds of this transaction will be used to replace short-term secured debt with long-term unsecured debt at attractive rates. In April we signed a new $1.25 billion five-year, unsecured credit facility and terminated our 2003 $1 billion facility. We paid off $300 million in secured debt related to the termination of this credit facility. Our new credit facility will give us the flexibility to borrow for our financing activities unsecured, better pricing, and improved covenants. In the second quarter we'll write off unamortized fees from the 2003 credit facility; it's about $13 million and will be $0.01 a share non-cash charge on second quarter earnings and, as I just mentioned, also in April, so it's a 2Q event. We contributed $226 million to our U.S. pension plan achieving 100% funded status on our current liability basis, the measure that ERISA uses for funding requirements. Lastly, we repurchased $238 million of shares in the first quarter. We've now completed the original $500 million authorization and $170 million of the second of our $1 billion plan. So we had major balance sheet accomplishments which will add significant value to shareholders going forward. To sum up, we've delivered solid post-sale and balance sheet performance, but were challenged on the cost side; a lower tax rate offset most of this. In second quarter we expect to be back on track. Now, back to Ann.

Thanks, Larry. I'll just quickly recap. We are encouraged by the post-sale trend and the healthy annuity stream that will fuel total growth. While install rates remained strong, equipment sales were largely impacted by declines in black and white production and we are on that issue and believe we'll start seeing some success in this space in Q2. Our focused strategy to grow color and services remains on track and the good news in these areas is flowing through to post-sale. Our first quarter profit was impacted by cost driven issues that hit post-sale margins. Again, we know it's not a systemic issue. We also know that we need to take it seriously; we have the attention on our people and are taking productive actions right now. As a result, our gross margins will improve next quarter. We're financially strong and remain diligent about generating cash and prioritizing profitability. For second quarter, we expect to deliver earnings in the range of $0.22 to $0.24 per share. This includes the $0.01 non-cash charge for the write-off of costs from the 2003 credit facility. Our expectations for full year earnings remain on track. We've identified and are addressing our Q1 challenges; we know the effectiveness of our business model is working and we are confident in our ability to deliver on our commitments, build value and win in the marketplace. Thank you for your attention; now Larry and I would be pleased to take your questions.

(Operator Instructions) Our first question comes from Shannon Cross, Cross Research. Shannon Cross - Cross Research: Good morning. Just a few questions. I just want to clarify: basically, based on your numbers of $0.20 this quarter -- and if you use the high end of $0.24 next quarter -- that would mean $0.44 at the high end of your $1.07. I hate to do math on a call, but basically it looks like relative to the consensus that's out there you're kind of taking up second half estimates. I'm just curious of, what makes you feel comfortable doing that at this point in time, given the weakness that we've seen this quarter?

Most importantly, I think we're giving you a range of $0.22 to $0.24, Shannon; that does include this $0.01 write off. I think as we go into Q2 there's a number of opportunities for us to improve our performance. First, I think on the post-sale trend, we're quite enthused about that. As we look at the compare on the post-sale side in Q2, certainly should continue the operational improvement we saw in Q1. I think that is going to continue to be the main driver for improvement in the quarter. As we look at Q2 also from a cost perspective, not only do we expect significant improvements on the cost issues that we saw to-date, we also have some compares that favorably impact Q2. You might remember we made a significant compensation investment in Q2 of last year that is not repeating in Q2 of this year. So from that perspective, we're quite comfortable with the fact that the compare in terms of gross profit will be quite favorable in the quarter as well. We will also have some new product announcements, particularly in the color area, by the way. Color will be the highlight in terms of new introductions in Q2 that we feel very strongly about. We've got the tailwind from IPEX in Europe which also should impact, with the demand that we took out of the IPEX show, a very strong production quarter in Europe as well; and continuing improvements in DMO. I guess what we're saying is that we have some issues in the first quarter that will not repeat themselves and some benefits as we look at the Q2 compare that definitely will generate a stronger quarter. Shannon Cross - Cross Research: If you run it through, is that just basically a continuation of the trends that you've just talked about for Q2 running through the remainder of the year?

Yes, and I think the significant piece of it is the post-sale momentum in the second half and the back-on-track production high-end business that's obviously been our largest challenge to date. Shannon Cross - Cross Research: If you think about the drivers of the $1.5 billion worth of cash that you expect in the year, obviously net income is one; but what are you thinking in terms of working capital and other things that need to come through to hit that?

I think the important thing on cash flow is there's a lot of timing issues associated with a lot of items, whether it's finance receivables or inventory or AP. Traditionally the first quarter is a lower quarter seasonally for cash flow, but I think the earnings is the number one driver. I think as we go towards the end of the year you'll see some improvements in inventory and AR and AP will even out. There's always a cutoff date in that, that costs you money or helps you in a particular quarter but it evens out over four quarters. So as I look at the results of the first quarter I'm confident that we can be in the high end of that range, given what I see. Shannon Cross - Cross Research: Assuming you're at the high end of that range, can you talk a little bit about how aggressive you think you'll be on share repurchase? Obviously you've acquired a lot of shares in the last two quarters and I think investors would like to see continued share repurchase.

Yes, I think our record speaks for itself here. We've been aggressive since the first 500 was covered. We've already completed that. We're 170, or one-third, into the second. So we intend to be aggressive, as we have been in the past, and when the 500 is used up we'll evaluate it again and make a decision. But we're firmly behind the program in general, so I think there's a real positive trend here. Shannon Cross - Cross Research: Thank you.

Our next question comes from Matthew Troy, Citigroup Matthew Troy - Citigroup: Good morning. I've got a couple questions. First, relating to Nuvera, we've been hearing about that for a little bit now and obviously it takes time to work through the kinks. Could you give us a little bit more detail on what tactically you've done and what you expect to do to firm up that platform? Second, I was wondering if you could just speak to concerns that this was less a product-specific issue with Nuvera necessarily and more maybe a platform issue where the market maybe has simply moved away from high end, more expensive black and white production systems? I have a follow-up after that.

Let me talk about Nuvera first. I think if you reflect back to our discussion at the end of the year as to what we were doing with Nuvera, we said that the finishing was very important as it related to expectations from our customers, and that that leverage would be primarily second half focused of the year versus taking off in the beginning of the year. We just introduced it in April. We also, like with any new platform, certainly have worked through the learning we get from the field and have now made a lot of enhancements just in terms of software capabilities and reliability. We are very confident about where Nuvera is in terms of its robustness and its ability to really do the job the high-end production market expects, which is quite different from the light production market. From a platform perspective -- and this is really more the market question -- I think we are looking at a more, if you will, integrated approach to the high-end market as a combination of DocuTech, which continues to remain strong; Nuvera, which will clearly get better particularly with the finishing capability and the higher speed 144 platform; and finally, something that we really are very excited about, and that is the promise of highlight color. Really looking at the customer who perhaps doesn't need full color to begin moving more aggressively to highlight color. We think that could have more of an impact on that high-end cutsheet production market than it has in the past. I would stay tuned for the combination of capabilities that we're going to use to really address the requirements of the high-end production market. All our eggs are not in one basket. We think that the suite of capabilities is definitely going to have a much stronger performance in the second half and second quarter. Matthew Troy - Citigroup: The next question would be just related to global services growth. I think you disclosed it was about 2% in the quarter. I'm just trying to disaggregate, how much of that potential growth is lost in terms of rolling up into other segments? Should we think about that being a higher growth segment and a logical crucible for acquisition activity going forward? Specifically, are you looking at more BPO type acquisitions? Has your acquisition focus shifted to drive faster growth in this business? What are some of the criteria used to evaluate potential deals? Thanks.

You will note that we decided to disclose the pipeline strength from our global services business. I think one of the reasons is that the small base and particularly some of the anomalies on a quarter-to-quarter compare don't always do justice to what we are very enthusiastic about, a very strong and growing pipeline of global services contracts. Obviously, because they're all annuity based, they have compounding impact over time and you don't necessarily get that very strong result within a single quarter. By the way, when we talk about the global services growing 2%, that includes all of our managed services contracts as well, Matt, which is a much bigger base. So the global services are the newer offerings, our Xerox Office Services and Business Processor Services grow, generally speaking, at a faster rate than the managed services contracts. But we think it's important that we put those together because they are blending. So we're going to report to you both the actual growth on a quarterly basis but also talk about pipeline, which is really a good indication of what the opportunity is downstream as it relates to the global services business. There's no question and we've been pretty consistent in saying that we will look for, and our number one priority is, extending our reach as it relates to our services business and we think that's an area of opportunity. We characterize our desires as being modest in the sense that these will be complementary to our current services offerings. There's a lot of private equity money out there. We're not going to be rash about doing something and overpaying, but we're being very diligent in keeping a total scope of the marketplace and expect that we will be able to augment, in an organic way, our services business over time. Matthew Troy - Citigroup: Thanks, Anne.

Our next question comes from Jay Vleeschhouwer, Merrill Lynch. Jay Vleeschhouwer - Merrill Lynch: Thanks, good morning. First, let me ask you about channel and sales. You pointed out a number of areas where you've had good install activity. Nevertheless, are there any parts of the market, SMB or any other addressable spaces, where you haven't mentioned but you could do better in terms of capacity or execution?

I probably would say there are two areas that we think could have performed better. The first one is actually our major account side. Particularly I would say it's more US-related than global. The time to contract and time to revenue on the major account side has been slower than we would like. We are working to make sure that we've got a very disciplined approach in terms of converting the pipeline now as quickly as possible. So I would say major accounts, US-based, were slower than expected. We're not losing. As a matter-of-fact, I think our hit rate is very positive. It's just that the complexity and size of some of these contracts does not yield as quickly as perhaps they did in the past. The other piece we mentioned, and that was really the slowdown in the OEM channel. I mean OEM on a broad basis, not a single OEM partner; that clearly slowed down. If the look at the growth rates in the OEM business this time last year, color printers was 180% and it was very modest this quarter. So although it's not a place we leverage profitability -- it's a relatively minor part of our business. I think our OEM business is about 3% of our revenues. The fact is that with the difference in growth rates year-over-year it had a fairly chilling impact overall on the total revenue, but most importantly, color. Jay Vleeschhouwer - Merrill Lynch: Okay. A couple competitive questions. You highlighted the price action you took in segments 3 to 5 for mono. When we look at the market data for the last year or so, it's not obvious that you were losing share in those segments nor that anyone else was necessarily gaining share. In fact, the share trends seem to be fairly static in those segments of mono. I'm wondering, is this just a case here of you're just trying to break the logjam or was there some other reason that you felt that you needed to get more aggressive?

I think a couple of things, Jay. I think when we really started to become aggressive was is last quarter, so it was a Q4/Q1 phenomenon. We've seen data from Q4 which said we gained about a point in the 2090 space which, by the way, on the size of that base is not trivial in terms of what that means to us as an increase in a very, very large base. Hopefully we'll see that kind of share data again coming out of Q1. This is all about maintaining a lot of our enterprise business. A lot of it is associated with our ex-OS, our office services contracts, so a lot of it's not going into the equipment sale bucket but it's going into annuity contracts. We think it's really important to own the enterprise from a black and white as well as a color perspective, particularly on the services side. It certainly caused us some short-term pain, but the long-term gains, we believe, is money in the bank and is worth going after. Jay Vleeschhouwer - Merrill Lynch: All right. Lastly, how much of the business, generally speaking, either for office or production or both, would you say is new because of underlying growth of the market versus just zero sum, a competitive wash? There's some concern that with Canon finally after a two-year drought getting back in the market starting in the summer to the end of the year that it's just going to make life that much more difficult for you. So maybe you can address how much of the business you think is directly exposed to the new rollouts from Canon.

Well, I think the best way to look at what real growth is in the market is no longer equipment sale, it's actually pages and then what we call MIFs which, as you know, is machines in field. From a page perspective you can see the strength. Office pages in color grew 48%; office digital grew 4%; production color grew 31%; production digital -- which obviously had felt the impact of the high end -- was down just 1%. Our total digital pages are growing and color grew in total at 41%. So as we look at the marketplace, pages really are, certainly I think, the most critical view of the overall technology business. The other thing is MIF; are you making the placements, are you getting the share? The MIF is up significantly. It's 10% digital MIF up. By the way, total MIF is almost flat which is the first time probably in three, four years we've been able to say total MIF is flat. Color MIF is up 33%. So in terms of installs and pages, the signs are positive. Our new business rates continue to be much better than they have been in the past. If anything, Jay, I would say, particularly in the office, the black and white space has been slower to churn than it had been in the past. The strength is really more in new business than it is in the trade world, which is good news in the sense that it's new revenues. We're very aware of what the competitive offerings are, it's the reason why we are making hay with the 240/250, why we will be introducing new products. Although we didn't preannounce them all at IPEX, we have a very strong set of color introductions that are taking place for the balance of the year. So where a lot of other competitive vendors will be catching up, we'll have strong placements already in the base with more products to come. So we think we're well-positioned. Jay Vleeschhouwer - Merrill Lynch: Thank you.

Our next question comes from Ben Reitzes, UBS. Ben Reitzes - UBS: Good morning. I wanted to ask a couple things. One is just back on the color. We've obviously been seeing for a lot of other companies that deal with Dell some rapid deceleration; even declines in their printer growth, as well as other businesses that are struggling. Given this is your first quarter -- and I know it's small, but it did have a big impact on the color growth rate going to 11%. Is this the first quarter we should see this drag for the year? Or do revenues in color, with the new products, get good enough in 2Q where we don't have to worry about the OEM business? Then I have a follow-up.

First of all, I want to be clear about the fact that we specifically said it was the OEM business and not Dell, because quite frankly, Dell was not the primary causal for the slowdown in the OEM business. By the way, this has been a trend over the last few quarters. So what we are doing is we are definitely cycling the strongest quarters as some of these OEM partners launched, and I think your observations are correct, that they have pulled back somewhat. They are not as aggressive in the market, which I think overall is good for the market. So we are cycling some very tough growth rates on the OEM business, but I would say it has been a continuing theme, and it is certainly not one I would point to and say is specific to Dell, by any means. We do feel good about the overall health of the color business. As you know, the low end of color printers has the least leverage for us over the long term because they generate a very low amount of pages. So if you look at our numbers here, our total revenue in terms of color growth without printers was 19%. Our post-sale revenue was 18%, which really is a strong compare versus Q4. So it is absolutely working in leveraging the production color streams. As I said, the pages are pretty compelling in terms of page growth of 41%. You are not going to get that in the color printer space. You're going to get it because you are driving billions of pages from the production color marketplace and that is really where the profitability gets created. So from our perspective, yes, we are confident that this snowball effect of the production color growth will clearly be the driver for strength in the future, that the anomaly on the low-end color printing business does create some volatility on the quarter-over-quarter comparison, but I am not concerned about that in light of the strength of the rest of the color market. Ben Reitzes - UBS: So just to summarize, on the post-sale trends and whatnot what the color can drive, you're not seeing this OEM phenomenon have an impact? But as far as what you report that there should be a drag for at least a few more quarters and you are putting some context around that?

Yes, and there is some impact on the color wholesales by printers, but it is less meaningful than it is certainly on the equipment side. We don't think that there is going to be a really material issue for us going forward in terms of the compare on the OEM business. Ben Reitzes - UBS: Just in terms of all the issues that you want to fix in gross margin sequentially and for the year, we talked about pricing. You're going to keep the price actions? I am sorry, did I hear that right? You're going to keep the price actions in place or is there something that happens in mix that allows the pricing portion that caused some of the pain in the 1Q to get better sequentially?

The only pricing issue that we highlighted was clearly on segments 3 to 5 because actually price for the quarter was very consistent with what we saw for all of 2005. So I wouldn't want to suggest that we see a decline in overall pricing. We drove, obviously, the segment 3 to 5 bite because of the aggressive placements. We think it will moderate a little bit. We did do some fleet deals, very large deals that drove probably a little bit of extra price deterioration in Q1, but we're going to continue to be aggressive in segments 3 to 5. It's the right thing to do and it's the right long-term action. Price overall was pretty well-behaved. It was about 6% for the quarter and we've been seeing anywhere between 5% to 7% for the last four quarters. So really no particular anomaly there. As we said, the issues that we're looking at from a cost perspective really have to do with controllable elements on the services side in terms of the amount of contract costs and start-up costs on the services contracts. Those are quite tactical and ones that clearly you can fix in a relatively short period of time. Ben Reitzes - UBS: Lastly, Larry, what tax rate should we model for the rest of the year?

Well, we think it's going to be the 34%, so the full year would come in at 32%. We've said that 34% is our going rate on taxes.

That obviously precludes any other event. Ben Reitzes - UBS: Thank you.

Our next question comes from Keith Bachman, Banc of America. Keith Bachman - Banc of America: A couple questions on revenue if I could. I didn't see any comments on revenue for either the June quarter or the full year. Larry, in past comments you've talked about revenue targets for the year of roughly 3% growth. This quarter was a little bit light relative to Street expectations. In order for that 3% to be still in existence, it would seem there has to be a pretty significant increase in revenue growth rates. Could you just talk a little bit about what your expectations are for the June quarter and for the year? And I have a follow-up, please.

Yes, I think generally speaking it's hard to call exact revenue targets by quarter or the full year and we threw 3% out as a general goal here. I think in that assumption was a little more equipment sales growth than we've currently seen over the last few quarters. The total revenue story is going to be driven by really the post-sale side of the business here. We actually like what we see in the post-sale side. So I feel confident that on a constant currently basis we may not be 3%, we might be 2%; but that the post-sale growth and the goodness in post-sale is going to drive the total revenue, which is the more important part of the equation here than what the equipment sales does in a particular quarter. Keith Bachman - Banc of America: Let's say that the revenue expectations have come down from 3% to 2% -- just to pick some numbers -- even if the guidance on EPS is staying the same, it obviously implies that your margins have to go up for the balance of the year; even after, frankly, what was a bit of a margin issue in the first quarter.

Keith, one of the things about that mix between equipment sale and post-sale is that a little bit less equipment sales and a little bit more post-sale, even if it's not an exact trade-off, allows you to deliver equivalent or greater amounts of profitability because the margin on post-sale is significantly better than the margins on equipment sales. Yes, we do expect improving margins and clearly we know how to do that and we're going to be very rigorous to make sure that the flow through from the revenue really does result in gross profit growth. So the intent is to make sure that the post-sale trend continues with the inputs of services, installs and color content and drives a higher margin on the revenue side so that the model works. Keith Bachman - Banc of America: Just one last one if I could. I think it's widely expected Canon is going to be coming out with new products from the second half of the year to the end of the year. So it sounds like it's going to be a much more competitive market on the equipment side. So it's hard to construe a scenario where pricing would improve in that context.

You know, I think we obviously have done our homework on the competitive environment and know what's coming and when. The significant introduction is the Canon 70, which they are now saying fourth quarter available. The price that has been announced at IPEX was higher than I would have expected. With the current portfolio of products plus the announcements that we'll be making in that space, there is no question that we've got a portfolio that can surround that offering very competitively and offer choices to our customers that are very attractive. So I think that it's their first entry into this production color space. We've got almost 17,000 production color units out there with more product introductions to come. And by the way, it's not just about product, it's about workflow, it's about tools and it's about channel, graphic arts channel that sells to very different customers. So I feel quite confident that we are well positioned to compete very effectively in the production color space. Keith Bachman - Banc of America: Okay, thank you.

Our next question comes from Jack Kelly, Goldman Sachs. Jack Kelly - Goldman Sachs: Good morning. You've commented on this already, but maybe just step back and comment on your conversations with customers with regard to spending on office equipment? Because I see a little bit of dichotomy between what we see in cap spending by companies in general and what appears to be their spending on office equipment. You mentioned longer time to contract, longer time to revenue. You're not losing share but is this just going to be maybe a flatter market in this recovery than in past recoveries?

I would kind of put the spending into two categories, Jack. There's overall spending and then there's capital investments. And I do think that the capital investment side of this is probably flatter or more constrained than it might be in other areas, but the spending I think is quite robust. It's definitely moving in a direction, though, of being annuity-based contracts, services led. That's where I think we've been on this one, we've been building the capacity to deliver on the services side for years now whereas our competitors have stayed on the hardware acquisition side. The pipeline that we're building in global services is really addressing what customers are telling us and that is that the annuity-based services contract, not necessarily acquiring fixed capital in this space, is one that better meets their needs. Now this is really a conversation more about enterprise-based clients and major accounts. Certainly in the FMB market it's still much more of a capital acquisition approach and we're not seeing a lot of change there. But for enterprise-based clients, I think services led, is having an impact on overall capital spending, but that can be very good for our business with our services offerings which are differentiated from our competitors. Jack Kelly - Goldman Sachs: Larry, could you just discuss the dynamics of the rebound in gross profit margin? Based on what you said the 50 basis point decline in the first quarter due to higher labor costs and the contract workers, that goes away so we can kind of count on that coming back. I think you said 60 basis points from equipment price cuts, it doesn't sound like that comes back. Then you mentioned 50 basis points or 40 -- whatever the arithmetic is -- in terms of non-recurring. I had 50 in higher labor costs going away and the 50 in non-recurring going away. So maybe it's 100 basis points and the other 60 doesn't come back right away?

Yes, I think that's about right. I think going forward we're going to be between 41 and 42. We've been consistently sort of at the low end of that 41.2, 41.3 and 41.4 and I think that's what we'll see going forward. And I think it's the 1 point or 1.1 point you talked about which is what comes back next quarter. Jack Kelly - Goldman Sachs: Just finally, Anne, on the pricing in the black and white, if you're successful using price to gain share, isn't it just logical to think that competitors see that for a quarter or two and then they do the same thing? So it becomes kind of a zero sum game at some point?

I think there's a couple of aspects there. Based upon the competitive mix of the product and also, as we said, a lot of this is being done within services contracts which include the people and the software and the embedded services that are taking place that are tough to compete with. I think the value proposition in total is tough to compete with right now on the office infrastructure space. I also think that one of the reasons we were aggressive about getting out there with our black and white and office pricing is, don't misunderstand that the margins are still very good. We're making money on those black and white office products. We have a lot of manufacturing productivity that comes from being the manufacturer of those products that clearly allows us rooms to play. In a year-over-year compare scenario it's an investment, but we can continue to make money in that space and I'm not sure that our competitors are as well positioned from a margin perspective to take those kinds of investments. Jack Kelly - Goldman Sachs: Okay, good. Thank you.

Our final question comes from Carol Sabbagha, Lehman Brothers. Carol Sabbagha - Lehman Brothers: Just a couple follow-ups. One on the gross margin question that Jack just asked. You had pressure you said from higher labor and technical services but also managed services as you took on big contracts. What was so unique about those contracts that shouldn't appear in future quarters, because you would assume if you continue to be successful in global services that you should continue to see margin pressure?

Let me began with the technical services piece of it and this was really done on the transitional aspect. As you know, we took restructuring to take out direct Xerox headcount and get ourselves a flexible buffer. As we were going through the transition and getting people trained, there was additional contract labor that was infused in so that we didn't see or take a hit on the customer satisfaction side. We also had a very strong install performance in March which said that a lot of those costs came at the back end of the quarter in March so it didn't give us a lot of time for recovery. But we do believe that we're back in shape and already through April, as Larry indicated, the contract costs have come way down and we can expect that to continue. On the global services side we did have several new contracts that started up simultaneously on a relatively small base, that did have a proportionate impact on the cost side without the revenues being in place. We do believe that this was somewhat of an anomaly in the quarter and there will be a better pacing of costs. We also learned some lessons as well in terms of how we should be putting the costs into the contract and managing that process in the future so that we don't see some of that impact within a single 90 days. So I think that one is more within our own control with regard to pace, as well as the convergence of a couple of big contracts that did start up at the same time. Carol Sabbagha - Lehman Brothers: One quick follow-up on the sales expectations for the year. What are you looking now for equipment sales to be for the year? Do you think they're still going to be up in the low single-digits or has anything this quarter changed your view on that?

I think we've been trying to stay away from a pinpoint estimate on equipment sales and watching very carefully the post-sale growth as the driver for total revenues. So I think we feel very confident about the fact that post-sale continues to trend right and therefore will be the driver of total revenue for the year. Equipment sales will move around more; it's just the nature of $10 million of equipment sales is a point of equipment sales growth. So it can shift back and forth very easily. We do expect some volatility. We do think it will get stronger. We've got some momentum on product launches and other areas going forward. We think the thing to do is really keep your eye on the post-sale line because not only is it going to be the driver of total revenue, it's going to be the driver of better gross profit as well and that's really the business model. Therefore, we can say that in terms of total revenue we're quite confident that it will deliver the earnings that we've set forth in our expectations for the full year. Carol Sabbagha - Lehman Brothers: One last question. It seems like for the last several quarters getting to the earnings expectations hasn't been as easy as it had been maybe a year-and-a-half, two years ago. Do you look at the environment and say it's getting more competitive, or would you say it's other factors playing out? Does it mean that you might need more aggressive cost-cutting actions?

Well, I think that there's no question that the focus on making sure that we stay focused on productivity and cost disciplines is more important than ever in this business. Certainly we've been, I think, on an uphill battle with regard to the impact of the post-sale declines from Light Lens. If you ask me what the most significant uphill portion of this was I would have said it was the rate of decline and the amount of pure revenues. Even this quarter, $66 million of post-sale revenues came out just from the Light Lens business and we know we have got maybe one or two quarters at a lower rate left before that, but that to me has been the most significant part of what has been a, if you will, pull in the negative direction in terms of flow through to earnings. I think we had a wake-up call this quarter in terms of cost discipline. We're good at this, we know how to do it, we'll get it back on track and ensure that the flow through into profitability is there going forward. This is now a revenue and gross profit story and that's what we'll be expected to deliver going forward. Carol Sabbagha - Lehman Brothers: Thank you very much.

Thank you, Carol. Thanks to everyone for your participation this morning. We appreciate your interest. Have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your presentation and you may now disconnect. Have a wonderful day.