Ursula M. Burns - Chairman and Chief Executive Officer Luca Maestri - Chief Financial Officer and Executive Vice President Lynn R.

Blodgett - Corporate Executive Vice President and President of Services Business

Ananda Baruah - Brean Murray, Carret & Co., LLC, Research Division Shannon S. Cross - Cross Research LLC Benjamin A.

Reitzes - Barclays Capital, Research Division Bill C. Shope - Goldman Sachs Group Inc., Research Division Gaurav Gupta Alban Gashi - Crédit Suisse AG, Research Division Chris Whitmore - Deutsche Bank AG, Research Division Mark A Moskowitz - JP Morgan Chase & Co, Research Division Jim Suva - Citigroup Inc, Research Division

Good morning, and thanks for joining us today. We'll get started on Slide 3 with a review of what we're seeing in the marketplace and how it's affecting our business.

We began the year knowing we'd face certain challenges, especially as the European economies came under significant pressure as we made strategic investments to ramp our services growth. However, we did not predict the incremental strains on the business from more worldwide -- widespread economic uncertainty, especially in the United States.

During the third quarter, we experienced a much more constrained spending environment in the States. European economies remained weak, and developing markets were stable.

Overall, our third quarter performance reflects shifts in our business as services become a larger portion of our revenue, as well as the dynamics of a challenging economy that's creating cost pressures for large enterprises and governments. For example, due to budget constraints, less funding is available for major government projects.

In the rare case, as we experienced this quarter, implementation on a committed project was halted even after we made upfront investments to get it off the ground. The resulting impact can be seen in our Q3 services margin, which came in lower than we expected.

The conservatism we're seeing in government has transferred to large enterprises as well. It leads to longer sales cycles, shorter contract durations and smaller related contract value.

This is certainly a prudent way to manage operations in times of economic volatility. It's definitely how we're managing our business and how our clients are managing theirs.

It's also one of the reasons that we're seeing clients adopt Managed Print Services, which deliver cost savings quickly with minimal upfront capital investment. That said, when I review our third quarter results through the lens of what's happening in the marketplace, I remain confident that our strategy is sound, that our healthy annuity and our diverse portfolio help us mitigate challenges, and that our focus on cost and operational efficiencies give us the flexibility to invest wisely in growth and in building shareholder value.

So let's move to Slide 4. I'll provide an overview of the quarter.

Luca will cover some additional details, and then we'll take your questions. In the third quarter, we delivered adjusted EPS of $0.25.

On a GAAP basis, earnings were $0.21 per share. This includes $0.04 related to the amortization of intangibles.

Total revenue of $5.4 billion was down 3% and down 1% in constant currency. It is important to note that the fundamentals of our strategy are delivering as expected.

We're managing our Services business for growth and our Technology business to maximize profit. Our Q3 results reflect consistent progress in both areas, top line revenue growth from services and operating margin improvement from technology.

Services revenue was up 6% in constant currency. This includes a 9% growth in our BPO business, a 4% growth in Document Outsourcing and 6% growth in IT Outsourcing, solid across-the-board progress.

Services now represent 52% of our total revenue. Revenue from Document Technology was down 7% in constant currency.

Equipment sales were more significantly impacted by economic and industry trends than prior quarters, especially in the United States and with large enterprises. We expect continued pressure in this area, and we remain clear-minded on the best way to invest in and manage the business.

For example, we're expanding indirect channels to capture more of the SMB opportunity, and in our mature, print-related businesses, we're maximizing profitability through a more efficient infrastructure. Margins from our Technology business held up well in the quarter.

Margins in Services did not. In addition to making planned upfront investments in several new services deals, which we knew will result in year-over-year margin decline, we saw the profitability of a few large government contracts become hampered by constraints in government spending, resulting in a greater quarter 3 margin decline than we expected.

So the major issues are understood but then, that doesn't make them acceptable. We're reacting quickly and working hard to mitigate the impact and get our margins back where they need to be.

To do this, we are planning for additional restructuring during the balance of this year, which will be primarily focused on delivering operational improvements in our Services business. Luca will share more details on the related Q4 charge.

We generated $594 million in cash from operations, keeping us on track to deliver $2 billion to $2.3 billion in full year operating cash, and we're counting -- we're continuing to use available cash for acquisitions and share repurchases. The quarterly numbers give one picture, but understanding the breadth of our new company is fundamental to the value and the sizable opportunities in front of us.

The Xerox brand is behind the scenes in many areas that may surprise you, areas where we're asserting leadership, we're earning customers' trust, and we're winning significant new business. Turn to Slide 5 for some of the examples.

It's important to note that many of our government contracts support nondiscretionary programs like Medicaid, which despite budgetary pressures, always needs to be fully funded. In fact, much of health care is nondiscretionary for providers and payers alike.

Xerox had a deep expertise in the business of health care simplifying the administrative complexities and preparing government, employers, providers and payers for changing regulations. As a result, major insurers depend on Xerox to handle their call centers for Medicare claims reimbursement.

And more and more health care providers are calling on us to help implement electronic health record systems, a rapidly growing business in which we are a key player. Emerging markets provide another area of growth for us and reflect one of the benefits of Xerox acquiring ACS.

Our brand strength is key to expanding outsourcing services beyond the U.S. We're able to tap into long-established relationships with enterprises around the globe to shift from being a Document Technology provider to a broader solutions partner.

For example, we're handling the transaction processing for clients in a major Latin American bank opening -- bank open new retail accounts. And in Russia, we're applying our IT and advanced imaging expertise to develop a new invoicing system for a large retailer.

Enterprise -- expertise and innovation play across several industries and are the differentiated advantage that we bring to clients who want more than a basic service. That's why McDonald's selected us to provide their restaurants' IT support in several regions and why we won $153 million deal to manage the data centers for a global energy company.

We don't want for opportunities, and we're making meaningful progress in capturing them around the world and throughout our business. Please turn to Slide 6.

There are 2 important points that these numbers reflect. First, reiterating the increasing strength of our Services business as it becomes a larger portion of our total revenue and why we are so focused on acquisitions, innovation and global expansion to give us even more scale and diversified offering.

A year ago, Services represented 49% of our total revenue, and now it's 52%. Second, a reminder of the significance of our annuity-driven business model.

As you see here, 85% of our revenue was annuity. That's $4.6 billion in recurring revenue, up 2% this year.

While equipment sales, the much smaller percentage of our business, is most impacted by economic and industry trends, we continue to benefit from the stability of an annuity-based business model that helps us deliver solid cash flow and earnings. So in summary, this quarter presented its fair share of challenges, and we believe economic headwinds are still ahead of us.

At the same time, we too are closely managing our operations to drive more efficiency and to give us more financial flexibility as our business dynamics shift. In Services, again our emphasis were in growth and margin improvement, prioritizing investments in areas that provide the strongest return.

And in Document Technology, maintaining our leadership in mature markets is a priority so we can continue to benefit from their profitable annuity streams. As important, we're pursuing key growth markets including digital color and SMB to help boost top line and bottom line performance.

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

Thank you, Ursula, and good morning, everyone. I will begin by reviewing our earnings and then spend some time on our segment performance, cash flow and capital allocation.

During the quarter revenue declined 1% on a constant-currency basis. We expected Document Technology revenue to be pressured, given a tough year-on-year compare, and in the end, a decline of 7% at constant currency was about 1 point below what we expected, driven by weakness in equipment revenue.

However, segment margins remained healthy. In services, revenue continue to show strong growth at 6% constant currency, but margins were below expectations, driven by pressures on a number of government contracts, as well as lower volumes in some areas.

As the result of these trends, we expect total revenues in Q4 to be flat year-over-year. The margin dynamics in Services drove an operating margin decline of 100 basis points.

The bottom line impact was partially offset by improvement in technology margin and continued efficiency and productivity actions on the expense side. Restructuring was $18 million higher year-over-year, and as a reminder, is fully reflected in our adjusted results.

Equity income was $9 million lower year-over-year, driven mainly by higher Fuji Xerox restructuring. Given the impacts of macro uncertainty, the government budgetary environment and declines in Document Technology, it's important that we continue to proactively manage the cost base of our business.

As a result, we will also be taking a restructuring charge during Q4, which we are in the process of assessing, and will likely be in the $50 million to $100 million range. This action will put us in a stronger position entering 2013 and will address productivity opportunities across the enterprise, primarily in the Services segment.

Adjusted EPS of $0.25 was down $0.01 from 2011 with the only adjustment to reported EPS being the amortization of intangibles. Moving on to segment performance, and we'll start with services.

We continue to see good revenue growth, up 6% during Q3. BPO revenue was up 9%, ITO was up 6%, and both were pretty consistent with the first half.

Document Outsourcing growth of 4% slowed a couple of points mainly due to lower volumes, but overall, it is showing good momentum. Year-to-date through September, BPO is up 10% constant currency, and the entire Services business is up 8%.

The 2 areas I would like to spend more time discussing are signings and margins, beginning with signings. Although they were up 19% sequentially, signings came in below our expectations and were down around 20% year-over-year.

Certainly, 2011 was an outstanding signings year with several mega deals. In contrast, this year, we have had smaller-sized deals, contract lengths have been shorter, and we are seeing customer decision delays caused by the increased economic uncertainty.

Q4, we'll have another difficult compare, but we expect to see sequentially higher new business signs, and we remain pleased with our high success rate on renewals. I also want to point out 3 positives that are not reflected in the signings data.

Document Outsourcing signings, given reporting limitations, do not include Partner Print Services, which have been growing very strongly. Second, the improvement in renewal rate this year creates less of a headwind from contract losses as we move into 2013.

And third, our pipeline is up 9% year-over-year, and it is at an all-time high. Turning to margins, which were well below our expectations, we had anticipated sequentially flat margins, but we experienced a sequential decline of 120 basis points due to 2 primary factors.

Government was the largest driver of the sequential miss. Within government, we specifically had to absorb in Q3 the defunding of a signed contract, which we got a write-off.

Additionally, budgetary forces are preventing government from moving forward on historically routine infrastructure advancements, which is lessening our add-on services opportunities. The second factor is lower volumes in some transactional areas.

Given the view that this environment will not change in the near term, we will be looking to proactively manage our cost structuring investments to counter these pressures. Going forward, we expect sequential margin improvement in Q4 and for the foreseeable future, a Services segment margin range of 10% to 12%.

Let's now turn to the Technology segment. Technology revenue was down 7% and document-related revenues, which includes Document Outsourcing, were down 4% at constant currency.

The decline was driven by a 15% equipment revenue decline and a 7% decline in unbundled supplies. Equipment revenue decline reflects greater uncertainty in the macro environment with increasing pressure in the U.S.

and continued weakness in Europe. It should also be noted that the trend in revenues is worsened by the prior year tsunami impacts, which disrupted supply in Q2 of 2011 and saw recovery in Q3.

We estimate that this specific impact caused revenue deterioration between 1 to 2 points year-over-year in Q3. Looking at product segments.

We saw good growth in entry installs from new products and relative strengths in SMB. High end had good color install growth, driven primarily by entry production products.

Mix in high end should improve with the recent launches of our latest iGen device and the new Nuvera platform announced at Graph Expo. And lastly, mid-range was weaker, reflecting cautionary purchasing trends in large enterprises.

This was the segment where we saw the greatest impact from the tsunami on the prior year compare. We expect equipment revenue to be pressured again in Q4 and therefore, for total revenue to be down mid single digits in Technology.

Segment margin of 10.8% was up 50 basis points from 2011 and reflect a continued good cost and expense control, as well as a gain that we realized as a result of the sale of a portion of our finance receivables. Turning to the Key Metrics slide.

Services signings have been lower this year driven by less mega deals and decision delays, as discussed. But our pipeline remains strong, up 9% year-over-year.

And with the improved renewal rate performance, we continue to be well positioned for good revenue growth in 2013. Document Technology metrics remain relatively stable as does technology annuity revenue.

Install growth is good overall. Machines in field is actually improving, and page volumes, although a bit weaker, driven by Europe, are still relatively in check.

The one metric to turn negative was Color revenue largely as a function of the lower equipment revenue and the tsunami compare. If we now turn to the next slide, I will take a moment to review Q3 cash flow.

Cash from operations were the source of $594 million, $228 million higher than Q3 of 2011. Through September, cash flow was $807 million, $124 million higher than in 2011.

This is in line with our expectations, and we remain well on track for $2 billion to $2.3 billion of operating cash flow for the year. Looking specifically at the drivers in the quarter, net income and depreciation were a source of $627 million.

Cash contributions to our global pension plans in Q3 were $73 million, which was $152 million lower than 2011, primarily due to the timing cadence this year versus last. Through September, pension contributions were $310 million versus $348 million in 2011.

For the full year, they would be about $75 million lower year-over-year, driven by the change in funding requirements brought about by recent pension legislation in the U.S. Working capital, including finance receivables and operating leases, was essentially neutral to cash in the quarter.

Within this, accounts receivable was a $390 million use of cash, and finance receivables was a $412 million source. The driver of this movement was a change in our lease financing strategy, which resulted in cash proceeds from a finance receivable sale of $314 million, offset for the most part by lower accounts receivable factoring.

In 2012, we have undertaken a thorough review of our leasing strategy, which validated for us the operational value and strong financial contribution of our leasing business but also identified some opportunities in our approach relative to the diversity and matching of our funding to our leases. We have a plan over time to improve the efficiency of our funding and employing a modest amount of finance receivables sales such as we did this quarter is one element of that plan.

Moving down the cash flow. We spent $140 million on CapEx consistent with our annual forecast of around $500 million and deployed $156 million on 3 acquisitions, which support our services expansion and SMB distribution strategies.

Dividends paid were $69 million, and we repurchased 361 million of stock for a total of 718 million repurchased through Q3. On the next slide, I will cover in more detail our capital structure and our progress on capital allocation.

Our Q3 ending debt balance of $9.4 billion reflect the typical seasonality of our business. We expect strong cash generation in Q4, as usual, and we continue to plan for $8.6 billion for year-end debt.

The majority of our debt, $5.4 billion, of the total $9.4 billion debt balance is in support of our financing of Xerox equipment to our customers. The finance debt is calculated assuming a 7:1 leverage of our finance assets of $6.2 billion.

These finance assets represent committed revenue streams from our customers. Shifting to capital allocation.

We are well on track to meet all our objectives for the year. Free cash flow will be in the guidance range of $1.5 billion to $1.8 billion and will be deployed in line with our original commitments.

Year-to-date, we have repurchased 718 million shares and continue to expect to repurchase 900 million to 1.1 billion for the year. We will spend $243 million on acquisitions, and we expect to be in the $300 million to $400 million range full year.

And dividend payments will be in the $300 million range. So we are confident to meet our commitments on all fronts.

During our November investor conference, we will provide a view of our capital allocation strategy for 2013. In closing, we have seen increasing headwinds in areas more sensitive to the economy, and we will continue to adjust our business as appropriate to respond to these pressures while continuing to invest in the growth of our Services business and maintaining leadership in Technology.

With that, I will hand it back to Ursula.

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

Until we finalize our restructuring plans for Q4, our earnings guidance does not include the expected charge. But it does comprehend our concerns that economic challenges will continue putting additional pressure on the business.

For the fourth quarter, we expect adjusted earnings of $0.33 to $0.35 per share. That brings us to a full year adjusted EPS of $1.07 to $1.09, which is at the low end of our previously stated guidance.

This macro environment calls for resiliency and the ability to quickly adapt to marketplace dynamics. That's our focus, and we remain confident that our strategy is sound, and our execution will effectively deliver solid results.

Growth in services, increase in annuity revenue, market share leadership, disciplined cost management and on track performance with past generation and capital allocation. These are all key drivers to build more value in our business, and we look forward to sharing more detail with you at the investor conference next month.

With that, I thank you again for joining us today. As we get to your questions, I know you'll have to -- you'll want to dive deeper into trends especially in our Services business.

So as in the past, Lynn Blodgett, President of Xerox services, will also join us for the Q&A session. Let's open it up for questions, and I'll field them and ask Luca and Lynn to chime in as well.

Thank you.

I guess, Ursula, just to sort of take advantage of having Lynn and then, this is probably for you as well. I guess, could you bridge for us the Services operating margin this quarter?

What was the impact from the government constraints and I guess the deal that you saw that kind of got shut down? And I guess you also mentioned in some of the press release comments, some contracts that were standing up.

Are those -- is that a separate issue from what you referenced? And I have a follow-up, if I could.

Okay. So let me step back and just do a little bit of a Service walk through, and then I'll ask Lynn and Luca to add anything if they want to.

So first on a year-over-year basis, margins, as I said, were down about 250 basis points. This is in line with what we expected, pretty much what we expected to happen as we stood up contracts from -- that we signed last year.

So contract ramp is one of the pieces of margin pressure, and then what we saw in addition to that, which drove sequential margins to be lower than we had expected were 2 unique items. One is a contract, this is the first time that it's ever happened in the business that we can see that we had signed and committed with a state that was defunded after we had started to actually invest in that contract to stand it up.

And we're still working with the state to actually come to some kind of a reasonable conclusion, but we took a write-off this quarter with that -- for that expense that was not matched with any revenue. In addition to that, and that's a significant hit but a unique area.

This is something that, like I said, has never happened before. And this is not in an area that is what we would call discretionary.

It was not in the Medicaid area or any of the nondiscretionary areas. This was in a segment of the business that the state actually had an option on, and they actually opted to move out.

In addition to that, we were seeing kind of across the board, not at a very high level but hitting a little bit everywhere, is volumes are on transactional. Some of the transactional portion of our business is a little bit lighter than it would have been in the government alone.

That alone, would not have been a big concern. We would have expected that in a down economy, but the combination of those 2 things, particularly at the end of the quarter, which we couldn't outrun, was the reason why we actually had sequential out of -- out-of-the-expected range margin performance in Services.

I don't know if anything else that you want to say, Lynn, on that.

I think that was well said.

Yes, so that's what we saw in margins. What we expect on a go-forward basis for the remainder of the year and one of the reasons why we're taking the restructuring charge which like I said we'll -- like Luca said we'll spend more time on in the investor conference, is to align -- to make sure that we can align our cost on a more cautionary and restricted go-forward spending environment in 2013.

As we do that, we'll be able to bring the margins more in line in a tighter range, probably not in the 11% to 13% range but probably in a 10% to 12% range, we'll be more short of our ability to actually deliver in that range.

And I think, there's one other thing. What we're seeing and as Ursula said, Medicaid contract is not a discretionary program, and that funding is very rock-solid.

There is some level of discretionary spending associated with those contracts like a system enhancement or whatever. And what we saw this quarter and what we expect to continue to see given the pressures on states is a little tightening or significant tightening on that discretionary spending.

So what we're doing with the restructuring is to make sure that we are aligning the organization to deal with that new reality, and that's where we're moving forward on and confident that we can do it.

And just a quick follow-up if I could. Ursula, on the December quarter guidance, you don't have the charges in there yet.

So should we assume that once you get the charges, a handle on the charges, I know you guys gave a range on the call. By my calculations it's something like $0.04 to $0.07 potentially in that range.

Is it possible or is there potential that you could reduce the guidance once you get a better handle on what the charges are? I just want to make sure we understand what the context...

Yes, so the answer is yes. There is more than a likely potential that we will reduce the guidance.

We will not be able to comprehend inside the numbers, a range of $0.03 to $0.06 that the $50 million to $100 million currently represent. We have to work further on this.

I mean, we literally are going through the planning process today, now and as we speak. We'll have a lot more information at the investor conference but you should assume that the quarter 4 earnings that I talked about does not include and will be impacted by the restructuring charge.

I guess, I want to follow up on the Services commentary and just sort of are you seeing revenue resets within contracts or -- I know you talked about lower volumes, but I guess, I'm still struggling with sort of what has changed with regard to how your contracts are priced or your positions in the last couple of years? And, Lynn, maybe if you could even give a little bit more perspective from the standpoint of the restructuring.

One of the question I had is basically how much restructuring have you done in the past within ACS? I mean, is there sort of low-hanging fruit that will be easy to pick?

Or it's always seemed like you've run a pretty tight ship. So how should we think about that?

So let me start -- let me open up with the question about Services resets, et cetera. No, we're not seeing a reset in contracts.

We're not seeing contracts that have been signed in states across the board asking for new pricing structure or to open them up, not at all. Actually, not at all.

What we are seeing though is contracts are generally made up of 3 different buckets. One is the basic contract that you saw -- and maybe 2 different markets, the basic contract that you sign, State of California, State of Texas, whatever it is, structural contracts, for example, in Medicaid.

That contract is priced and signed and baked into our ongoing operations. In addition to that, generally almost all the time, there are additional add-ons that come after that contract is signed.

Once the state knows what they're doing and what we're doing, they ask for additional add-on work to upgrade a system, to refine a collection process, to find fraud, whatever the add-ons would be. What we're seeing is not the core contract changing at all.

That's contractual, which is good. But what we're seeing is those little add-ons that would normally come, that are normally baked into how we would actually manage the business are long, are harder in coming.

So harder in coming, so they're not doing as many of them, longer to get if they are doing them, it's a lot of work to get them to agree to do them, or not happening at all. And so those -- that's the part that we have to adjust to, this normal work that we would have seen outside of the discretionary portion.

We're now going to have to assume that, that work for the foreseeable future will be significantly constrained for states, and that's what we're actually taking a restructuring for. As far as the restructuring for services, I'll let Lynn go into it, but for the company in the last couple of years and as we've taken restructuring, it has been focused almost solely on our Technology business and getting our Technology business infrastructure aligned more to the realities of the revenue on a go-forward basis.

So we have not taken since ACS has come on and as part of Xerox, restructuring has focused heavily on the Services business.

Yes, I think that the issue of us running a relatively tight ship, I think that's true. And I think that's been true for a long time.

This has been a very good exercise. We don't like the fact that there isn't as much discretionary money there.

But what we have done because of the reality is that we've gone through the organization sort of top to bottom and said, "Okay, even though we have a good, a very good organization, what can we do to make it better?" And so we've looked at a very methodical approach to spans some layers and reporting structures and have just gone through and scrubbed the organization.

So when we finish this, we will be far more competitive. We've been able to take out costs in some areas that actually have surprised some of our operating people where they say, "We thought we had that thing tuned about as well as we could," and we found, by going through this methodical approach, that there were things that we could improve upon.

So we think the organization is good, but we feel like there are reasonable things that we're doing now that will make us more competitive that will deal with this problem of the discretionary and when that restores, which I believe it will in the future, we'll be that much more better positioned.

Just one follow-up, if I could. If you could talk a little bit about the trends you're seeing on the Technology side, because, obviously, all the questions have been focused on Services, just in terms of demand in Europe and North America, and maybe linearity in the quarter.

And then that's my question.

Okay. Great.

So I'll do this quickly. What we're seeing is a continued downward pressure on equipment sales in Technology.

The thing that actually we didn't see in quarter 2 that we did see in quarter 3, and we expect to see in quarter 4 and it's not totally that surprising to me when I look out at most of my clients who are reporting around the same kind of environment that we're reporting in is equipment sales in North America across the board in large enterprises in particular, in government in particular are definitely stressed. Europe continues to be very weak.

We're not seeing a lot of uptick there. And if anything, we're seeing a little bit of additional headwind.

DMO developing economies continue to be pretty stable, a little bit of weakness, but I mean pretty stable. They're outperforming all of the other regions.

U.S. is the place that we saw a fairly significant downturn in equipment sales, actually.

The equipment sales performance in North America starting in the middle of the quarter and definitely towards the end of the quarter definitely accelerated from a downward perspective. So we're seeing pressure there.

From a competitive standpoint, we're not seeing -- we're seeing the same -- the good news is everybody's facing the same environment so we're not losing ground. As a matter of fact, we still hold the #1 equipment revenue share.

We're still a leader in color, et cetera, but we're seeing a dampened environment just across the board in general in large enterprises. SMB, a little bit better, and large enterprise is definitely pressured.

Could you talk a little bit more about the factoring of your finance receivables? It looks like it was responsible for over $300 million of the cash flow.

Is this something you're going to be doing from now on? And I got to say like you're factoring finance receivables, it just doesn't seem to be something a company with healthy cash flow would need to do and I was wondering what went into that decision and how you balance that.

Ben, I'll answer that. As I thought I had explained during my remarks, the reason why we did that transaction is because we really did a very careful review of our leasing business during the first 6 months of 2012.

And we clearly identified an opportunity to fund this business better, and increase the diversity of the sources for that business and do a better matched funding of our leases. So we implemented this transaction in Q3.

As I explained before, as part of this change in strategy, we certainly generated cash from the sale of finance receivables. We generated significantly less cash from the typical factoring that we do.

We, at the end of the day, when you look at working capital in full, it was actually flat. So we did not generate cash to working capital during the quarter.

And the gain that we realized actually proves the fact that the funding that we were able to obtain on this transaction is significantly better than the funding that we were able to obtain previously. So as we go forward, we will continue to look at different possibilities to optimize the funding of the leasing portfolio, and it's certainly not an issue that is around our ability to meet our range in terms of cash flow, nothing to do with it.

How are we supposed to take these gains? Because you guys can obviously do these transactions.

This one was $0.01. In addition to the cash flow, I mean, if services margins continue to be weak, is this where we're going to get the earnings power to make up for it?

What's the philosophy behind these gains? I mean, it's $0.01 this quarter, how many is it going to be in upcoming quarters in terms of these gains, and is this what we're going to use to offset the Services margin pressures?

It's really nothing to do with that. We're really looking at how we can fund a leasing portfolio that is a very profitable business for us, and it's a great way for us to be more competitive as we go to market with our customers.

And so we're going to be looking at ways to reduce the funding cost over time, and it will depend on the structures that we're going to be able to find in the market. They will depend on the geographies that we're going to be looking at.

So we don't have a firm plan around this, and it's totally independent from how other segments may be doing or not. And as you know, we report Services performance completely separate from Technology, and so we are very focused on the measures that we're willing to take on the Services business.

I just wanted a clarification on Services. What -- so I assume it's California Medicaid and how much more business do you have with California that's at risk?

And I guess why wouldn't every other state kind of see what California's doing and do the same thing given these tough times? And then I have a follow-up.

By the way -- yes, so I just want to make sure we're very clear. We did not refer to California Medicaid as the state that had anything to do with the defunding of the contract.

That has nothing to do with California Medicaid, nothing at all. It's really important to understand that.

I don't want California to get pissed at us before...

Okay, I'm sorry. That was mentioned as an example, I guess?

We didn't actually say anything about California, but California is a very big contract, but they are not defunding anything at all. They're -- I'll have Lynn...

Yes, I think absolutely the defunding was at a different state and...

And it was not a Medicaid contract.

Yes, not Medicaid. It was a project that would be considered as discretionary.

This has never happened to us before, and it was a very singular kind of experience or event. But where you could be thinking about California is that we did say that discretionary, what would be systems maintenance, some of the sort of discretionary system improvements that we normally see in our Medicaid contracts, we're not seeing as much of that, and that would apply to the state of California.

Okay. Well, I apologize.

Just the question though still is I think has some valid points is that what state was this and could it go into every contract you have with that state? Because I assume that you talk to each other.

Yes, the answer is we're still working with the state so I prefer to not actually state what state it was and will not. And the likelihood of it going into other contracts is -- I mean, it's infinitesimally small.

This is a very unique situation with a very unique state with some very unique politics in that state. So, and we are -- by the way, we've gone through our contracts.

We're pretty sure that we do not have an issue that is going to spread across the contracts that we have.

So you guys have given us a ton of data here on what's going on in Services, but I don't want to beat a dead horse but frankly, there's still obviously a lot of confusion here. And I think I'd like to focus more on how we should think about your government exposure in general.

Government and state and local conditions have been very weak for a while. This has been a concern for investors for a while, and we've seen other companies that have taken hits on in over the past year and past few quarters.

But the argument for Xerox had been that your Services business wasn't as exposed to this dynamic primarily due to the unique nature of the Services model and the types of contracts you had exposure to. So can you help us understand what really changed in this most recent quarter that suddenly impacted profitability, and why it was a surprise?

And I guess, perhaps helping to answer that, can you give us an idea of what percentage of your government-exposed Services business is what you would define as discretionary?

I'll have Lynn take it.

Yes, I think it would be -- as far as the overall sort of sensitivity to economic conditions and our government portfolio, I think it's really a tribute to the resiliency of the portfolio that even though government, state governments' budgets have been under pressure, as you said, for quite some time, and we have been able to really continue in the face of that pressure. What has happened quickly was this defunding of a contract was an event, unanticipated event that, as we say, we've not seen before and don't expect to see that.

And it was not one of our discretionary programs, it was in a -- it was in a discretionary program not a nondiscretionary. And as far as the percentage of revenue in our Government business that is -- that we would consider discretionary, this is an estimate on my part, but it's certainly less than 10%.

Most of our state work is in -- large bulks of the revenue are in the health care sector, and that's generally mandated by some law or some edict, and that's where we participate a lot. California's there, Texas is there, these kinds of contracts are there.

We do have contracts though, smaller percentage of it about 10%, 15% of them that are other things. I mean, we do call-center work for people that are not associated with the mandatory side of the business, and those would be more susceptible to this kind of work.

But even with that susceptibility, we've never seen it happen before. It turns out that we do have, as a business, a very strong position in government.

We provide services, a lot of them nondiscretionary services to government. And as governments are pressured, we have to pay significantly more attention to that portfolio of business.

No doubt about it. But as the largest buyer in the United States, it's really -- it's very difficult for us to figure out a way to run a successful business without serving them.

And up until this one contract, we've served them very well. And even in this quarter, we're serving them very, very well.

Revenue is growing. Our participation in contracts are growing, and we just have to make sure that we pay very, very close attention to and count on downward pressure from the discretionary portion of the government budget.

And that's what we're doing, and that's what we're going to do with our restructuring charge.

Okay. So just to clarify the defunding issue that Ben was asking about, you generally view that as a one-time issue but the discretionary portion of the portfolio is the reason why you're adding this restructuring and lowering the targeted margin range for the intermediate term?

Absolutely. And one of the things that we're -- we're just seeing a lot -- the headwind from just a softer economy, it's a bad thing to say but it gives you the opportunity to step back and say, "Whoa."

If this is the trend that we're going to see for quarter 4 and 2013, which is what we're assuming, let's go back and let's literally start to scrub everything, scrub it down and as we start to see opportunities arise and expansion, we will match that expansion but we can't assume that we're going to have a lot more upside in 2013. Revenue is holding very well in services across the board in all lines.

BPO, ITO and in Document Outsourcing, we're seeing good revenue. We're continuing to expand around the world, Europe and Latin America.

And we are very, very, very focused on assuring that the biggest contracts for sure, but all of them have the right cost to match the revenue on the minimum level. So what the restructuring will do is actually take out any service provision that we have, any cost that we have associated with an upside, we're going to manage these things to be very, very tight.

And that will give us some breathing room in a tight economy. That's the strategy going forward.

It will be interesting to say one last thing on this. We watched the quarter as the months went by, so month 1 in the quarter, month 2 in the quarter.

This problem that we had with this particular contract we worked till the last day of the quarter. Literally, we didn't know that we would not end up on the right side of this until the very, very end of the quarter and which is, which goes to show just how tightly this piece of business actually came forward.

This is not a widespread move that we saw. We were actually working this till the very end.

This is Gaurav for Keith Bachman. I have a couple of questions as well.

I guess the first question is on the services but more on the signings front. I know this quarter, the signings have improved significantly sequentially.

So I guess the question is, given all the commentary about the weak economic environment impacting both the government or the commercial side, are you seeing any changes in the competitive environment? And what I mean by that is any change in the structuring of the deal or the pricing?

And within the category, are you seeing more strength in the BPO, ITO. I guess you mentioned the pipeline is up 9% and what does it imply about the margin guidance for the next year?

Is it actually more on the 10% side versus the 12%?

So there's like 5 questions in there. I'll start with Luca on -- in the beginning and then we'll kind of walk down the question.

So I think I'll try to give you a few points. Yes, I think the increase in the pipeline represent the fact that we are quite competitive in the marketplace and the fact that there have been decision delays.

So that decisions that we thought would get to a contract signing during the Q2 and also Q3 have been postponed, right? So but those are not bids that we have lost to competitors, and therefore, the pipeline has been growing.

Across the board, we see relatively -- of course, pricing is -- because of the tight environment, pricing has some level of pressure. We see that probably, particularly in Document Outsourcing in our NPS [ph] dates, particularly in large enterprises, there is more pricing competition than maybe we've seen in the past.

And that is what gets reflected, of course, on the services margin side. And that's why it is so important for us to adjust our cost structure accordingly to reflect the existing environment.

And I think the other thing that has impacted us is that we have not had this year the kind of mega deal volume that we had last year. Last year was a record for us, and this year, the deals have been typically a little bit smaller.

And if it's not a mega deal, it tends to be a little bit shorter. So the duration has been a little shorter, the size is a little smaller, and that has had an impact.

One thing that I think we need to make sure people understand is that we talk a lot about renewal rates. And last quarter, there were a lot of questions about it.

Renewal rates are as critical to growth as bookings. And this year, we had higher renewal rates than last year to the tune of about $110 million of additional revenue that we didn't lose, if you can think of it that way.

So that essentially offsets a significant decline in bookings. Now we want bookings to be as high as we can get them, but the positive renewal rate will help us with growth even if bookings are a little bit lower than they were last year.

I guess, just looking again at the services margins that you guys have for the quarter, it's about 1.2 percentage points lower sequentially. And if we look sort of some of the things you outlined in the government as being more onetime or due to the write-offs, how do we sort of think of the 1.2% allocated between sort of the more of the transactions and the write-offs and the government versus sort of more longer structural trends within the sector and then sort of how can you guys get back to your historical range of 11%, 13% for the segment?

That's a good question. When you think about this write-off that we take, we should be thinking it was a number that was over $10 million.

And so when you think about percentage points, you would say there was a 120-basis-point decline. It was possibly half-and-half, half of it was kind of write-offs that we had committed to take in the quarter, and the rest is this more systemic issue that we need to address through restructuring.

Okay. That's great.

And then also last quarter, you sort of talked about new business signings as being more of an area that you guys like to focus on. That was up last quarter, and then you also indicated that next quarter should be an increase from the current quarter.

What was it in the current quarter?

New business signings in the current quarter were weaker than they were in the previous quarter. We did have good renewal rates this quarter, but new business signings were down.

Signings across the board were down. And I just want to make sure that you heard what both Luca and Lynn said.

We're not losing these signings to competition. It's literally they're taking a lot longer to sign now.

So the pipeline is big. The pipeline grew by about 9%, and what we're seeing is people taking a lot more time to -- both large enterprises and government are taking a lot more time to make a decision on a contract.

But they're still up and open, and we're not losing them to competition but -- and they should be higher in quarter 4 or this quarter, the current quarter.

And they actually were year-over-year as Ursula said, they were down. But sequentially from Q2 to Q3, they were up about 19%, and we expect that trend of increasing sequentially to continue in the fourth quarter.

But it is a very, very important metric and one that we keep an eye on. And we want to make sure that if we don't sign that it stays in the pipeline and we don't lose it.

And that's the key thing. But the trend for contract negotiations and contract just nibbling back and forth is definitely one that's going towards the longer side not towards the shorter side.

Okay, that's it. I guess just one final question on the inventory levels on the technology side sort of what are you guys seeing on the channel I guess just globally?

Inventory levels were very much in line with our historical ranges. We didn't have anything particular on the inventory side.

My first question goes back to this problem contract. I'm curious how this happens.

My understanding that terms and conditions are pretty well set in the original contract. I'm just wondering around the scrutiny you place on these deals and whether or not you're taking outsized risk to close deals in this tough environment.

The answer to this latter part of the question is we are not. We do not take outsized risks.

But we are extremely focused on that independent of size. One of the things that we have learned we learned it from ACS, we learned it from our Document Outsourcing business is that Ts and Cs and risk review is a big portion of the management of this kind of a business.

So we are not taking outsized risk. I cannot get into all of the details.

The more I get into the more specific, it will become and the more -- we'll probably have a public disclosure that I don't want to have until we actually manage our way through this with the state. Suffice it to say that we don't take outsized risk.

It is very, very unusual. We think it is unusual as well, which is why we're still working with the state, and it is not something that should be considered to be like a natural outcome.

The terms and conditions are generally written in a way that we can actually -- almost always written in a way that we have recourse.

Okay. And just a follow-up.

Thinking about the 2013 model, you're guiding to about flat revenue in Q4. Bookings and services have been tracking down north of 20%, and you have some tough compares from a revenue standpoint, et cetera.

Do you think you can hold revenue flat in 2013 or should we expect revenue to decline?

Of course, we're going to give you total visibility in mid-November when we have the investor conference. But at this point of the planning process, we feel pretty confident that the revenue dynamics both in services and technology will continue.

And so we feel confident that we're going to be on the positive side of revenue growth getting into 2013. Again, I think it's important to keep in mind revenue -- renewal rates have been good this year, we got a strong pipeline and there is very...

Revenue is there. I mean [indiscernible].

There is money to be allocated to acquisitions as well.

Right, exactly.

I have 2 questions, if I could. Just following up on Services.

It's been a pretty hot topic throughout the year in terms of the targets or the pursuit of improved operating margin and also gross margin. And some of your commentary earlier today seems to almost suggest that some of this perceived weakness here in the third quarter was actually anticipated, but we didn't really get that sense in the last earnings call.

So can you kind of help us reconcile that commentary, please?

Yes, please.

So when we had the call, the Q2 call, we talked about sequentially being more or less flat going into Q3. And what you will see is that we missed by 120 basis points, which as I explained before when you break it down, about half of that miss was driven by one-off charges.

And we talked about particularly this defunding of a contract, and the rest was related to these additional government pressures around discretionary spending, change orders in particular and some lower volumes in some transactional areas. That's what happened.

I think very clearly we are disappointed with the level Services margins have gone and the miss is about 120 basis points, versus is what we told you 3 months ago.

But it's important to note, Mark, that we had told you that what we are tracking to is we knew that we'll have -- we thought that we would have sequential expansion, from quarter 2 to quarter 3, but we knew we would have year-over-year pressure, right? So we thought it would be about in the range quarter 2 to quarter 3 about flat, but we knew we would have sequential pressure on margins -- I mean, a year-over-year pressure on margins, and so that part is not changing.

We're not -- we are seeing the year-over-year pressure. The difference that we saw this quarter, which is -- disappointing is a mild word, which is angry, is the fact that we actually had one contract that we had to literally take a write-off on and that we have some pressure in some of the transactional volume perspective.

If it was only transactional volume, I would actually have felt a little bit better about the quarter.

Okay, appreciate that. And then my other question is just around the magnitude of the deterioration.

Clearly, your tone in your commentary is a lot more marked here in terms of the incremental deterioration since the July earnings call. I just wanted to get a sense in terms of especially in the U.S.

sector both for government and large enterprise, when did this all kind of start to manifest? What month?

And then as you went through the rest of the quarter and then into this month of October, has it stabilized or is it getting worse? And then kind of a follow-up to that is, are you starting to see some customers now as a result of the macro pressures drive to a reduced number of preferred service vendors to try to contain costs?

So let me start with the first. We've seen weakening of the U.S.

economy throughout the quarter. So in the first, I don't know, we can like to say the first month or the second month or third month but by the time September rolled around, it was very, very clear that we were headed south from a U.S.

economy, and then it was starting to become clearer even earlier in the quarter. I've spent a little bit of time with other CEOs and with other business leaders, and it is clear to me that we are seeing a dampening of enthusiasm in North America or in the U.S.

for sure. We see continued weakness in Europe.

So I think that we saw that expand throughout the quarter, and we're expecting it to hold for quarter 4. We're hoping that some settling of the economy comes in the beginning of the year, but we're not counting on it.

That's that. As far as your second part, the second part of your question about I think it was, are we ready or are we prepared, was that?

This idea of, are customers wanting to consolidate suppliers. I think that, that has been a movement for quite some time.

It's expensive to manage a large portfolio of suppliers. And so that idea of consolidating to a few larger and smaller number of suppliers has been going on now for 2 or 3 years.

And we haven't seen a marked increase or decline in that.

Ursula, a question for you as you kind of lead your company during this challenging economic time. When you look at the strategy of leading them, is there anything if we continue in this challenging state that you're looking at changing or refocusing or anything that's going to impact your cash flows?

Because this year was also pretty challenging. Just kind of as you lead the company, can you give us kind of the big picture of what you see for the direction for them?

Yes, I think that there is a duality here that you -- that I have to employ when I lead a company of this size and the varying nature of the businesses that we're in. One is to make sure that we're clear about where the opportunities lie and not get ourselves too wrapped up in all of the downside.

We have to know where growth is happening, and we have to invest to pursue that growth. And we know where it's happening.

In Document Technology, that's a predefined set of either solution types or client types, small or midsized businesses, developing economies, color, we know that. We have to literally focus on those, not get confused about those, and move our resourcing, our funding, our focus away from areas that are not really growing.

That doesn't mean we abandon clients or anything, but we actually have to make sure that we weight our investments towards growth. And on services, we have to be literally very methodical and not too impatient, which is not a good -- for that -- one of my strengths, not too impatient and skip over opportunities.

Our Services business, it's relatively new for us. The good news is we have an experienced team.

One of the first things we have to do was stabilize the business as we brought it on board and start to grow revenue to apply the strength that we had from Xerox to ACS and make revenue growth possible. We have been able to do that.

We are very confident about our ability to do that. Second thing we had to do is make sure that we take some of these very large contracts, which we have signed more of them than ACS had ever signed before.

We have to actually get those stood up and stabilized, move on that path, and then we have to drive towards margin expansion. And that's that, and literally really not focus on the other areas of the business.

So disinvest from contract sell off businesses that are not really core to us or profitable. So focus on opportunities and be kind of brutal and ruthless on things that are not aligned toward growth and not get ourselves too wrapped up in anything too short term or too, too long term.

So that's -- and that's the way that you would manage this business and you have to focus on the people and focus on their customers. If you do those 3 things, you got it made in the shade.

It's a difficult economy right now, but I think we're doing a pretty good job in navigating our way through it. Thank you for your time and for all of your interest.

I really do encourage you to spend some time with us at the investor conference at the New York Stock Exchange on November 13, and we'll be able to get into more detail about the business then. Thank you.