A n n u a l R e p o r t 2 0 0 5
True Colors
Quality measured in tolerances that approach
perfection. Adaptability that consistently beats
our competitors to the marketplace with new
offerings. A passion for innovation and creativity
that allows our customers to be even better
than they thought they could be. A steadfast
and demonstrable commitment to diversity and
social responsibility.
These are the True Colors of Xerox.
In everything that we do, our True Colors
inspire us to succeed and allow our customers
to reveal theirs. They keep us at the forefront
of technological innovation, timely product
delivery and end-to-end services that spur
profitable growth. They keep us financially
strong and intently focused on increasing value
to our shareholders. The True Colors of Xerox
guide us every day and will continue to propel
us in the future.
01
Financial Overview
02
Chairman’s Letter
09
True Colors of Our Customers
14
Social Responsibility
16
Description of Business
26
Management’s Discussion and Analysis of
Results of Operations and Financial Condition
104
Corporate Information
Financial Overview ($ millions, except EPS)
Total Revenue
Equipment Sales
2005
2004
$ 15,701
$ 15,722
4,519
4,480
Post Sale, Finance Income and Other Revenue
11,182
11,242
Net Income
Diluted Earnings Per Share
978
0.94
859
0.86
1
Anne M. Mulcahy
Chairman and Chief Executive Officer
Fellow shareholders:
2
I am pleased to report another solid year of progress
for Xerox. Our company is in excellent financial health.
Our balance sheet is strong and getting stronger. Our
new business model is doing what we intended: whatever
the challenges of our business, we are able to adjust
quickly and produce earnings growth. In fact, we have
met or exceeded our earnings expectations in 13 of the
last 14 quarters.
Our global operations are producing significant cash
flow. At the same time, we have virtually eliminated
debt except for the debt that supports our customer
financing activities.
As a result of our performance as well as confidence
that it will continue, the Xerox Board of Directors has
authorized the company to repurchase $1 billion in Xerox
common shares. It’s a tangible way to deliver shareholder
value and to assure you that we take very seriously the
trust you have placed in us.
Our progress in 2005 provided more evidence that
we are on track and continuing to build momentum:
• Net income of $978 million or 94 cents per share, an
increase of 9 percent from full-year 2004.
• Gross margins of 41.2 percent – in line with our expectations.
• Selling, general and administrative (SAG) expenses of
26.2 percent of revenue – down one-half point from
the previous year.
• Debt balance of $7.3 billion, a reduction of $2.8 billion
from year-end 2004 – and virtually all of what remains
is in support of our customer financing activities.
• Operating cash flow of $1.4 billion.
• Year-end cash and short-term investments balance of
$1.6 billion.
Xerox is at a pivotal point. We get a lot of credit these days
for turning Xerox around. We’re pleased by that, but hardly
satisfied. All of our hard work these past five years has
been done with a single-minded purpose – to return Xerox
to growth, thereby providing value to our shareholders.
We made progress in 2005, but not enough. We accelerated
the pace of install activity for Xerox digital systems such
as color printers, digital presses and multifunction devices
that print, copy, fax and scan. In fact, activity increased
by double-digit rates in our key markets. At the same time,
we aggressively ramped our services business, winning
more global consulting contracts for Xerox’s document
management expertise.
All of this bodes well for our long-term success: increased
equipment installs drives more pages printed on Xerox
systems. More pages fuel growth for Xerox supplies and
service. This translates into “post-sale” revenue, which
represents about 70 percent of Xerox’s total revenue. More
multi-year contracts for Xerox’s document management
services also flows through to support our annuity stream.
Our post-sale revenue turned positive in the second half
of 2005 – an important sign that our annuity-based
business model is working. However, total revenue was
flat, slightly below our expectations. We know we can
do better and are confident we will. And that’s what I’d
like to take this opportunity to discuss with you – how
we will grow Xerox over the next few years.
C h a i r m a n ’ s L e t t e r
We do business in a very attractive – and therefore very
competitive – market that currently affords us a $112
billion opportunity. Parts of that market are stable, parts
are growing rapidly, and parts are being created. In each,
we have a clear, consistent and credible strategy. Simply
put, it’s this:
• Compete aggressively and effectively in the relatively
stable $58 billion digital black-and-white printing market.
• Drive the rapidly growing $17 billion digital color printing
market, where the breadth and depth of our technology
gives us a commanding competitive advantage.
• Create a new $17 billion market by harnessing digital
technology to the world of offset printing with applications
such as print-on-demand, personalized communications
and one-to-one marketing. We call it the New Business
of Printing®.
• Lead the burgeoning document services market by working
with our customers to reduce document costs, streamline
processes and enable the free flow of documents down the
hall, cross-town and around the world.
That’s the opportunity we’re attacking. It’s a blend of
markets where we have traditionally competed and
natural extensions of those markets – extensions that
are enabled by new technology and inspired by the
evolving needs of our customers. A question I’m often
asked by investors is how Xerox believes it will win in
this $112 billion market. It’s a fair question. When I
reflect on it, I believe there are six tangible – and one
intangible – reasons why Xerox will succeed.
First, our technology – a past, present and future
strong suit for Xerox. We routinely invest 6 percent of
our revenues in research, development and engineering.
Our research investments are closely aligned with our
growth strategy; this way we’re always outrunning
our competitors. For example, Xerox and our partner
Fuji Xerox are jointly investing about two-thirds of our
combined research and development budget on color.
Over the last decade, this investment has resulted in
more than 2,700 color-related patents.
During 2005, we brought 49 new products to market –
products that won more than 260 industry awards.
In fact, fully two-thirds of our equipment sales last year
came from products introduced in the past two years.
3
It’s fair to say that no other company has a broader
or better set of offerings than Xerox. Perhaps more
importantly, we remain committed to our ongoing
investment in research and technology – investment
that is yielding great returns.
During 2005, the Xerox scientific community was
awarded 643 patents, placing the patent portfolio in
the top 25 of American companies. And, in 2005,
we filed 60 percent more patent applications than
in the previous year. This relentless focus on innovation
assures us that we will be able to bring added value
to our customers far into the future.
Third, our superior knowledge of documents and
the way people work with them. Ever since creating the
plain-paper copier industry 50 years ago, documents
have been part of the DNA of Xerox. We have research
teams around the world that study the flow of documents
in a workplace and develop smarter software and
services that simplify this workflow. Our customers in
industries such as health care, legal and manufacturing
rely solely on Xerox to manage the huge volume of paper
and digital documents that keep their businesses running.
As we like to say, we know more about the document,
care more about the document and can do more with
the document than anyone in our industry. Period.
Second, color. The demand for color in today’s world
is great. Our response is straightforward – make it
affordable and make it easy to use. That strategy has
made us the revenue leader in a market that is expected
to double by 2009.
Color has rapidly become a business-critical tool
for our customers. More and more businesses are
shifting to digital color systems to produce personalized,
colorful materials such as marketing collaterals,
financial statements, catalogs and user guides on
Xerox digital devices. The number of pages printed
on Xerox color devices has doubled in the past
two years. In fact, color now represents approximately
30 percent of our total revenue.
The potential for color technology is as enormous as
it is profitable. Two facts stand out: around 7 percent
of the pages printed or copied on Xerox devices today
are color, and color pages are five times more profitable
than black-and-white. The combination presents us with
a world of opportunity. We intend to capture it.
“ The potential for
color technology
is as enormous as
it is profitable.”
4
That’s an enormous advantage as the document
becomes more digital, more dynamic and more critical
to the conduct of business. Heretofore, the substantial
cost of documents flew under the radar screen of most
Chief Information Officers and Chief Financial Officers.
Everyone used documents, but no one was accountable
for their management. That is rapidly changing and it
plays to our expertise. We can save our customers up
to 30 percent of their document costs. And we are.
An increasing number of customers are turning to us
to simplify their document-intensive work processes;
manage their document-related assets; develop systems
to easily store, search and retrieve digital files; and
provide other services that add value.
Fourth, our broadening portfolio of distribution channels.
It includes 8,000 sales professionals, 7,000 agents
and concessionaires, 10,000 resellers, a world-class
teleweb operation, strong OEM relationships, IT and
consulting partners – all backed up by industry experts
and business analysts. It’s a critical mass of people and
expertise that no one else can match.
Those distribution and consulting resources span the
world and give us a presence that global customers
covet. Digital documents and business enterprises
don’t stop at geographic boundaries. Neither does
our ability to help our customers.
Increased Net Income
Net Income (Loss)
($ millions)
978
859
C h a i r m a n ’ s L e t t e r
360
91
’02
’03
’04
’05
(94)
’01
Steady
Equipment Sales
($ millions)
4,403
3,970
4,250 4,480 4,519
’01
’02
’03
’04
’05
Accelerated
Color Revenue
(Included in Total
Revenue – $ millions)
4,634
3,903
2,759 2,781
3,267
’01
’02
’03
’04
’05
Decreased Debt
as of December 31
($ billions)
16.7
14.2
11.2
10.1
7.3
’01
’02
’03
’04
’05
Stabilized
Gross Margins
(Percent)
42.8
42.6 41.6 41.2
38.6
Reduced Selling,
Administrative and
General Expenses
($ millions)
’01
’02
’03
’04
’05
4,728
4,437 4,249 4,203 4,110
A growing list of global companies are turning to Xerox
for help in managing their worldwide document needs.
The Dow Chemical Company is a good example.
They’ve signed a $66 million deal with us to consolidate
all of their document assets – printers, copiers, fax
machines and scanners – in 54 countries. Dow will get
more technology at less cost, seamless integration
around the world and the value of working with a global
partner. We believe arrangements such as this are
the wave of the future. You can read more about our
relationship with Dow on page 10 in this report.
Fifth, the customer-centric culture we have built and
continue to strengthen. Our people recognize that the
customer is our priority among priorities – the reason
we exist. Some 12,000 of our people – that’s one in
five – literally work every day on customer sites. We
work with our customers, offering not just our products,
but also providing solutions to the most pressing
problems of our customers.
The vast majority of our leadership team – including
people such as our Chief Accounting Officer and General
Counsel – have personal responsibility for the relationship
with one of our major customers. Whenever I call on a
customer – and that’s every chance I get – they tell me
that the most important reason they do business with
us is the caliber and commitment of our people. It’s a
priceless asset.
Sixth, the strength of our brand. We nurture it.
We invest in it. And we know that it opens doors, gives
us permission to compete for business and positions
us as an attractive and trusted partner.
One recent brand-building achievement is worthy of
special mention. J.D. Power and Associates named Xerox
the first document management company to receive
its certification for excellence in customer service
and support. J.D. Power evaluated the breadth of our
on-site, phone and online customer service. In addition,
auditors conducted several comprehensive visits to
our call centers and surveyed hundreds of our customers.
It’s quite an honor and one that will motivate us to strive
for even higher levels of performance.
’01
’02
’03
’04
’05
5
C h a i r m a n ’ s L e t t e r
So there you have it – a half-dozen reasons that
give us a competitive advantage in the marketplace
and should serve to give you confidence that you
have invested your money wisely.
As I write this letter, I am gathered with the senior
leadership team of Xerox – some 300 individuals whom
I am proud to call my colleagues. They and the people
they lead are the intangible reason I am confident we
will continue to be successful.
Most of the leadership team has been with the
company through our most challenging times. Others
were recruited to Xerox to fill gaps in our capabilities
and provide leadership in key areas. All chose to be
part of our turnaround, to be with us during the most
difficult, yet most rewarding period in our history.
We’re proud of our accomplishments, but not satisfied.
We’re confident in our strategy, but not complacent.
We’re bullish on our future, but take nothing for granted.
Because our opportunities are large, our competition is
formidable. As we get better, so do they. As we deliver
value to our customers, they expect more. As you invest
in us, you anticipate greater returns.
We do not shrink from those expectations; we embrace
them. They are an opportunity to continue to show our
True Colors. This is a management team that has been
tested by adversity and sharpened by challenge.
We’re going after a $112 billion opportunity. We’re
competitively advantaged to attack it aggressively. Our
financial health enables continued investments to keep
us on the leading edge of our markets. Our business
“ We’re going after a $112 billion
opportunity. We’re competitively
advantaged to attack it aggressively.”
model is tested and flexible. We adapt to changes in the
marketplace, holding steady on our gross margins and
increasing earnings for our shareholders. Our leadership
team and our people are aligned around a common
set of objectives aimed at delivering shareholder value.
You should expect no less. We aim to deliver no less.
Because of our people, I believe our best days are
ahead of us – just ahead.
Anne M. Mulcahy
Chairman and CEO
They inherited a company that lost $273 million dollars
in 2000, but had a noble history. And they brought
it back to a company that made $978 million last
year, adding another inspiring chapter to a storied
past. They refused to let Xerox fail, exhibiting what I’ve
come to call steely optimism in the face of enormous
adversity. While others predicted failure, they said
not on our watch. Xerox cannot and will not fail.
They showed their True Colors.
Now they are focused with an intensity that’s hard
to describe, but easy to feel. They are writing another
chapter in our history – the story of our return to
growth. As I met and talked with the leadership team
this week, I was galvanized by their dissatisfaction
with the status quo. To them, good is not good enough.
They are on a mission to put Xerox back on a growth
trajectory and give you a solid return on the trust
you place in us. As one of them put it: “We’ve been
playing defense. Now it’s time to play offense.”
6
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7
5
3
4
2
10
9
8
1
11
B o a r d o f D i r e c t o r s
A: Member of the Audit Committee
B: Member of the Compensation Committee
C: Member of the Corporate Governance Committee
D: Member of the Finance Committee
* Will not stand for reelection at the 2006 annual
meeting of shareholders
** Elected to the Board March 1, 2006
1. Anne M. Mulcahy
Chairman and Chief Executive Officer
Xerox Corporation Stamford, CT
2. Glenn A. Britt A, C
President and Chief Executive Officer
Time Warner Cable Stamford, CT
3. Ann N. Reese C, D
Executive Director
Center for Adoption Policy Rye, NY
4. William Curt Hunter A, C
Dean and Distinguished Professor
of Finance
University of Connecticut School
of Business Storrs, CT
5. Stephen Robert D*
Chancellor Brown University
Chairman and Chief Executive
Officer Renaissance Institutional
Management LLC New York, NY
6. Richard J. Harrington A
President and Chief Executive Officer
The Thomson Corporation Stamford, CT
7. Robert A. McDonald A
Vice Chairman – Global Operations
The Procter & Gamble Company
Cincinnati, OH
8. Vernon E. Jordan, Jr. B, C
Senior Managing Director
Lazard Fréres & Co., LLC New York, NY
Of Counsel, Akin, Gump, Strauss,
Hauer & Feld, LLP Attorneys-at-Law
Washington, DC
9. Hilmar Kopper B, D
Former Chairman and Chief Executive
Officer Deutsche Bank AG
Frankfurt, Germany
10. Ralph S. Larsen B, C
Former Chairman and Chief
Executive Officer Johnson & Johnson
New Brunswick, NJ
11. N. J. Nicholas, Jr. B, D
Investor New York, NY
Mary Agnes Wilderotter**(not pictured)
Chairman and Chief Executive Officer
Citizens Communications
Stamford, CT
7
“Our True Colors come
through in our people.
That’s more than
14,000 variations.”
“ I love this business. Whether it’s wedding invitations,
greeting cards, customized newsletters or targeted
mailings, what’s more important to bringing people
together than the right communication, at the right
time? Even in the most ‘paperless’ society, there will
always be the printed word.
“ At the same time, the True Colors of the success
we’ve enjoyed at Taylor Corporation could apply to
any business, in any industry. Passion and enthusiasm,
hard work, intelligence, common sense and, above
all, people.
“ The right people don’t just happen. They get that way
by being nurtured, challenged, empowered and given
the space to succeed.
“ We encourage our people through ‘opportunity and
security.’ Some might look at these as distinct concepts.
To the Taylor team, they’re one and the same. Seizing
opportunity is security. In fact, it’s the only security
this world has to offer.
“ That philosophy is embedded in our culture. Which
is why we’ve grown to 85 Taylor companies. I like
to think of them as entrepreneurial ventures that are
continually evolving.
“ When we touch customers, what are they really
getting? People. Human interaction. The desire,
responsiveness and expertise that they know can
improve their business, and their lives.
“ I know it sounds corny, but I really like people. I am
continually refreshed by the human spirit. Any success
we have at Taylor is that spirit multiplied by 14,000.”
“Taylor’s people exemplify
the New Business of Printing.”
All 85 Taylor companies are driven by a passion to
improve the entire range of printed communication.
So are we. That makes Taylor and Xerox natural partners.
Together, we understand that the “New Business of
Printing” is not really just about printing. It’s about
increasing value to client companies. That means, for
example, communicating with prospective customers
one-to-one while retaining the impact of full color. Which
can lower the overall cost of acquiring those customers.
Or presenting existing customers with personalized
offers based on past buying behavior. Which boosts
per-customer revenue and builds loyalty.
Xerox team
from left to right:
TC Campbell
Denise De’te
Steve Cullers
Kim Armstrong
That’s where the Xerox iGen3® Digital Production Press
is changing the landscape. It allows Taylor to provide
variable and on-demand color printing solutions that
are economically feasible, at quantities from one to tens
of thousands. And we don’t mean just changing names
and addresses. We mean changing 100% of the content
and four-color photographs. So there’s more variation,
shorter runs, less waste and less warehousing.
In short, Taylor’s iGen3 presses produce much more than
striking, made-to-order printed materials. They produce
cost-effective results – and satisfied customers.
That’s important work. And we’re privileged to be a
part of it.
TC, Denise, Steve, Kim
Brad Schreier
CEO Taylor Corporation
9
“We strive, every day, to
improve what is essential
to human progress.”
“ We enable collaboration and consistency around
the world by engaging best-in-class technology and
work-process systems. The result is that we’re truly
global. Walk into an operation in Argentina and you’ll
see the same approach to our business as in Osaka.
Which means our quality remains uniformly excellent
and our productivity is always improving.
“ Making continuous improvements to our operations
energizes me. As our founder, Herbert Dow, observed,
‘If you can’t do it better, why do it?’ It’s gratifying to
know that the Dow culture can seize on a better idea
and implement it across the globe. Not for the sake
of change itself, but because what we’re doing is so
important. Our mission is to improve what is essential
to human progress – including crops, drinking water,
pharmaceuticals, building materials and consumer goods.
“ We make those improvements through science and
technology, but at the core of our 110 years of
success is integrity. That’s what you might expect
to hear from any well-meaning executive, but at Dow,
it’s part of the DNA. It means living by our word.
It means doing the right thing without being asked.
It means leaving things better than we found them.
We take integrity very seriously.
“ Combine integrity with the ability to implement
globally and you have an organization that is capable
of making the world a better place, every day.
By creating solutions for society. By protecting
the health and safety of our people and our
communities around the world. By viewing every
customer relationship as a partnership in which
we create value for one another. These really
are the True Colors of Dow. And the reasons I’ve
invested my entire career here.”
“350 locations, 54 countries,
one solution.”
Think global, execute local. That became our charge
when Dow tapped Xerox to streamline its copy, print,
scan and fax capabilities at all of its locations worldwide.
We learned pretty quickly that Dow does nothing by
halves. When it makes improvements, it does so globally.
The direction seemed straightforward enough: Make
sure that uniform, cost-effective document-management
functionality is a defined distance from the users who
need it. And make sure they’re fully satisfied!
Thank goodness Xerox, like Dow, lives by Lean
Six Sigma, a data-driven method for removing costs
and improving processes. It resulted in the exact
number of correct assets in every location at the
lowest possible cost.
Xerox team
from left to right:
Kent Purvis
Katherine Agbe
Tom Marler
Susan Loberg
Now documents of any length, size, color or complexity
can be sent halfway around the world as easily as to
the building next door. That means huge savings in time
and cost, as Dow’s documents will no longer have to
be shipped and caught up in transportation delays before
they’re delivered.
It might sound easy, but the implementation has been,
well, significantly more complicated than a domestic
initiative. There are 54 countries we’re working with and
that’s where Xerox’s global leadership shines through.
We’ve devised processes that work in any culture, and
we’ve trained and set up help desks in over ten languages.
Even though the solution is global, Dow is measuring
success one local user at a time.
Kent, Katherine, Tom, Susan
Mack Murrell
Senior Director
Enterprise IT Operations & Office Facilities
The Dow Chemical Company
11
“Our True Colors
are helping people
discover theirs.”
“ We founded The ConferenceWorks! as a company
dedicated to the evolution of personal consciousness.
Through natural self-healing, alternative medicine,
essential life wisdom and other enriching topics, our
seminars showcase today’s most relevant presenters,
who seek to bring to our attendees learning, wisdom
and new perspectives.
“ There’s an accumulating body of evidence that raising
consciousness one person at a time has a beneficial
effect on other people who may not seem to be otherwise
connected. Thoughts truly do make a difference in
creating what we call Aha! opportunities.
“ So I guess you could say that the True Colors of
The ConferenceWorks! are to promote deeper learning,
new ideas and real tools our clients can use to support
conscious evolution in their lives, their works and
their relationship with the world in which they live.
“ I’m continually encouraged and gratified at the number
of insights and positive experiences that our clients have
many weeks, even months, after attending our seminars.
“ My job is particularly enriching since more than anyone,
I’m responsible for getting people to our seminars in the
first place. We need to convince them that spending a
weekend with us for something that, at first, they only
vaguely understand is worth their effort, time and money.
“ Challenging to be sure, but gratifying. As close to 100%
customer satisfaction as I’ve ever seen. It’s a great feeling
to promote a product that I believe in so strongly and that
actually changes the world for the better.”
“Our routine inquiry became a
transformational experience.”
Our work started when we were following up on an
historical agreement report. These tell us when a client
is coming off lease and may be interested in renewal
or an upgrade.
Enter Indiana Business Equipment, one of Xerox’s
1,100 authorized sales agencies that sell the complete
line of Xerox office systems to small and medium-sized
businesses.
What our sales agents found went way beyond the analog
copiers and printers that they were using for everyday
office management. It turns out The ConferenceWorks!
was outsourcing the printing of almost all of its marketing
material. That meant long lead times, excessively large
print runs and, ultimately, more time and money than
were necessary.
Xerox team
from left to right:
Kyle Smelser
Andrea Hall
Ryan Gerber
Our solution started with listening and exploring the
possibilities, which, as you might expect, is something
The ConferenceWorks! encourages. They let us examine
their entire marketing approach from the time they
solicit a potential client to when that prospect becomes
a bona fide customer.
What we discovered led us to the Xerox WorkCentre®
Pro C3545 and its ability to bring high-quality, affordable
color to an office environment. Talk about an Aha!
opportunity. As the result of our analysis and solution,
The ConferenceWorks! now produces color documents
every bit as vibrant as those from an offset press.
And no matter what the quantity, they can customize
the message. All for about a third less than they were
spending on outsourcing. And in a fraction of the time.
Any time we can make a client better at what they do,
it’s a great feeling. When we can do it for a client that’s
transforming lives, that’s even better.
Kyle, Andrea, Ryan
Sharon Krieg
Operations Manager The ConferenceWorks!
13
S o c i a l R e s p o n s i b i l i t y
Our Commitment to Good
Citizenship is Unwavering
Of the True Colors of Xerox, none is brighter and more
enduring than our commitment to corporate citizenship,
a core value since the company’s founding. Here are
some examples:
support sustainable growth. Among Xerox’s efforts: the
Palo Alto Research Center’s work on “clean technologies”
and renewable energy.
• Xerox solid ink color printers – based on the company’s
proprietary technology – generate about 95% less waste
than laser printers. Xerox is extending this technology to
more products, like the WorkCentre C2424, launched in
2005 as the industry’s first solid ink multifunction system.
• The Xerox Foundation invested $13.2 million in 2005,
which included 42 grants to university science programs,
more than 190 grants for college scholarships and
support, and 550 grants to nonprofits.
• Xerox paper comes from suppliers that meet the
company’s stringent environmental requirements, which
are designed to ensure that all Xerox paper is sourced
from sustainably managed forests.
• Xerox provided $2 million for Southeast Asia earthquake
and tsunami relief and $2 million in financial and technical
assistance for victims of Hurricane Katrina.
• Through its supplier diversity program, Xerox placed
$400 million worth of orders with minority-, women- and
veteran-owned businesses in 2005.
• Black Enterprise, DiversityInc, the Human Rights
Campaign, Computerworld, Hispanic Business and
several other entities recognize Xerox’s workplace as
being among the best.
• Following Xerox’s mission to make “waste-free products
in waste-free factories to help customers attain waste-free
workplaces,” the company diverts more than 140 million
pounds of waste from landfills. Nearly all eligible new
products launched in 2005 met the international ENERGY
STAR® and Canada’s Environmental Choice standards.
• Xerox pledged to drive its worldwide greenhouse gas
emissions 10% lower than 2002 levels, by 2012.
• Xerox became a charter partner in the Business
Roundtable’s new “S.E.E. Change” initiative, which calls
for corporations to strengthen business strategies that
14
“ Xerox is one of our
nation’s pillars, advancing
important social and
economic goals for
communities across
the country.”
– U.S. Chamber of Commerce upon awarding Xerox a 2005 Corporate
Citizenship Award.
• Xerox encourages employees to volunteer in their
communities through programs like Social Service
Leave, which offers paid sabbaticals for community
service; the Community Involvement Program,
which provides seed money for Xerox teams to fund
volunteers projects; and the Science Consultant
Program, through which employees bring real-life
science experiments into the classroom.
• Xerox’s Board of Directors is more than 90 percent
independent with Xerox Chairman and CEO
Anne Mulcahy serving as the only employee director.
• Fortune Magazine’s 2006 “U.S. Most Admired
Companies” survey ranked Xerox No. 1 in its industry
for “social responsibility.”
For more information, visit www.xerox.com/csr.
T A B L E O F C O N T E N T S
16
Description of Business
26
Management’s Discussion and Analysis of
Results of Operations and Financial Condition
46
Consolidated Statements of Income
47
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
48
49
Consolidated Statements of Common Shareholders’ Equity
Notes to the Consolidated Financial Statements
50
99
Reports of Management
100
Report of Independent Registered Public Accounting Firm
Quarterly Results of Operations (Unaudited)
101
102
Five Years in Review
103
Officers
104
Corporate Information
X e r o x A n n u a l R e p o r t 2 0 0 5
15
D E S C R I P T I O N O F B U S I N E S S
Global Overview
Xerox is a
$15.7 billion
Revenues by
Geography
technology and services
enterprise and a leader in
the global document market.
($ millions)
We develop, manufacture, market, service and finance a complete
range of document equipment, software, solutions and services.
U.S.:
$8,388
$5,226
Europe:
Other Areas: $2,087
We operate in over160
countries worldwide.
Globally we have 55,200
direct employees.
We have over 8,000 Sales Professionals, over 12,000
Managed Service Employees at customer sites and
13,000 Technical Service Employees. In addition, we
have over 7,000 Agents and Concessionaires and over
10,000 Resellers.
Overview
References herein to “we,” “us,” “our,” the “Company” and “Xerox”
refer to Xerox Corporation and its subsidiaries unless the context
specifically states or implies otherwise.
Xerox is a $15.7 billion technology and services enterprise and a
leader in the global document market. We develop, manufacture,
market, service and finance a complete range of document
equipment, software, solutions and services. Our international
operations represented approximately one-half of our total revenues
in 2005. Our largest subsidiary outside the United States is Xerox
Limited, which operates predominantly in Europe. We conduct our
Latin American operations through subsidiaries or distributors in
over 38 countries. Fuji Xerox, an unconsolidated entity of which
we own 25%, develops, manufactures and distributes document
processing products in Japan, China, Hong Kong and other areas
of the Pacific Rim, Australia and New Zealand.
The document industry is transitioning from older technology
light-lens devices to digital systems, from black and white to color
and from paper documents to an increased reliance on electronic
documents. More and more people are creating and storing
documents digitally and using the Internet to easily exchange
electronic documents. We believe these trends play to the
strengths of our product and service offerings and represent
opportunities for future growth within the $112 billion market we
serve. In our core markets of Production and Office, we believe
we are well placed to capture core growth opportunities by
leading the transition to color and by reaching new customers
with our broadened offerings and expanded distribution channels.
We are expanding our core markets with Document Services and
we are creating new market opportunities with digital printing
as a complement to traditional offset printing, which we refer
to as the “Eligible Offset” market. Our Document Services are
organized around three offerings: Xerox Office Services, where
we help our customers reduce costs and maximize productivity
by optimizing their print infrastructure; Document Outsourcing
and Communication Services, which focuses on optimizing the
production environment; and Business Process Services, where
16
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
*The document industry is transitioning from the older
technology of light-lens devices to the new digital systems,
from black and white to color, and from paper documents
to electronic documents. More and more people are creating
and storing documents digitally, and using the Internet allows
the easy exchange of electronic documents. We believe these
trends play to the strengths of our product and service offerings
and represent opportunities for future growth within the
$112 billion market we serve.
Markets
We serve a$112*
billion market.
This estimate, and the market estimates which follow, is
calculated by leveraging third-party forecasts from firms
such as International Data Corporation and InfoSource in
conjunction with our assumptions about our markets.
($ billions)
$20
$17
$ 8
$67
Services: Our value-added services deliver solutions, which not only optimize
enterprise output spend and infrastructure, but also streamline, simplify and digitize
our customers’ document-intensive business processes.
Eligible Offset: We are creating new market opportunities with digital printing as
a complement to traditional offset printing. (This is an estimate for this “Eligible
Offset” market.)
Production: We are the only manufacturer in the market that offers a complete
family of monochrome production systems from 65 to 180 impressions per minute
and color production systems from 40 to 110 pages per minute (“ppm”).
Office: We are well placed to capture growth by leading the transition to color
and by reaching new customers with our broadened offerings and expanded
distribution channels.
we show our customers how to improve their processes by using
digital workflow. Within the Eligible Offset market we offer leading
digital technology, led by our market-making Xerox iGen3® tech-
nology and accompanied by the industry’s broadest migration
path to digital, which meets the increasing demand for short-run,
customized and quick-turnaround offset quality printing.
Our products include high-end printing and publishing systems,
digital multifunctional devices (“MFDs”) (which can print, copy,
scan and fax), digital copiers, laser and solid ink printers, fax
machines, document-management software, and supplies such
as toner, paper and ink. We provide software and workflow
solutions that can help businesses easily and affordably print
books, create personalized documents for their customers
and scan and route digital information. In addition, we provide
a range of comprehensive document management services,
such as operating in-house production centers, developing online
document repositories and analyzing how customers can most
efficiently create and share documents in the office.
Our business model is an annuity model, based on increasing
equipment sales and installations in order to increase the number
of machines in the field (“MIF”) that will produce pages and gener-
ate post sale and financing revenue streams. We sell the majority
of our equipment through sales-type leases that are recorded as
equipment sale revenue. Equipment sales represented 29% of
our 2005 total revenue. Post sale and financing revenue includes
equipment maintenance and consumable supplies, among other
elements. We expect this large, recurring revenue stream to
approximate three times the equipment sale revenue over the
life of a lease. Thus, the number of equipment installations is
a key indicator of post sale and financing revenue trends. The
mix of color pages is another significant indicator of post sale
revenue trends because color pages use more consumables
per page than black and white. Thus, color pages generate
approximately five times the revenue and profit per page as
compared to black and white. In addition, market development,
particularly within the Eligible Offset market, is key to increasing
pages and we have leading tools and resources to develop this
large market opportunity.
X e r o x A n n u a l R e p o r t 2 0 0 5
17
$12010080604020 D E S C R I P T I O N O F B U S I N E S S
Segment Information
Our reportable segments are Production, Office, Developing
Markets Operations (“DMO”) and Other. Operating segment
financial information is presented in Note 2 to the Consolidated
Financial Statements, which is incorporated by reference.
We have a very broad and diverse base of customers, both
geographically and demographically, ranging from small and
medium businesses to graphic communications companies,
governmental entities, educational institutions and large (Fortune
1000) corporate accounts. None of our business segments
depends upon a single customer, or a few customers, the loss
of which would have a material adverse effect on our business.
Reviews by Business Segment
Production
Office
DMO
Other
28.92%
48.52%
11.54%
11.02%
Production
$4,540
Office
DMO
Other
$7,618
$1,812
$1,731
million
million
million
million
We provide high-end digital
monochrome and color
systems designed for
customers in the graphic
communications industry
and for large enterprises.
Our Office segment serves
global, national and
small to medium-size
commercial customers
as well as government,
education and other
public sector customers.
The Other segment
primarily includes revenue
from paper sales, wide-
format systems and
value-added services.
DMO includes marketing,
direct sales, distributors
and service operations
for Xerox products,
supplies and services
in Latin America, the
Middle East, India, Eurasia,
Central-Eastern Europe
and Africa.
18
X e r o x A n n u a l R e p o r t 2 0 0 5
Production
We provide high-end digital monochrome and color systems
designed for customers in the graphic communications industry
and for large enterprises. These high-end devices enable digital
on-demand printing, digital full-color printing and enterprise
printing. We are the only manufacturer in the market that offers
a complete family of monochrome production systems from 65
to 180 impressions per minute and color production systems
from 40 to 110 pages per minute (“ppm”). In addition, we offer
a variety of pre-press and post-press options and the industry’s
broadest set of workflow software.
The Xerox Freeflow™ digital workflow collection improves our
customers’ work processes from content creation and management
to production and fulfillment. Our digital technology, combined
with total document solutions and services that enable personali-
zation and printing on demand, delivers value that improves our
customers’ business results.
Our 2005 Goals
Our goals in the Production segment in 2005 were to strengthen
our leadership position in monochrome and color and leverage
the power of digital printing in the Eligible Offset market. Our
“New Business of Printing” strategy complements the traditional
offset press market with digital printing capabilities, which
includes introducing innovative production systems and solutions
to expand our leadership position and focus on the higher-growth
digital color opportunities. To reach our 2005 goals, we:
Our 2005 Accomplishments
• Increased our presence in the monochrome digital light
production market and scaled the new monochrome publishing
platform (Xerox Nuvera™).
– Xerox 4110: In February 2005, we launched the Xerox 4110,
a 110 ppm copier/printer. We first entered the light production
space in 2003 with the introduction of the Xerox 2101. We
took market share in 2004 and continued to maintain a strong
position in 2005 with the success of the 4110.
– Xerox Nuvera 100/120: We launched the Xerox Nuvera
100/120 full-production systems in Europe in the fourth
quarter of 2004 and in North America in the first quarter
of 2005.
– Xerox Nuvera 144: In September 2005, we announced the
Xerox Nuvera 144 Digital Production System, which prints at
144 ppm (a 20% increase over the previous Nuvera production
system) and features a more powerful print controller and
finishing options. We will continue to add features and func-
tionality to Nuvera platform products into 2006.
X e r o x C o r p o r a t i o n
• Expanded our leading product line of color systems and increased
our presence in the graphic communications environment.
– Xerox iGen3: During 2005, we continued to increase installations
of our flagship Xerox iGen3 Digital Production Press (“Xerox
iGen3”). In March 2005, we announced the Xerox iGen3 110,
a 110 ppm full-color production system, which represents
a 10% increase in speed from the previous system. At an
operating cost of approximately 5 cents per image, the
Xerox iGen3 uses next-generation color technology which
we expect will expand the digital color print on-demand
market as its speed, image quality, personalization and cost
advantages enable the device to capture valuable pages in
the color offset printing market.
– DocuColor™ 7000: In May 2005, we launched the DocuColor
7000 Digital Press, a 70 ppm production system, which
provides a new digital full-color entry point for our graphic
communications and central reproduction center customers.
– DocuColor 240 and 250: In September 2005, we announced
the production version of the DocuColor 240/250, a 40 and
50 ppm digital color MFD with three external controllers
designed for the production environment. We now offer our
customers the broadest migration path to digital with digital
color devices offered at 40, 50, 52, 60, 70, 80 and 110 ppm.
• Leveraged the power of digital printing in the offset
printing market.
– Workflow and Market Development: We continue to expand
and improve our leading workflow collection. In September
2005, we introduced several enhancements to the FreeFlow
Digital Workflow collection, expanded the remote services
offering, PrinterAct, to include the DocuColor 7000 and
8000 (previously available for Xerox iGen3 and Xerox
Nuvera systems), and ramped up our ProfitAccelerator™
program, which helps customers maximize digital technology
investments. All products are interoperable, consisting of
open architecture that links and controls print shop activities
with digital and offset printing equipment. They help print
providers streamline job ordering and management, reduce
manual steps and automate error-prone parts of the printing
process. These new workflow products make it easy to
integrate digital printing into JDF (job definition format)-
based workflows, enabling a common set of software
instructions to direct a print job from creation to completion,
in a consistent, uniform manner.
X e r o x A n n u a l R e p o r t 2 0 0 5
19
D E S C R I P T I O N O F B U S I N E S S
Office
Our Office segment serves global, national and small to medium-
size commercial customers as well as government, education
and other public sector customers. Office systems and services,
which include monochrome devices at speeds up to 90 ppm and
color devices up to 40 ppm, as well as 50 ppm color devices
with an embedded controller, include our family of CopyCentre®,
WorkCentre® and WorkCentre® Pro digital multifunction systems;
DocuColor printer/copiers; color laser, LED (light emitting
diode), solid ink and monochrome laser desktop printers; digital
copiers; light-lens copiers and facsimile products. We are leading
the transition to digital by mapping our feature-rich, innovative
laser and solid ink MFDs to powerful scanning technology in
the enterprise environment, which enables our customers to
maximize their document workflow. We provide further value
to our customers by offering a range of solutions including the
Office Document Assessment (“ODA”), in which we analyze a
business’ workflow and document needs, and then we identify
the most efficient, productive mix of office equipment and
software for that business, thereby helping to reduce the
customer’s document-related costs.
Our 2005 Goals
Our goals in the Office segment in 2005 were to digitize the
office by leading in MFDs, drive the transition to color and reach
more customers with a broadened product line and expanded
distribution channels. To reach our 2005 goals, we announced
a significant refresh of our Office systems, including most of
our black and white MFDs, and introduced new solid ink and
laser color printers and MFDs. To reach our 2005 goals, we:
– The Phaser 6300 and 6350: The Phaser 6300 and 6350
laser printers at speeds of 26 ppm color and 36 ppm
black and white. These new laser printers have the fastest
print speeds and fastest first-page-out speeds in their class.
– The DocuColor 240 and 250: The DocuColor 240 and
250 “light production” color MFDs with speeds of 40 ppm
and 50 ppm color, respectively. These devices include an
embedded controller and smaller footprint, which are geared
toward the larger office. Further, these devices provided
significant growth opportunity in the Office and Production
segments (see “Production”), depending upon configuration.
– Desktop management software: An expanded line of desktop
management software and solutions including security
features and remote services.
– The Phaser 7400 and 6120 and the WorkCentre Pro 133
and WorkCentre PE 220: The October 2005 launch of two
new laser printers including the Phaser 7400 and Phaser
6120, as well as the WorkCentre Pro 133 advanced MFD
(also available in WorkCentre and CopyCentre) and the
WorkCentre PE 220.
• Continued to drive the transition to color by making color more
affordable, easier to use, faster and more reliable.
– Our color-capable devices provide an attractive entry point
into color by offering black and white pages at the same
cost as black and white systems. Our patented solid ink
technology offers unmatched ease of use, vibrant color
image quality, and economic color run cost that support
color transition leadership.
Our 2005 Accomplishments
• Announced new products, including:
• Expanded distribution channels.
– The first solid ink MFD, the C2424: The March 2005
introduction of three new solid ink devices including the first
solid ink MFD, the C2424, which runs at 24 ppm – in color
or black and white, and offers copy, print and scan functions.
– Expanded distribution channels through increased use of
our indirect distribution model in Europe and greater use
of Teleweb (a combination of telephone and Internet selling)
and OEM partnerships in the U.S.
– The Phaser 8500 and 8550: The June 2005 introduction
of two new solid ink office printers including the
Phaser 8500 and Phaser 8550, with speeds of 24 ppm
and 30 ppm, respectively.
– WorkCentre Pro 232, 238, 245, 255, 265 and 275:
The WorkCentre Pro 232, 238, 245, 255, 265 and 275 –
advanced black and white digital MFDs that combine
high-performance printing, copying, scanning and faxing
in one easy-to-use office system. These products are also
available as WorkCentre, offering copy/print capabilities
and optional fax and CopyCentre standalone digital copiers.
20
X e r o x A n n u a l R e p o r t 2 0 0 5
DMO
DMO includes marketing, direct sales, distributors
and service operations for Xerox products, supplies and
services in Latin America, the Middle East, India, Eurasia
and Central-Eastern Europe and Africa. Brazil, Eurasia and
Central-Eastern Europe represented approximately 12%
of total revenues in 2005. In countries with developing
economies, DMO manages the Xerox business through
operating companies, subsidiaries, joint ventures, product
distributors, affiliates, concessionaires, resellers and
dealers. Two-tiered distribution has proven very successful
in the high-growth geographies of Russia and Central-Eastern
Europe and we are currently implementing it throughout
Latin America. We manage our DMO operations separately
as a segment because of the political and economic volatility
and unique nature of its markets. Our 2005 DMO goals
included revenue stabilization and improvement, a continued
focus on cost structure to improve margins, and increased
profitability for growth.
Other
The Other segment primarily includes revenue from paper
sales, wide-format systems and value-added services.
We sell cut-sheet paper to our customers for use in their
document processing products. The market for cut-sheet
paper is highly competitive and revenues are significantly
affected by pricing. Our strategy is to charge a premium over
mill wholesale prices, which is adequate to cover our costs
and the value we add as a distributor.
We offer document processing products and devices in
our wide-format systems business designed to reproduce
large engineering and architectural drawings up to three
feet by four feet in size.
An increasingly important part of our offering is value-added
services, which leverage our document industry knowledge
and experience. Xerox value-added services deliver solutions,
which not only optimize enterprise output spend and infra-
structure, but also streamline, simplify and digitize our customers’
document-intensive business processes. Often the value-added
services solutions lead to larger Xerox managed services
contracts, which include Xerox equipment, supplies, service
and labor. The revenue from these contracts is reported within
the Production, Office or DMO segments. In 2005, value-added
services and managed services revenue, including equipment,
totaled $3.3 billion.
Revenue
Revenue Stream
29%
71%
Approximately 29% of our revenue
comes from Equipment sales, from
either lease arrangements that
qualify as sales for accounting
purposes or outright cash sales.
The remaining 71% of our
revenue, “Post sale and financing,”
includes annuity-based revenue
from maintenance, service, supplies
and financing, as well as revenue
from rentals or operating lease
arrangements.
X e r o x C o r p o r a t i o n
Twenty-nine percent of our revenue comes from Equipment sales,
primarily from either lease arrangements that qualify as sales for
accounting purposes or outright cash sales. The remaining 71%
of our revenue, “Post sale and finance income,” includes annuity-
based revenue from maintenance, service, supplies and financing
as well as revenue from rentals or operating lease arrangements.
We sell most of our products and services under bundled lease
arrangements, in which our customers pay a monthly amount
for the related equipment, maintenance, services, supplies and
financing elements over the course of the lease agreement.
These arrangements are beneficial to our customers and us
since, in addition to customers receiving a bundled offering,
the arrangement allows us to maintain the customer relationship
for subsequent sales of equipment and services.
We are required for accounting purposes to analyze these
arrangements to determine whether the equipment component
meets certain accounting requirements such that the equipment
should be recorded as a sale at lease inception (i.e., sales-type
lease). Sales-type leases require allocation of a portion of the
monthly payment attributable to the fair value of the equipment
which we report as “equipment sales.” The remaining portion
of the monthly payment is allocated to the various remaining
elements based on fair value – service, maintenance, supplies
and financing – which are generally recognized over the term
of the lease agreement and reported as “post sale and other
revenue” and “finance income” revenue. In those arrangements
that do not qualify as sales-type leases, which has been starting
to occur more frequently as a result of our services-led strategy,
the entire monthly payment will be recognized over the term
of the lease agreement (i.e., rental or operating lease) and is
reported in “post sale and other revenue.” Our accounting
policies related to revenue recognition for leases and bundled
arrangements are included in Note 1 to the Consolidated Financial
Statements in our 2005 Annual Report.
X e r o x A n n u a l R e p o r t 2 0 0 5
21
$10020406080020406080100020406080100120 D E S C R I P T I O N O F B U S I N E S S
Research and Development
Patents, Trademarks and Licenses
We are a technology company. With our PARC subsidiary, we
were awarded nearly 450 U.S. utility patents in 2005, ranking
us 35th on the list of companies that had been awarded the
most U.S. patents during the year. With our research partner,
Fuji Xerox, we were awarded nearly 650 U.S. utility patents in
2005. Our patent portfolio evolves as new patents are awarded
to us and as older patents expire. As of December 31, 2005,
we held approximately 8,100 design and utility U.S. patents.
These patents expire at various dates up to 20 years or more
from their original filing dates. While we believe that our portfolio
of patents and applications has value, in general no single
patent is essential to our business or any individual segment.
In addition, any of our proprietary rights could be challenged,
invalidated or circumvented, or may not provide significant
competitive advantages.
In the U.S., we are party to numerous patent licensing agreements,
and in a majority of them, we are a licensee. Most of the patent
licenses expire concurrently with the expiration of the last patent
identified in the license. In 2005, with our PARC subsidiary, we
added approximately 15 agreements to our portfolio of patent
licensing agreements, and either we or our PARC subsidiary
was a licensor in 13 of the agreements. Xerox’s licensing efforts
include a number of cross-licensing agreements with companies
with substantial patent portfolios. Those agreements vary in
subject matter, scope, compensation, significance and time.
Among the more recent licenses are agreements with Canon,
Microsoft, IBM and Hewlett-Packard.
In the U.S., we own approximately 560 trademarks (either
registered or applied for). These trademarks have a perpetual
life, subject to renewal every ten years. We vigorously enforce
and protect our trademarks. We hold a perpetual trademark
license for “DocuColor.”
Investment in R&D is critical to drive future growth and we
have aligned our investments with our strategic planks: Office,
Production and Services. Our goal is to continue to create
innovative technologies that will expand current and future
markets. Our R&D investments employ three key themes:
1) continue to reinvent our machines to deliver better quality,
more functionality and improved productivity, 2) rethink how
people work, including the use of variable information printing
to customize documents and 3) redefine the document through
new inventions. Our research scientists regularly meet with
customers and have dialogues with our business groups to
ensure they understand customer requirements and develop
products and solutions that can be commercialized.
In 2005, R&D expense was $755 million, compared with
$760 million in 2004. 2005 R&D spending focused primarily on
the development of high-end business applications to drive the
“New Business of Printing,” on extending our color capabilities,
and on lower-cost platforms and customer productivity enablers
to drive digitization of the office. The Xerox iGen3, an advanced
next-generation digital printing press launched in October
2002 that uses our patented imaging technology to produce
photographic-quality prints indistinguishable from offset,
is an example of the type of breakthrough technology we
developed and that we expect will drive future growth.
In addition, sustaining engineering expenses reported within
R,D&E, were $188 million in 2005 and $154 million in 2004.
Xerox Research, Development and Engineering Expenses
($ millions)
$943
$914
Our R&D is strategically coordinated with that of Fuji Xerox, which
invested $720 million in R&D in 2005 and $704 million in 2004.
22
X e r o x A n n u a l R e p o r t 2 0 0 5
$1000200400600800050402004006008001000 Competition
Marketing and Distribution
X e r o x C o r p o r a t i o n
Although we encounter aggressive competition in all areas of
our business, we are the leader, or among the leaders, in each
of our principal business segments. Our competitors range
from large international companies to relatively small firms.
We compete primarily on the basis of technology, performance,
price, quality, reliability, brand, distribution, and customer service
and support. To remain competitive, we invest in and develop
new products and services and continually enhance our existing
offerings. Our key competitors include Canon, Ricoh, IKON,
Hewlett-Packard and, in certain areas of the business, Pitney
Bowes, Kodak, Oce, Konica-Minolta and Lexmark.
We believe that our brand recognition, reputation for document
knowledge and expertise, innovative technology, breadth of
product offerings, global distribution channels and our customer
relationships and large customer base are important competitive
advantages. We and our competitors continue to develop and
market new and innovative products at competitive prices and,
at any given time, we may set new market standards for quality,
speed and function.
We manage our business based on the principal business segments
described above. The marketing and selling of our products and
solutions, however, are organized according to geography and
channel types. Our products and solutions are sold directly to
customers by our worldwide sales force of approximately 8,000
employees and through a network of independent agents, dealers,
value-added resellers and systems integrators. Increasingly, we
are utilizing our direct sales force to address our customers'
more advanced technology, solutions and services requirements,
while expanding our use of cost-effective indirect distribution
channels, such as Teleweb, for basic product offerings.
We market our Phaser line of color and monochrome laser-class
and solid ink printers through office information technology
industry resellers, who typically access our products through
distributors. In 2005, we increased the product offerings
available through a two-tiered distribution model in Europe
and DMO. Through a multi-phased roll-out, we will continue to
increase offerings through this lower-cost distribution channel
for our Office portfolio. Additionally, we expanded our distribution
channels in North America in 2005.
In Europe, Africa, the Middle East, India and parts of Asia, we
distribute our products through Xerox Limited, a company
established under the laws of England, and related non-U.S.
companies (collectively "Xerox Limited"). Xerox Limited enters into
distribution agreements with unaffiliated third parties covering
distribution of our products in certain countries located in these
regions, including Iran, Sudan and Syria. Iran, Sudan and Syria,
among others, have been designated as state sponsors of
terrorism by the U.S. Department of State and are subject to
U.S. economic sanctions. We maintain an export and sanctions
compliance program and believe that we have been and are in
compliance with applicable U.S. laws and government regulations
related to these countries. In addition, we had no assets, liabilities
or operations in these countries other than liabilities under the
distribution agreements. As a result of the termination of these
agreements, we anticipate that our revenues attributable to these
countries will decline over time. Xerox Limited is terminating its
distribution agreements related to these countries and expects
that, by the end of 2006, it will have only legacy obligations such
as providing spare parts and supplies to these third parties. In
2005, we had total revenues of $15.7 billion, of which less than
$10 million was attributable to Iran, Sudan and Syria.
X e r o x A n n u a l R e p o r t 2 0 0 5
23
Manufacturing Outsourcing
In the fourth quarter of 2001, we outsourced certain manufac-
turing activities for the Office segment to Flextronics, a global
electronics manufacturing services company. Our inventory
purchases from Flextronics currently represent approximately
25% of our overall worldwide inventory procurement. The initial
term of the Flextronics supply agreement is five years through
November 2006, and is subject to our right to extend for two
years. Thereafter, it will automatically be renewed for one-year
periods, unless either party elects to terminate the agreement.
We have agreed to purchase from Flextronics most of our
requirements for certain products in specified product families.
Flextronics must acquire inventory in anticipation of meeting our
forecasted requirements and must maintain sufficient manufac-
turing capacity to satisfy such forecasted requirements. Under
certain circumstances, we may become obligated to repurchase
inventory that remains unused for more than 180 days, becomes
obsolete or upon termination of the supply agreement.
In addition, Xerox sources certain other Office products from
various third parties, to maximize breadth of its product portfolio
and to meet channel requirements. Xerox also has arrangements
with Fuji Xerox whereby it purchases products from and sells
products to Fuji Xerox. Certain of these purchases and sales are
the result of mutual research and development arrangements.
Our remaining manufacturing operations are primarily located
in Rochester, New York, and Dundalk, Ireland, for our high-end
production products and consumables and Wilsonville, Oregon,
for solid ink products, consumable supplies and components
for our Office segment products.
D E S C R I P T I O N O F B U S I N E S S
In January 2006, Xerox Limited entered into a five-year
distribution agreement with an unaffiliated third party covering
distribution of our products in Libya. Libya is also designated
as a state sponsor of terrorism by the U.S. Department of State.
The decision to enter into this distribution agreement was made
in light of recent U.S. federal government actions that have
lifted the country-wide embargo previously imposed on Libya.
Our sales in Libya through this distribution agreement will be
subject to our export and sanctions compliance program and
will be in accordance with applicable U.S. laws and government
regulations as they relate to Libya.
We are increasing our use of partners to improve our market
coverage. Through alliances with Premier Partners and Fuji
Ennovation, we expanded coverage to market our DocuColor
series to commercial printers. Our alliance with Electronic
Data Systems ("EDS") is designed to integrate EDS' information
technology ("IT") services with our document management
systems and services to provide customers with full IT
infrastructure support.
Our brand is a valuable resource and continues to be recognized
in the top ten percent of all U.S. brands.
Service
As of December 31, 2005, we had a worldwide service force
of approximately 13,000 employees and an extensive network
of independent service agents. We are expanding our use of
cost-effective remote service technology for basic product
offerings while utilizing our direct service force and a variable
contract service force to address customers’ more advanced
technology requirements. The increasing use of a variable
contract service force is consistent with our strategy to reduce
service costs while maintaining high-quality levels of service. We
believe that our service force represents a significant competitive
advantage in that the service force is continually trained on our
products and their diagnostic equipment is state-of-the-art.
Twenty-four-hours-a-day, seven-days-a-week service is available
in major metropolitan areas around the world. As a result,
we are able to provide a consistent and superior level of
service worldwide.
24
X e r o x A n n u a l R e p o r t 2 0 0 5
Fuji Xerox
Other Information
X e r o x C o r p o r a t i o n
Xerox is a New York corporation and our principal executive
offices are located at 800 Long Ridge Road, P. O. Box 1600,
Stamford, Connecticut 06904-1600. Our telephone number is
(203) 968-3000.
Through the Investor Information section of our Internet website,
our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and all related amendments
are available, free of charge, as soon as reasonably practicable
after such material is electronically filed with or furnished to the
Securities and Exchange Commission. Our Internet address is
http://www.xerox.com.
Fuji Xerox Co., Limited is an unconsolidated entity in which
we currently own 25% and Fuji Photo Film Co., Ltd. (“FujiFilm”)
owns 75%. Fuji Xerox develops, manufactures and distributes
document processing products in Japan, China, Hong Kong
and other areas of the Pacific Rim, Australia and New Zealand.
We retain significant rights as a minority shareholder. Our
technology licensing agreements with Fuji Xerox ensure that
the two companies retain uninterrupted access to each other’s
portfolio of patents, technology and products.
International Operations
Certain financial measures by geographical area for 2005,
2004 and 2003, included in Note 2 to the Consolidated
Financial Statements in our 2005 Annual Report, are hereby
incorporated by reference.
Backlog
We believe that backlog, or the value of unfilled orders,
is not a meaningful indicator of future business prospects
due to the significant proportion of our revenue that follows
equipment installation, the large volume of products delivered
from shelf inventories and the shortening of product life cycles.
Seasonality
Our revenues are affected by such factors as the introduction of
new products, the length of the sales cycles and the seasonality
of technology purchases. As a result, our operating results
are difficult to predict. These factors have historically resulted
in lower revenue in the first quarter than in the immediately
preceding fourth quarter.
X e r o x A n n u a l R e p o r t 2 0 0 5
25
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
Financial Overview
In 2005, we expanded earnings and made significant progress
in positioning ourselves for revenue growth while significantly
improving our overall financial condition and liquidity. Our
continued focus on investment in the growing areas of digital
production and office systems, particularly with respect to color
products, contributed to equipment sales growth, as the majority
of our equipment sales were generated from products launched
in the last two years. Total revenue was comparable to the prior
year, as modest equipment sales growth was offset by declines
in finance income. Post sale and other was comparable to
the prior year. Color revenue was up 19% over the prior year,
reflecting our investments in this market.
We maintained our focus on cost management throughout 2005.
While 2005 gross margins were slightly below 2004, we continued
to more than offset lower prices with productivity improvements.
Gross margins were impacted by a change in overall product
mix reflecting a higher proportion of sales of products with lower
gross margins. We reduced selling, administrative and general
(“SAG”) expenses as administrative and general expense effi-
ciencies, and reductions in bad debt expense more than offset
increased selling expenses. We continued to invest in research
and development, prioritizing our investments in the faster-
growing areas of the market. In addition, we reduced interest
expense by decreasing debt by over $2.8 billion during the year.
To understand the trends in the business, we believe that it is
helpful to analyze the impact of changes in the translation of
foreign currencies into U.S. dollars on revenue and expense growth.
We refer to this analysis as “currency impact” or “the impact from
currency.” Revenues and expenses from our Developing Markets
Operations are analyzed at actual exchange rates for all periods
presented, since these countries generally have volatile currency
and inflationary environments, and our operations in these countries
have historically implemented pricing actions to recover the impact
of inflation and devaluation. We do not hedge the translation effect
of revenues or expenses denominated in currencies where the local
currency is the functional currency.
A substantial portion of our consolidated revenue is derived
from operations outside of the United States where the U.S. dollar
is not the functional currency. When compared with the average
of the major European currencies on a revenue-weighted basis,
the U.S. dollar was largely unchanged in 2005, 10% weaker in
2004 and 17% weaker in 2003. As a result, the foreign currency
translation impact on revenue was negligible in 2005. For 2004
and 2003, foreign currency translation had a 3-percentage point
and 5-percentage point favorable impact, respectively.
The following Management’s Discussion and Analysis (“MD&A”) is
intended to help the reader understand the results of operations
and financial condition of Xerox Corporation. MD&A is provided
as a supplement to, and should be read in conjunction with, our
consolidated financial statements and the accompanying notes.
Throughout this document, references to “we,” “our,” the “Company”
and “Xerox” refer to Xerox Corporation and its subsidiaries.
References to “Xerox Corporation” refer to the stand-alone parent
company and do not include its subsidiaries.
Executive Overview
We are a technology and services enterprise and a leader in the
global document market, developing, manufacturing, marketing,
servicing and financing the industry’s broadest portfolio of docu-
ment equipment, solutions and services. Our industry is undergoing
a series of transformations from older technology light-lens
devices to digital systems, from black and white to color, and
from paper documents to an increased reliance on electronic
documents. We believe we are well positioned as these trans-
formations play to our strengths and represent opportunities for
future growth, since our research and development investments
have been focused on digital and color offerings.
We operate in competitive markets and our customers demand
improved solutions, such as the ability to print offset-quality color
documents on demand; improved product functionality, such
as the ability to print, copy, fax and scan from a single device;
and lower prices for the same functionality. Customers are also
increasingly demanding document services such as consulting
and assessments, managed services, imaging and hosting, and
document-intensive business process improvements.
We deliver advanced technology through focused investment
in research and development and offset lower prices through
continuous improvement of our cost base. The majority of
our revenue is recurring revenue (supplies, service, paper, out-
sourcing and rentals), which we collectively refer to as post sale
revenue. Post sale revenue is heavily dependent on the amount
of equipment installed at customer locations and the utilization
of those devices. As such, our critical success factors include
hardware installations, which stabilize and grow our installed base
of equipment at customer locations, page volume growth and
higher revenue per page. Connected multifunction devices, new
services and solutions are key drivers to increase equipment
usage. The transition to color is the primary driver to improve
revenue per page, as color documents typically require signifi-
cantly more toner coverage per page than traditional black and
white printing. Revenue per color page is approximately five
times higher than revenue per black and white page.
26
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Our 2005 balance sheet strategy focused on reducing our total
debt, optimizing operating cash flows and matching our remaining
debt portfolio to support our customer financing operations. The
successful implementation of this strategy in 2005 enabled us to
significantly improve our liquidity and finish the year with a cash,
cash equivalents and short-term investments balance of $1.6
billion. Our prospective balance sheet strategy includes: returning
our credit rating to investment grade; optimizing operating cash
flows; achieving an optimal cost of capital; rebalancing secured
and unsecured debt; and effectively deploying cash to deliver and
maximize long-term shareholder value. In addition, our strategy
includes maintaining our current leverage of financing assets
(finance receivables and equipment on operating leases) and
maintenance of a minimal level of non-financing debt.
Revenues for the three years ended December 31, 2005 were as follows:
(in millions)
Equipment sales
Post sale and other revenue
Finance income
Total Revenues
Year Ended December 31,
Percent Change
2005
2004
2003
2005
2004
$ 4,519
10,307
875
$ 4,480
10,308
934
$ 4,250
10,454
997
$15,701
$15,722
$15,701
1%
–
(6)%
–
5%
(1)%
(6)%
–
Total Color revenue included in total revenues
$ 4,634
$ 3,903
$ 3,267
19%
19%
The following presentation reconciles the above information to the
revenue classifications included in our Consolidated Statements
of Income:
(in millions)
Year Ended December 31,
2005
2004
2003
Sales
Less: Supplies, paper
and other sales
Equipment Sales
Service, outsourcing
and rentals
Add: Supplies, paper
and other sales
$ 7,400 $ 7,259 $ 6,970
(2,881)
(2,779)
(2,720)
$ 4,519 $ 4,480 $ 4,250
$ 7,426 $ 7,529 $ 7,734
2,881
2,779
2,720
Post sale and other revenue
$10,307 $10,308 $10,454
Total 2005 revenues of $15.7 billion were comparable to
the prior-year period. Currency impacts on total revenues
were negligible for the year. Total 2005 revenues included
the following:
• 1% growth in Equipment sales, including a negligible impact
from currency, primarily reflecting revenue growth from color in
Office and Production, low-end black and white office products
as well as growth in DMO. These growth areas were partially
offset by revenue declines in higher-end office black and white
products, and black and white production products.
• Comparable Post sale and other revenues, including a negligible
impact from currency, primarily reflecting revenue growth from
digital products and in DMO, which were partially offset by
declines in light lens.
• 6% decline in Finance income including benefits from currency
of 1-percentage point, which reflects lower finance receivables.
Total 2004 revenues of $15.7 billion increased modestly as
compared to 2003 including a 3-percentage point benefit from
currency. Total 2004 revenues included the following:
• 5% growth in Equipment sales, reflecting the success of our
color and digital light production products and a 3-percentage
point benefit from currency.
• 1% decline in Post sale and other revenues due to declines in
older light-lens technology products and Developing Market
Operations (“DMO”), driven by Latin America, were partially
offset by growth in digital office and production color, as well
as a 3-percentage point benefit from currency. The light-lens
and DMO declines reflect a reduction of equipment at customer
locations and related page volume declines. As our equipment
sales continue to increase, we expect the effects of post sale
declines will moderate and ultimately reverse over time.
• 6% decline in Finance income, including a 4-percentage point
benefit from currency, which reflects a decrease in equipment
lease originations over the past several years.
X e r o x A n n u a l R e p o r t 2 0 0 5
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M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
Net income and diluted earnings per share for the three years
ended December 31, 2005 were as follows:
(in millions, except share amounts)
Year Ended December 31,
2005
2004
2003
Net income
Preferred stock dividends
Income available to
common shareholders
Diluted earnings per share
$ 978
(58)
$ 859
(73)
$ 360
(71)
$ 920
$0.94
$ 786
$0.86
$ 289
$0.36
2005 Net income of $978 million, or 94 cents per diluted share,
included the following:
• $343 million after-tax benefit related to the finalization of the
1996-1998 IRS audit.
• $84 million after-tax ($115 million pre-tax) charge for litigation
matters relating to the MPI arbitration panel decision and
probable losses for other legal matters.
• $58 million after-tax ($93 million pre-tax) gain related to the sale
of our entire equity interest in Integic Corporation (“Integic”).
• $247 million after-tax ($366 million pre-tax) restructuring charges.
2004 Net income of $859 million, or 86 cents per diluted share,
included the following:
• $83 million after-tax ($109 million pre-tax) gain related to the
sale of substantially all of our investment in ContentGuard
Holdings, Inc. (“ContentGuard”).
• $38 million after-tax pension settlement benefit from Fuji Xerox.
• $30 million after-tax ($38 million pre-tax) gain from the sale of
our investment in ScanSoft, Inc. (“ScanSoft”).
• $57 million after-tax ($86 million pre-tax) restructuring charges.
2003 Net income of $360 million, or 36 cents per diluted share,
included the following:
• $146 million after-tax ($239 million pre-tax) charge related to
the court-approved settlement of the Berger v. RIGP litigation.
• $111 million after-tax ($176 million pre-tax) restructuring
charges.
• $45 million after-tax ($73 million pre-tax) loss on early
extinguishment of debt and income tax benefits of $35 million
from the reversal of deferred tax asset valuation allowances.
28
X e r o x A n n u a l R e p o r t 2 0 0 5
Application of Critical Accounting Policies
In preparing our Consolidated Financial Statements and accounting
for the underlying transactions and balances, we apply various
accounting policies. We consider the policies discussed below as
critical to understanding our Consolidated Financial Statements,
as their application places the most significant demands on
management’s judgment, since financial reporting results rely on
estimates of the effects of matters that are inherently uncertain.
Specific risks associated with these critical accounting policies
are discussed throughout this MD&A where such policies affect
our reported and expected financial results. For a detailed dis-
cussion of the application of these and other accounting policies,
refer to Note 1 to the Consolidated Financial Statements.
Senior management has discussed the development and
selection of the critical accounting policies, estimates and related
disclosures, included herein, with the Audit Committee of the Board
of Directors. Preparation of this annual report requires us to make
estimates and assumptions that affect the reported amount of
assets and liabilities, as well as disclosure of contingent assets
and liabilities. These estimates and assumptions also impact
revenues and expenses during the reporting period. Although
actual results may differ from those estimates, we believe the
estimates are reasonable and appropriate. In instances where
different estimates could reasonably have been used in the
current period, we have disclosed the impact on our operations
of these different estimates. In certain instances, such as with
respect to revenue recognition for leases, because the accounting
rules are prescriptive, it would not have been possible to have
reasonably used different estimates in the current period. In these
instances, use of sensitivity information would not be appropriate.
Changes in assumptions and estimates are reflected in the
period in which they occur. The impact of such changes could
be material to our results of operations and financial condition
in any quarterly or annual period.
Revenue Recognition Under Bundled Arrangements: We sell most
of our products and services under bundled lease arrangements,
which typically include equipment, service, supplies and financing
components for which the customer pays a single negotiated
monthly fixed price for all elements over the contractual lease
term. These arrangements typically also include an incremental,
variable component for page volumes in excess of contractual
page volume minimums, which are often expressed in terms of
price per page. Revenues under these arrangements are allocated
considering the relative fair values of the lease and non-lease
deliverables included in the bundled arrangement based upon
the estimated relative fair values of each element. Lease deliver-
ables include maintenance and executory costs, equipment and
financing, while non-lease deliverables generally consist of the
supplies and non-maintenance services. Our revenue allocation
for the lease deliverables begins by allocating revenues to the
maintenance and executory costs plus profit thereon.
The remaining amounts are allocated to the equipment and
financing elements. We perform extensive analyses of available
verifiable objective evidence of equipment fair value based on
cash selling prices during the applicable period. The cash selling
prices are compared to the range of values included in our lease
accounting systems. The range of cash selling prices must be
reasonably consistent with the lease selling prices, taking into
account residual values that accrue to our benefit, in order for us
to determine that such lease prices are indicative of fair value.
Our pricing interest rates, which are used in determining customer
payments, are developed based upon a variety of factors including
local prevailing rates in the marketplace and the customer’s
credit history, industry and credit class. Effective in 2004, our
pricing rates are reassessed quarterly based on changes in local
prevailing rates in the marketplace and are adjusted to the extent
such rates vary by twenty-five basis points or more, cumulatively,
from the last rate in effect. The pricing interest rates generally
equal the implicit rates within the leases, as corroborated by our
comparisons of cash to lease selling prices.
Revenue Recognition for Leases: Our accounting for leases
involves specific determinations under applicable lease accounting
standards, which often involve complex and prescriptive provi-
sions. These provisions affect the timing of revenue recognition
for our equipment. If the leases qualify as sales-type capital leases,
equipment revenue is recognized upon delivery or installation of
the equipment as sale revenue as opposed to ratably over the
lease term. The critical elements that we consider with respect
to our lease accounting are the determination of the economic life
and the fair value of equipment, including the residual value. For
purposes of determining the economic life, we consider the most
objective measure to be the original contract term, since most
equipment is returned by lessees at or near the end of the con-
tracted term. The economic life of most of our products is five
years, since this represents the most frequent contractual lease
term for our principal products and only a small percentage of our
leases are for original terms longer than five years. There is no
significant after-market for our used equipment. We believe five
years is representative of the period during which the equipment
is expected to be economically usable, with normal service, for
the purpose for which it is intended. Residual values are estab-
lished at lease inception using estimates of fair value at the
end of the lease term and are established with due consideration
to forecasted supply and demand for our various products,
product retirement and future product launch plans, end-of-lease
customer behavior, remanufacturing strategies, competition
and technological changes.
X e r o x C o r p o r a t i o n
Accounts and Finance Receivables Allowance for Doubtful Accounts
and Credit Losses: We perform ongoing credit evaluations of our
customers and adjust credit limits based upon customer payment
history and current creditworthiness. We continuously monitor
collections and payments from our customers and maintain a
provision for estimated credit losses based upon our historical
experience and any specific customer collection issues that have
been identified. While such credit losses have historically been
within our expectations and the provisions established, we cannot
guarantee that we will continue to experience credit loss rates
similar to those we have experienced in the past. Measurement of
such losses requires consideration of historical loss experience,
including the need to adjust for current conditions, and judgments
about the probable effects of relevant observable data, including
present economic conditions such as delinquency rates and
financial health of specific customers. We recorded bad debt
provisions of $72 million, $110 million and $224 million in
selling, administrative and general expenses in our Consolidated
Statements of Income for the years ended December 31, 2005,
2004 and 2003, respectively. The declining trend in our provision
for doubtful accounts is primarily due to improvements in customer
administration, receivables aging, write-off trends, collection
practices and credit approval policies.
As discussed above, in preparing our Consolidated Financial
Statements for the three years ended December 31, 2005,
we estimated our provision for doubtful accounts based on
historical experience and customer-specific collection issues.
This methodology has been consistently applied for all periods
presented. During the five-year period ended December 31,
2005, our allowance for doubtful accounts ranged from 3.6%
to 5.5% of gross receivables. Holding all other assumptions
constant, a 1-percentage point increase or decrease in the
allowance from the December 31, 2005 rate of 3.6% would
change the 2005 provision by approximately $100 million.
Historically, about half of the provision for doubtful accounts
relates to our finance receivables portfolio. This provision is
inherently more difficult to estimate than the provision for trade
accounts receivable because the underlying lease portfolio
has an average maturity, at any time, of approximately two to
three years and contains past due billed amounts, as well as
unbilled amounts. The estimated credit quality of any given
customer and class of customer or geographic location can
significantly change during the life of the portfolio. We consider
all available information in our quarterly assessments of the
adequacy of the provision for doubtful accounts.
Pension and Post-retirement Benefit Plan Assumptions: We sponsor
pension plans in various forms in several countries covering
substantially all employees who meet eligibility requirements.
Post-retirement benefit plans cover primarily U.S. employees for
retirement medical costs. Several statistical and other factors
that attempt to anticipate future events are used in calculating
X e r o x A n n u a l R e p o r t 2 0 0 5
29
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
the expense, liability and asset values related to our pension and
post-retirement benefit plans. These factors include assumptions
we make about the discount rate, expected return on plan assets,
rate of increase in healthcare costs, the rate of future compen-
sation increases and mortality, among others. For purposes of
determining the expected return on plan assets, we utilize a
calculated value approach in determining the value of the pension
plan assets, as opposed to a fair market value approach. The
primary difference between the two methods relates to a systematic
recognition of changes in fair value over time (generally two
years) versus immediate recognition of changes in fair value.
Our expected rate of return on plan assets is then applied to the
calculated asset value to determine the amount of the expected
return on plan assets to be used in the determination of the net
periodic pension cost. The calculated value approach reduces
the volatility in net periodic pension cost that results from using
the fair market value approach. The difference between the actual
return on plan assets and the expected return on plan assets is
added to, or subtracted from, any cumulative differences that
arose in prior years. This amount is a component of the unrecog-
nized net actuarial (gain) loss and is subject to amortization to
net periodic pension cost over the average remaining service
lives of the employees participating in the pension plan.
As a result of cumulative historical asset returns being lower than
expected asset returns, as well as declining interest rates, 2006
net periodic pension cost will increase. The total unrecognized
actuarial loss as of December 31, 2005 was $1.9 billion, as
compared to $2.0 billion at December 31, 2004. The change
from December 31, 2004 relates to improved asset returns as
compared to expected returns, partially offset by a decline in
the discount rate. The total unrecognized actuarial loss will be
amortized in the future, subject to offsetting gains or losses that
will change the future amortization amount. We have recently
utilized a weighted average expected rate of return on plan assets
of 8.0% for 2005 expense, 8.1% for 2004 expense and 8.3% for
2003 expense, on a worldwide basis. In estimating this rate, we
considered the historical returns earned by the plan assets, the
rates of return expected in the future and our investment strategy
and asset mix with respect to the plans’ funds. The weighted
average expected rate of return on plan assets we will utilize to
calculate our 2006 expense will be 7.8%.
Another significant assumption affecting our pension and post-
retirement benefit obligations and the net periodic pension and
other post-retirement benefit cost is the rate that we use to
discount our future anticipated benefit obligations. The discount
rate reflects the current rate at which the pension liabilities could
be effectively settled considering the timing of expected payments
for plan participants. In estimating this rate, we consider rates of
return on high-quality fixed-income investments included in various
published bond indexes, adjusted to eliminate the effects of call
provisions and differences in the timing and amounts of cash
30
X e r o x A n n u a l R e p o r t 2 0 0 5
outflows related to the bonds. In the U.S. and the U.K., which
comprise approximately 81% of our projected benefit obligations,
we consider the Moody’s Aa Corporate Bond Index and the
International Index Company’s iBoxx Sterling Corporates AA Cash
Bond Index, respectively, in the determination of the appropriate
discount rate assumptions. The weighted average rate we will
utilize to measure our pension obligation as of December 31, 2005
and calculate our 2006 expense will be 5.2%, which is a decrease
from 5.6% used in determining 2005 expense. Primarily as a
result of the reduction in the discount rate, our 2006 net periodic
pension cost is expected to be $32 million higher than 2005.
On a consolidated basis, we recognized net periodic pension
cost of $343 million, $350 million and $364 million for the
years ended December 31, 2005, 2004 and 2003, respectively.
Pension cost is included in several income statement components
based on the related underlying employee costs. Pension and
post-retirement benefit plan assumptions are included in Note
14 to the Consolidated Financial Statements. Holding all other
assumptions constant, a 0.25% increase or decrease in the
discount rate would change the 2006 projected net periodic
pension cost by approximately $35 million. Likewise, a 0.25%
increase or decrease in the expected return on plan assets
would change the 2006 projected net periodic pension cost
by approximately $15 million.
Income Taxes and Tax Valuation Allowances: We record the
estimated future tax effects of temporary differences between
the tax bases of assets and liabilities and amounts reported in
our Consolidated Balance Sheets, as well as operating loss and
tax credit carryforwards. We follow very specific and detailed
guidelines in each tax jurisdiction regarding the recoverability of
any tax assets recorded in our Consolidated Balance Sheets and
provide necessary valuation allowances as required. We regularly
review our deferred tax assets for recoverability considering
historical profitability, projected future taxable income, the
expected timing of the reversals of existing temporary differences
and tax planning strategies. If we continue to operate at a loss
in certain jurisdictions or are unable to generate sufficient future
taxable income, or if there is a material change in the actual
effective tax rates or time period within which the underlying
temporary differences become taxable or deductible, we could
be required to increase the valuation allowance against all or
a significant portion of our deferred tax assets, resulting in
a substantial increase in our effective tax rate and a material
adverse impact on our operating results. Conversely, if and when
our operations in some jurisdictions were to become sufficiently
profitable to recover previously reserved deferred tax assets, we
would reduce all or a portion of the applicable valuation allowance
in the period when such determination is made. This would result
in an increase to reported earnings in such period. Adjustments to
our valuation allowance, through (credits) charges to income tax
expense, were $(38) million, $12 million, and $(16) million for the
years ended December 31, 2005, 2004 and 2003, respectively.
There were other increases/(decreases) to our valuation
allowance, including the effects of currency, of $61 million,
$(21) million and $69 million for the years ended December 31,
2005, 2004 and 2003, respectively, that did not affect income
tax expense in total, as there was a corresponding adjustment
to deferred tax assets or other comprehensive income. Gross
deferred tax assets of $3.6 billion and $3.5 billion had valuation
allowances of $590 million and $567 million at December 31,
2005 and 2004, respectively.
We are subject to ongoing tax examinations and assessments
in various jurisdictions. Accordingly, we may incur additional tax
expense based upon our assessment of the probable outcomes
of such matters. In addition, when applicable, we adjust the
previously recorded tax expense to reflect examination results.
Our ongoing assessments of the probable outcomes of the
examinations and related tax positions require judgment and
can materially increase or decrease our effective tax rate as
well as impact our operating results.
Legal Contingencies: We are involved in a variety of claims,
lawsuits, investigations and proceedings concerning securities
law, intellectual property law, environmental law, employment law
and ERISA, as discussed in Note 16 to the Consolidated Financial
Statements. We determine whether an estimated loss from a
contingency should be accrued by assessing whether a loss is
deemed probable and can be reasonably estimated. We assess
our potential liability by analyzing our litigation and regulatory
matters using available information. We develop our views on
estimated losses in consultation with outside counsel handling our
defense in these matters, which involves an analysis of potential
results, assuming a combination of litigation and settlement
strategies. Should developments in any of these matters cause
a change in our determination as to an unfavorable outcome and
result in the need to recognize a material accrual, or should any
of these matters result in a final adverse judgment or be settled
for significant amounts, they could have a material adverse effect
on our results of operations, cash flows and financial position in
the period or periods in which such change in determination,
judgment or settlement occurs.
Summary of Results
Segment Revenues
As discussed in Note 2 to the Consolidated Financial Statements,
operating segment financial information for 2004 and 2003 has
been restated to reflect changes in operating segment structure
made during 2005. In 2005, we implemented a new financial
reporting system, which has enabled greater efficiencies in
financial reporting and provides enhanced analytical capabilities
X e r o x C o r p o r a t i o n
including activity-based cost analysis on shared services and
internal cost allocations. As a result of the implementation, we
made changes to the allocation of certain segment costs and
expenses. These changes included a reallocation of costs
associated with corporate and certain shared service functions.
These changes did not involve a change in the composition of
our reportable segments and did not impact segment revenue.
We have reclassified prior-period amounts to conform to the
current period’s presentation.
Our reportable segments are consistent with how we manage the
business and view the markets we serve. Our reportable segments
are Production, Office, DMO and Other. Our offerings include
hardware, services, solutions and consumable supplies. The
Production segment includes black and white products, which
operate at speeds over 90 pages per minute (“ppm”) and color
products which operate at speeds over 40 ppm, excluding 50
ppm products with an embedded controller. Products include
the Xerox iGen3® digital color production press, Xerox Nuvera™,
DocuTech®, DocuPrint®, Xerox 4110™ and DocuColor® families,
as well as older technology light-lens products. These products
are sold predominantly through direct sales channels in North
America and Europe to Fortune 1000, graphic arts, government,
education and other public sector customers. The Office segment
includes black and white products that operate at speeds up to
90 ppm, and color devices up to 40 ppm, as well as 50 ppm
color devices with an embedded controller. Products include the
suite of CopyCentre®, WorkCentre® and WorkCentre Pro digital
multifunction systems, DocuColor color multifunction products,
color laser, solid ink and monochrome laser desktop printers,
digital and light-lens copiers and facsimile products. These
products are sold through direct and indirect sales channels
in North America and Europe to global, national and mid-size
commercial customers as well as government, education and
other public sector customers. The DMO segment includes our
operations in Latin America, Central and Eastern Europe, the
Middle East, India, Eurasia, Russia and Africa. This segment
includes sales of products that are typical to the aforementioned
segments; however, management serves and evaluates these
markets on an aggregate geographic basis, rather than on a
product basis. The segment classified as Other includes several
units, none of which met the thresholds for separate segment
reporting. This group primarily includes Xerox Supplies Business
Group (predominantly paper), Small Office/Home Office (“SOHO”),
Wide Format Systems, Xerox Technology Enterprises and value-
added services, royalty and license revenues. Paper sales were
approximately 45% of Other segment revenues in 2005. Other
segment profit (loss) includes the operating results from these
entities, other less significant businesses, our equity income from
Fuji Xerox, and certain costs which have not been allocated to the
Production, Office and DMO segments, including non-financing
interest as well as other items included in Other expenses, net.
X e r o x A n n u a l R e p o r t 2 0 0 5
31
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
Revenues by segment for the years ended 2005, 2004 and 2003 were as follows:
Production
Office
DMO
Other
Total
$ 1,368
2,830
342
$ 2,436
4,670
512
$ 558
1,245
9
$ 157
1,562
12
$ 4,519
10,307
875
$ 4,540
$ 7,618
$ 1,812
$ 1,731
$15,701
$ 1,358
2,880
352
$ 2,431
4,644
552
$ 503
1,194
10
$ 188
1,590
20
$ 4,480
10,308
934
$ 4,590
$ 7,627
$ 1,707
$ 1,798
$15,722
$ 1,188
2,943
376
$ 2,426
4,622
594
$ 466
1,285
12
$ 170
1,604
15
$ 4,250
10,454
997
$ 4,507
$ 7,642
$ 1,763
$ 1,789
$15,701
Production
2005 Equipment sales increased 1% from 2004, primarily reflecting
install growth with a negligible impact from currency, partially
offset by price declines of approximately 5% and product mix.
Production system install activity for 2005 included the following:
• 30% growth in installs of production color products largely
driven by strong iGen3 and DocuColor 240, 250, 7000 and
8000 activity.
• 9% growth in installs of black and white production systems,
reflecting the success of the 4110 light production system,
as well as growth in production publishing systems.
2004 Equipment sales increased 14% from 2003, as improved
product mix, installation growth and favorable currency of
4-percentage points more than offset price declines of approxi-
mately 3%. Production system install activity for 2004 included
the following:
• Strong 2004 production color equipment install growth of
11% due to increased installations driven by the DocuColor
5252 and Xerox iGen3 digital color production press products.
• 2004 production monochrome equipment install growth of
7% driven by the success of the Xerox 2101 copier/printer and
strong demand for the Xerox Nuvera 100 and 120 copier/printers,
more than offset declines of 32% in production publishing,
printing and older technology light lens products.
(in millions)
2005
Equipment sales
Post sale and other revenue
Finance income
Total Revenue
2004
Equipment sales
Post sale and other revenue
Finance income
Total Revenue
2003
Equipment sales
Post sale and other revenue
Finance income
Total Revenue
Equipment Sales
Equipment sales reflect the results of our technology investments
and the associated product launches, as approximately two-thirds
of 2005 equipment sales were generated from products launched
over the past two years. During 2005, we launched 49 new
products including 6 products in the fourth quarter.
2005 Equipment sales of $4.5 billion increased 1% from
2004, reflecting:
• Negligible impact from currency.
• Growth in lower-end office black and white devices, color
printers, as well as office and production color systems, which
more than offset declines in other monochrome office and
monochrome production products.
• Growth in color equipment sales of $306 million, or 22%,
from the prior comparable period. Color equipment sales
represented 38% of total equipment sales versus 32% for
the prior-year comparable period.
2004 Equipment sales of $4.5 billion increased 5% from
2003, reflecting:
• 3-percentage point benefit from currency.
• Market acceptance of our color and digital light production
products.
• Continued equipment sales growth, reflecting the success
of numerous products launched in the past two years, as
the majority of 2004 equipment sales was generated from
these products.
• Continued color equipment sales growth in 2004 representing
approximately one-third of total equipment sales.
32
X e r o x A n n u a l R e p o r t 2 0 0 5
Office
2005 Equipment sales were comparable to 2004, including a
negligible impact from currency. Strong install growth was offset
by price declines of approximately 7% and product mix, which
reflected an increased proportion of lower-end equipment sales.
Office product install activity for 2005 included the following:
• 22% install growth in black and white digital copiers and
multifunction devices driven by strong sales of Segment 1 and
2 devices (11-30 ppm), which more than offset declines of
Segment 3 to 5 devices (31-90 ppm).
• 51% install growth in office color multifunction systems driven
in part by strong sales of the DocuColor 240/250, which was
announced during the second quarter of 2005.
• 111% improvement in install activity for color printers.
2004 Equipment sales were essentially unchanged from 2003,
reflecting the following:
• Installation growth of approximately 20% and favorable currency
of 3-percentage points were offset by moderating price declines
of approximately 6% and the impact of product mix. Product mix
reflected an increased proportion of low-end equipment due to
very strong growth in office monochrome (“Segments 1 and 2”)
of 30% as well as monochrome and color printers of 54%.
• Color printer growth of 74% primarily reflects the success of
the solid ink Phaser® 8400, the first product launched from our
new solid ink platform in January 2004, as well as other color
printer introductions.
DMO
Equipment sales in DMO consist primarily of Segment 1 and 2
devices and office printers. Equipment sales in 2005 increased
11% from 2004, primarily reflecting strong growth in Eurasia and
Central and Eastern Europe. Equipment sales in 2004 increased
8% from 2003, primarily reflecting growth in Russia and Central
and Eastern Europe offset by declines in Latin America, primarily
driven by Brazil, and shift in product mix to lower segments.
Other
2005 Equipment sales declined 16% from 2004, driven by
declines in value-added services. The decline in value-added
services reflects the integration of a portion of our service
contracts into our outsourcing business, the revenue from which
is included in the Office and Production segments. Other 2004
equipment sales grew 11% from 2003, primarily due to growth
in equipment sales associated with our value-added services
business and a 2-percentage point currency benefit.
X e r o x C o r p o r a t i o n
Post Sale and Other Revenue
Post sale revenue is largely a function of the equipment placed
at customer locations, the volume of prints and copies that our
customers make on that equipment and the mix of color pages,
as well as associated services.
2005 Post sale and other revenues of $10.3 billion were
comparable to the prior year period, with our growth areas
(“digital office, digital production and value-added services”)
collectively growing 5% and DMO growing 4%, more than
offsetting a 40% decline in analog light-lens products. Color
post sale and other revenue grew 16% for 2005, and color
sales represented 26% of post sale and other revenue in 2005
versus 22% in 2004. In 2005, approximately 7% of our pages
were printed on color devices, which is up from 5% in 2004.
Color pages generate around five times more revenue and
gross profit dollars than black and white pages.
2004 Post sale and other revenues of $10.3 billion declined 1%
from 2003, including a 4-percentage point benefit from currency.
These declines reflect lower equipment populations, as post sale
revenue is largely a function of the equipment placed at customer
locations, the volume of prints and copies that our customers
make on that equipment and the mix of color pages, as well as
associated services. 2004 supplies, paper and other sales of
$2.8 billion (included within post sale and other revenue)
increased 2% from 2003, primarily reflecting currency benefits
which offset declines in supplies. Supplies sales declined due
to our exit from the SOHO business in 2001. 2004 service,
outsourcing and rental revenue of $7.5 billion declined 3% from
2003, as declines in rental and facilities management revenues
more than offset benefits from currency. Declines in rental
revenues primarily reflect reduced equipment populations within
DMO and declines in facilities management revenues reflect
consolidations by our customers as well as our prioritization
of profitable contracts.
Production: 2005 Post sale and other revenue declined 2% from
2004, as declines in older light-lens technology were only partially
offset by revenue growth from digital products. Currency impact
was negligible for 2005. 2004 Post sale and other revenue declined
2% from 2003, as declines in monochrome products, driven
primarily by lower page volumes, offset favorable mix from color
page growth of approximately 40% as well as favorable currency.
Office: 2005 Post sale and other revenue increased 1% from
2004, primarily reflecting a 1-percentage point benefit from
currency and growth in digital black and white, color printing
and color multifunctional products. These positive effects were
partially offset by declines in older light-lens technology. 2004
post sale and other revenue improved modestly from 2003 as
favorable mix to color pages, digital page growth and favorable
currency were partially offset by declines in older technology
light lens products.
X e r o x A n n u a l R e p o r t 2 0 0 5
33
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
DMO: 2005 Post sale and other revenue grew 4% from 2004,
reflecting growth in Eurasia and Central and Eastern Europe,
more than offsetting declines in Brazil. 2004 Post sale and other
revenue declined 7% from 2003, primarily reflecting a decline in
Latin America’s rental equipment population. In response, we have
continued our transition to indirect distribution channels that is
intended to increase, over time, the sales of office devices and
the associated supplies and service revenue.
Other: 2005 Post sale and other revenue declined 2% from 2004,
including a negligible impact from currency, as declines in SOHO
and other revenues were partially offset by growth in value-added
services. 2004 Post sale and other revenue declined 1% from
2003, as declines in SOHO were essentially offset by currency
benefits and growth in value-added services as well as other activity.
2006 Projected Revenues
We expect 2006 Equipment sales will continue to grow, as we
anticipate that new platforms and products launched during the
past 2 years, and those planned in 2006, will enable us to further
strengthen our market position. Excluding currency impacts,
compared to 2005, we expect 2006 Post sale and other revenue
and financing income will grow following the transition to positive
growth during the second half of 2005. Growth in post sale and
other revenue and financing income will be driven by our success
at increasing the amount of our equipment at customer locations
and the volume of pages and mix of color pages generated on
that equipment. Excluding currency impacts, we expect 2006
total revenues to increase approximately 3% from 2005 levels.
Segment Operating Profit
Segment operating profit and operating margin for the three years ended December 31, 2005 were as follows:
(in millions)
2005
Operating Profit
Operating Margin
2004
Operating Profit
Operating Margin
2003
Operating Profit
Operating Margin
Production: 2005 Operating Profit declined $84 million and
operating margin declined 1.7-percentage points from 2004.
The declines primarily reflect reduced gross margins impacted
by mix, and higher selling expenses, which were partially offset
by improvements in G&A and R,D&E efficiencies. 2004 operating
profit increased $45 million and operating margin increased
0.8-percentage points from 2003. These increases primarily
reflect R&D efficiencies and lower bad debt expenses, which
were partially offset by lower gross margin.
Office: 2005 Operating Profit increased $40 million and
operating margin improved 0.6-percentage points from 2004.
The improvements primarily reflect lower SAG, partially offset
by lower gross margins impacted by mix and higher R,D&E.
2004 operating profit decreased $11 million and operating
margin declined 0.1-percentage points from 2003. The declines
primarily reflect lower gross margins, partially offset by lower
bad debt expense.
34
X e r o x A n n u a l R e p o r t 2 0 0 5
Production
Office
DMO
Other
Total
$427
9.4%
$819
10.8%
$ 64
$ 151
$1,461
3.5%
8.7%
9.3%
$511
11.1%
$779
10.2%
$ 35
$ (125)
$1,200
2.1%
(7.0)%
7.6%
$466
10.3%
$790
10.3%
$172
$ (440)
$ 988
9.8%
(24.6)%
6.3%
DMO: 2005 Operating Profit increased $29 million from 2004
and operating margin improved 1.4-percentage points from
2004. These improvements primarily reflect increasing revenues
and operating margin contributions from Eurasia and Central and
Eastern Europe. 2004 operating profit declined $137 million from
2003, primarily reflecting results in Latin America, where the pace
of revenue declines have exceeded cost and expense reductions.
Other: 2005 Operating Profit increased $276 million as
compared to 2004, principally due to:
• Reduced interest expense of $157 million, primarily due to
lower average debt balances.
• Higher interest income of $63 million, which includes $57 million
associated with the finalization of the 1996-1998 IRS audit.
• An improvement in aggregate currency gains and losses of
$68 million.
• A gain on the sale of Integic of $93 million.
• These items were partially offset by the absence of the $38
million pension settlement gain from Fuji Xerox in 2004, as
well as the absence of the $38 million gain from the 2004 sale
of our ownership interest in ScanSoft.
2004 operating loss improved by $315 million as compared
to 2003, principally due to:
• Reduced interest expense of $127 million.
• An increase in equity income from Fuji Xerox of $93 million.
• Gain on sale of our interest in ScanSoft of $38 million.
Gross Margins
Gross margins by revenue classification were as follows:
Year Ended December 31,
2005
2004
2003
Total gross margin
Sales
Service, outsourcing and rentals
Finance income
41.2%
36.6%
43.3%
62.7%
41.6%
37.4%
43.0%
63.1%
42.6%
37.6%
44.3%
63.7%
2005 Gross margin of 41.2% decreased 0.4-percentage points
from 2004, reflecting a decline in product mix of 1.3-percentage
points, reflecting a higher proportion of sales in office printer
and light production systems. Price declines of 1.5-percentage
points were more than offset by cost improvements of
2.3-percentage points.
2004 Gross margin of 41.6% declined 1.0-percentage points
from 2003. Approximately 0.8-percentage points of the decline
is due to product mix impacts from a greater proportion of lower
gross margin products in the Office and Production segments.
Approximately 0.6-percentage points of the decline reflects the
impact of DMO results. The decline in DMO results relates to
Brazil’s revenue, which has declined faster than declines in its
cost levels and a shift in product mix to lower gross margin products
in various DMO geographies. Productivity improvements essentially
offset the impact of lower prices.
2005 Sales gross margin of 36.6% decreased 0.8-percentage
points from 2004, driven by product mix declines of 1.5-percent-
age points. Price declines of 2.2-percentage points were more
than offset by cost improvements of 2.4-percentage points.
Product mix reflects a higher proportion of sales of products with
lower gross margins, including office printers and light production
systems, and a lower proportion of sales of products with higher
gross margins such as higher-end office black and white multi-
function devices and high-end production black and white systems.
2004 Sales gross margin of 37.4% decreased 0.2-percentage
points from 2003. Approximately 0.4-percentage points of the
decline results from product mix and DMO results contributed
0.6-percentage points to the decline. Additionally, productivity
improvements offset lower prices and other variances.
X e r o x C o r p o r a t i o n
2005 Service, outsourcing and rentals gross margin of 43.3%
increased 0.3-percentage points driven by cost improvements
of 2.6-percentage points, which more than offset price
declines of 1.1-percentage points and product mix declines
of 0.9-percentage points.
2004 Service, outsourcing and rentals gross margin of 43.0%
declined 1.3-percentage points from 2003. The majority of the
decline is attributed to a change in product mix in the Office
and Production segments as well as DMO results. Productivity
and cost improvements offset lower prices for the year.
2005 Finance income gross margin of 62.7% declined 0.4-per-
centage points due to interest costs specific to equipment
financing. Equipment financing interest is determined based on
an estimated cost of funds, applied against an estimated level
of debt required to support our finance receivables. The esti-
mated cost of funds is primarily based on our secured borrowings
rates. The estimated level of debt is based on an assumed 7 to 1
leverage ratio of debt/equity as compared to our average finance
receivables. This methodology has been consistently applied for
all periods presented.
2004 Finance income gross margin decreased 0.6-percentage
points from 2003 due to interest costs specific to equipment
financing.
Research, development and engineering (“R,D&E”) of $943 million
in 2005 was $29 million higher than the prior year. We expect 2006
R,D&E spending to approximate 6% of total revenue in 2006.
Research and development (“R&D”) of $755 million in 2005
decreased from the prior year by $5 million. This period-over-
period comparison reflects lower expenditures in the Production
segment, which were partially offset by increased spending in the
Office segment. The lower spending in the Production segment
was a result of recent product launches, and cost efficiencies
that we captured from our platform development strategy. We
invest in technological development, particularly in color, and
believe our R&D spending is sufficient to remain technologically
competitive. Our R&D is strategically coordinated with that of
Fuji Xerox, which invested $720 million and $704 million in R&D
in 2005 and 2004, respectively. 2004 R&D expense of $760
million was $108 million lower than the prior year, primarily
due to improved efficiencies as we captured benefits from our
platform development strategy as well as the commercial launch
of the Xerox iGen3.
Sustaining engineering costs of $188 million increased by
$34 million from the prior year, based on increases in year-over-
year product launches. Refer to Note 1 – “Basis of Presentation”
and Note 19 – Research, Development and Engineering in the
Consolidated Financial Statements for additional information.
On average, the reclassification of sustaining engineering costs
increased gross margins by approximately 1% for the year
ended 2005.
X e r o x A n n u a l R e p o r t 2 0 0 5
35
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
The following table illustrates the effects of our 2005 reclassification of our sustaining engineering costs from cost of sales to R,D&E:
(in millions)
Q1
Q2
2004
Q3
Q4
YTD
Q1
Q2
2005
Q3
Q4
YTD
Total Sustaining Engineering (“SE”)
$ 30
$ 41
$ 45
$ 38
$ 154
$ 42
$ 54
$ 46
$ 46
$ 188
Gross Margin %, with SE
Gross Margin %, without SE
R&D % revenue, without SE
R,D&E % revenue, with SE
39.8% 41.3% 41.3% 40.1% 40.6%
40.6% 42.4% 42.5% 41.0% 41.6%
4.8%
5.1%
5.8%
6.3%
4.4%
5.3%
4.9%
5.9%
5.0%
5.8%
40.7% 39.0% 40.1% 40.3% 40.0%
41.8% 40.4% 41.3% 41.4% 41.2%
4.8%
5.2%
6.0%
6.4%
4.4%
5.5%
4.8%
6.2%
4.9%
6.0%
Selling, Administrative and General Expenses (“SAG”): SAG expense information was as follows (in millions):
Total SAG expenses
SAG as a percentage of revenue
Year Ended December 31,
Amount Change
2005
2004
2003
2005
2004
$4,110
$4,203
$4,249
$ (93)
$ (46)
26.2%
26.7%
27.1%
(0.5)%
(0.4)%
In 2005, SAG expenses decreased primarily as a result of
the following:
• An $86 million reduction in general and administrative (“G&A”)
expenses due to continued expense management initiatives.
• A $38 million decrease in bad debt expense.
• A partially offsetting increase in selling expenses of $31 million
from 2004 due to additional spending for advertising and
marketing programs to support product launches and other
selling expenses, as well as special compensation payments
related to the 2005 merit increase process. These increases
in selling expenses were partially offset by the absence of the
$28 million Olympic marketing expense that occurred in 2004.
In 2004, SAG expenses decreased primarily as a result of
the following:
• A $114 million decline in bad debt expense.
• Reductions in G&A due to efficiencies from continued expense
management initiatives.
• An offsetting increase in selling expenses of $52 million
from 2003, reflecting increased spending in selling and
marketing initiatives, as well as unfavorable currency impacts
of $141 million.
Bad debt expense included in SAG was $72 million, $110 million
and $224 million in 2005, 2004 and 2003, respectively. The
2005 reduction reflects improved collections performance,
receivables aging and write-off trends. Bad debt expense as a
percent of total revenue was 0.5%, 0.7% and 1.4% for 2005,
2004 and 2003, respectively.
For the three years ended December 31, 2005, 2004 and 2003
we recorded restructuring charges of $366 million, $86 million
and $176 million, respectively, primarily related to the headcount
reductions of approximately 3,900, 1,900 and 2,000 employees,
respectively, across all geographies and segments. The 2005
restructuring initiatives are focused on implementing a flexible
workforce in our service operations, as well as creating cost
efficiencies in our manufacturing and back-office support opera-
tions. We expect prospective annual savings associated with the
2005 actions to be approximately $290 million. The remaining
restructuring reserve balance as of December 31, 2005 for all
programs was $236 million. In the next 12 months, we expect to
spend approximately $212 million of this reserve.
Worldwide employment of 55,200 as of December 31, 2005
declined approximately 2,900 from December 31, 2004,
primarily reflecting reductions attributable to our restructuring
programs and other attrition. Worldwide employment was
approximately 58,100 and 61,100 at December 31, 2004
and 2003, respectively.
Gain on Affiliate’s Sale of Stock: In 2003, we recorded cumulative
gains on an affiliate’s sale of stock of $13 million, reflecting our
proportionate share of the increase in equity of ScanSoft Inc.,
an equity investment. The gain resulted from ScanSoft’s issuance
of stock in connection with its acquisition of Speechworks, Inc.
ScanSoft is a developer of digital imaging software that enables
users to leverage the power of their scanners, digital cameras
and other electronic devices. As discussed in Note 21 to the
Consolidated Financial Statements, in April 2004 we completed
the sale of our ownership interest in ScanSoft.
36
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Other Expenses, Net: Other expenses, net, for the three years ended December 31, 2005 consisted of the following:
(in millions)
Non-financing interest expense
Interest income
(Gain) loss on sales of businesses and assets
Currency losses, net
Amortization of intangible assets
Legal matters
Minorities’ interests in earnings of subsidiaries
All other expenses, net
Year Ended December 31,
Amount Change
2005
$ 231
(138)
(97)
5
38
115
15
55
$ 224
2004
$363
(75)
(61)
73
37
9
8
15
$369
2003
$522
(65)
13
11
36
242
6
111
$876
2005
$ (132)
(63)
(36)
(68)
1
106
7
40
$(145)
2004
$ (159)
(10)
(74)
62
1
(233)
2
(96)
$(507)
Non-financing Interest Expense: In 2005, non-financing interest
expense decreased due to lower average debt balances as a
result of scheduled term debt repayments and medium-term
note redemptions, as well as the full-year effect of the December
2004 Capital Trust II liability conversion. 2004 non-financing
interest expense was $159 million lower than in 2003, primarily
due to lower average debt balances as a result of the full-year
effect of the June 2003 recapitalization and other scheduled
term debt repayments.
Interest Income: Interest income is derived primarily from our
invested cash and cash equivalent balances and interest resulting
from periodic tax settlements. In 2005, interest income increased
primarily due to:
• A $57 million increase associated with the previously
disclosed settlement of the 1996-1998 IRS audit (refer
to Note 15 – Income and Other Taxes in the Consolidated
Financial Statements).
• A $23 million increase primarily reflecting higher rates of
return from our money market funds.
• Partially offset by the absence of $26 million of interest
Currency Gains and Losses: Currency gains and losses primarily
result from the mark-to-market of foreign exchange contracts utilized
to hedge foreign currency-denominated assets and liabilities, the
re-measurement of foreign currency-denominated assets and
liabilities and the mark-to-market impact of hedges of anticipated
transactions, primarily future inventory purchases, for which we
do not generally apply cash flow hedge accounting treatment.
In 2005, 2004 and 2003, currency losses totaled $5 million,
$73 million and $11 million, respectively. The decrease in 2005
from 2004 was primarily due to the strengthening of the U.S.
and Canadian Dollars against the Euro and the Yen in 2005, as
compared to the weakening U.S. Dollar in 2004, and decreased
costs of hedging foreign currency-denominated assets and
liabilities due to lower spot/forward premiums in 2005. The
increase in currency losses in 2004 from 2003 was primarily
due to the weakening U.S. Dollar in 2004 and increased costs
of hedging foreign currency-denominated assets and liabilities
due to higher spot/forward premiums in 2004.
Legal Matters: In 2005, legal matters costs consisted of
the following:
income related to a 2004 domestic tax refund.
• $102 million, including $13 million for interest expense,
In 2004, interest income increased primarily as a result of $26
million related to a domestic tax refund claim in 2004, partially
offset by the absence of $13 million of interest income related
to Brazilian tax credits in 2003.
(Gain) Loss on Sales of Businesses and Assets: In 2005, gain on
sales of businesses and assets primarily relate to the $93 million
gain in the first quarter on the sale of Integic. In 2004, gains on
the sale of businesses and assets primarily reflect the $38 million
pre-tax gain from the sale of our ownership interest in ScanSoft,
as well as gains totaling $14 million related to the sale of certain
excess land and buildings in Europe and Mexico. The 2003
amount primarily included losses related to the sale of Xerox
Engineering Systems subsidiaries in France and Germany, which
were partially offset by a gain on the sale of our investment in
Xerox South Africa.
related to the MPI arbitration panel ruling (refer to Note 16 –
Contingencies in the Consolidated Financial Statements).
• $13 million related to other legal matters, primarily reflecting
charges for probable losses on cases that have not yet
been resolved.
In 2004, legal matters costs consist of expenses associated
with the resolution of legal and regulatory matters, none
of which was individually material, partially offset by the
adjustment of an estimate associated with a previously
recorded litigation accrual.
X e r o x A n n u a l R e p o r t 2 0 0 5
37
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
In 2003, legal matters costs primarily consisted of a $239
million provision for litigation relating to the court-approved
settlement of the Berger v. Retirement Income Guarantee Plan
(“RIGP”) litigation. RIGP represents the primary U.S. pension
plan for salaried employees. The settlement was paid from
RIGP assets and was reflected in our 2004 actuarial valuation.
The obligation related to this settlement was included in plan
amendments in the change in the benefit obligation.
Refer to Note 16 – Contingencies in the Consolidated Financial
Statements for additional information regarding litigation against
the Company.
All Other Expenses, Net: In 2005 all other expenses, net, included
the following individually significant items:
• $15 million for losses sustained from Hurricane Katrina
related to property damage and impaired receivables. We
continue to reassess the estimate of our losses from the
effects of Hurricane Katrina. Our current estimate as of
December 31, 2005, of total assets at risk in the affected
areas, primarily finance receivables from customers, was
approximately $20 million.
• $26 million charge related to the European Union Waste
Directive, including the associated adoption of FASB Staff
Position No. 143-1, “Accounting for Electronic Equipment
Waste Obligations,” which provided guidance on accounting
for the European Union (EU) Directive on the disposal of elec-
tronic equipment. Refer to Note 1 – Summary of Significant
Accounting Policies in the Consolidated Financial Statements.
In 2003, all other expenses, net, included a $73 million loss on
early extinguishment of debt reflecting the write-off of the remain-
ing unamortized fees associated with the 2002 Credit Facility.
Income tax (benefits) expenses were as follows (in millions):
Year Ended December 31,
2005
2004
2003
Pre-tax income
Income tax (benefits) expenses
Effective tax rate
$ 830
(5)
(0.6)%
$ 965
340
35.2%
$ 436
134
30.7%
The 2005 effective tax rate of (0.6)% was lower than the U.S.
statutory tax rate primarily due to:
• Tax benefits of $253 million associated with the finalization of
the 1996-1998 IRS audit in the second quarter.
• Tax benefits of $42 million primarily from the realization of
foreign tax credits offset by the geographical mix of income
and the related tax rates in those jurisdictions.
• Tax benefits of $31 million from the reversal of a valuation
allowance on deferred tax assets associated with foreign
net operating loss carryforwards. This reversal followed
a re-evaluation of their future realization resulting from a
refinancing of a foreign operation.
38
X e r o x A n n u a l R e p o r t 2 0 0 5
• These impacts were partially offset by losses in certain
jurisdictions where we are not providing tax benefits and
continue to maintain deferred tax valuation allowances.
The 2004 effective tax rate of 35.2% was comparable to the
U.S. statutory tax rate, primarily reflecting:
• The impact of nondeductible expenses and $20 million of
unrecognized tax benefits primarily related to recurring
losses in certain jurisdictions where we maintained deferred
tax asset valuation allowances.
• Partially offset by tax benefits from other foreign adjustments,
including earnings taxed at different rates, tax law changes of
$14 million and other items that are individually insignificant.
The 2003 effective tax rate of 30.7% was lower than the U.S.
statutory tax rate, primarily reflecting:
• Tax benefits of $35 million resulting from the reversal of
valuation allowances on deferred tax assets following a
re-evaluation of their future realization due to improved financial
performance, other foreign adjustments, including earnings
taxed at different rates, the impact of Series B Convertible
Preferred Stock dividends and state tax benefits.
• Partially offset by tax expense for audit and other tax return
adjustments, as well as $19 million of unrecognized tax benefits
primarily related to recurring losses in certain jurisdictions
where we maintained deferred tax asset valuation allowances.
Our effective tax rate is based on recurring factors including the
geographical mix of income before taxes and the related tax
rates in those jurisdictions, as well as available foreign tax credits.
In addition, our effective tax rate will change based on discrete
or other nonrecurring events (such as audit settlements) that
may not be predictable. We anticipate that our effective tax rate
for 2006 will approximate 34.0%, excluding the effects of any
discrete items.
Equity in Net Income of Unconsolidated Affiliates: Equity in net
income of unconsolidated affiliates of $98 million, principally
related to our 25% share of Fuji Xerox income, decreased $53
million in 2005 as compared to 2004, reflecting the following:
• A $44 million decrease in our 25% share of Fuji Xerox’s net
income. The lower net income related to the absence of the
$38 million pension settlement gain in 2004. Refer to Note 7 –
Investments in Affiliates, at Equity in the Consolidated Financial
Statements for condensed financial data of Fuji Xerox.
• The absence of $7 million of equity income from Integic
Corporation. In the first quarter of 2005, we sold our entire
equity interest in Integic Corporation.
X e r o x C o r p o r a t i o n
Equity in net income of unconsolidated affiliates increased
$93 million in 2004 as compared to 2003, reflecting:
• $38 million related to our share of a pension settlement gain
recorded by Fuji Xerox subsequent to a transfer of a portion
of their pension obligation to the Japanese government in
accordance with the Japan Welfare Pension Insurance Law.
• The remainder of the 2004 increase is primarily due to the
improved operational performance of Fuji Xerox.
Income from Discontinued Operations: Income from discontinued
operations, net of tax, for the years ended December 31, 2005
and 2004 was as follows (in millions):
2005
2004
2003
Insurance Group Operations
tax benefits
$53
$ –
Gain on sale of ContentGuard,
net of income taxes of $26
Total
–
$53
83
$ 83
$ –
–
$ –
As disclosed in Note 15 – Income and Other Taxes, in June 2005
we received notice that our 1996-1998 Internal Revenue Service
(“IRS”) audit was finalized. Of the total tax benefits realized,
including the reversal of existing reserves, $53 million was
attributed to our discontinued operations.
In the first quarter 2004, we sold all but 2% of our 75% ownership
interest in ContentGuard Inc. (“ContentGuard”) to Microsoft
Corporation and Time Warner Inc. for $66 million in cash. The
sale resulted in an after-tax gain of approximately $83 million
($109 million pre-tax) and reflects our recognition of cumulative
operating losses. The revenues, operating results and net assets
of ContentGuard were immaterial for all periods presented.
ContentGuard, which was originally created out of research
developed at the Xerox Palo Alto Research Center (“PARC”),
licenses intellectual property and technologies related to digital
rights management. During 2005, we sold our remaining interest
in ContentGuard.
Recent Accounting Pronouncements: Refer to Note 1 of the
Consolidated Financial Statements for a description of recent
accounting pronouncements including the respective dates of
adoption and effects on results of operations and financial condition.
Capital Resources and Liquidity
Cash Flow Analysis: The following summarizes our cash flows for each of the three years ended December 31, 2005, as reported in our
Consolidated Statements of Cash Flows in the accompanying Consolidated Financial Statements:
(in millions)
Net cash provided by operating activities
Net cash (used in) provided by investing activities
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
2005
2004
2003
$ 1,420
(295)
(2,962)
(59)
(1,896)
3,218
$ 1,750
203
(1,293)
81
741
2,477
$ 1,879
49
(2,470)
132
(410)
2,887
2005
Amount
Change
$ (330)
(498)
(1,669)
(140)
(2,637)
741
2004
Amount
Change
$ (129)
154
1,177
(51)
1,151
(410)
Cash and cash equivalents at end of period
$ 1,322
$ 3,218
$ 2,477
$(1,896)
$ 741
Cash, cash equivalents and short-term investments reported in
our Consolidated Financial Statements were as follows:
December 31,
Cash and cash equivalents
Short-term investments
Total Cash, cash equivalents and
2005
2004
$ 1,322
244
$ 3,218
–
Short-term investments
$ 1,566
$ 3,218
For the year ended December 31, 2005, net cash provided by
operating activities decreased $330 million from 2004, primarily
as a result of the following:
• $258 million decrease due to modest growth in accounts
receivable in 2005 compared to a decline in 2004.
• $83 million decrease due to lower finance receivable run-off.
• $124 million decrease due to higher inventory growth in
2005 compared to 2004, reflecting an increase in the number
of new products.
X e r o x A n n u a l R e p o r t 2 0 0 5
39
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
• Partially offsetting these items were lower tax payments of $96
million due to refunds from audit and other tax settlements, as
well as the timing of payments associated with restructuring.
• Decrease of $48 million due to lower proceeds from the sale
of excess land and buildings.
• Partially offsetting these items was a $15 million decrease in
• Partially offsetting lower pension contributions of $21 million.
capital and internal use software expenditures.
For the year ended December 31, 2004, net cash provided by
operating activities decreased $129 million from 2003, primarily
as a result of the following:
• Lower finance receivable reductions of $159 million reflecting
the increase in equipment sale revenue in 2004.
• Higher cash usage related to inventory of $100 million to
support new products.
• Increased tax payments of $46 million due to increased income.
• Lower cash generation from the early termination of interest
We expect 2006 capital expenditures including internal use
software to approximate $250 million.
For the year ended December 31, 2004, net cash from investing
activities increased $154 million from 2003, primarily as a result
of the following:
• An increase of $156 million in proceeds from the sale of busi-
nesses and investments, consisting of the $191 million referred
to above, as offset by $35 million of proceeds from the 2003
divestitures of investments in South Africa, France and Germany.
rate swaps of $62 million.
• An increase of $43 million of proceeds from the sale of certain
excess land and buildings.
• Partially offsetting these items was a $12 million decrease due
to the acquisition of an additional interest in Xerox India in 2004,
and a $31 million decrease due to a lower net reduction of
escrow and other restricted investments. 2003 investing cash
flows included $235 million related to our former reinsurance
obligations with our discontinued operations.
For the year ended December 31, 2005, net cash used in
financing activities increased $1.7 billion from 2004, primarily
as a result of the following:
• A $1.5 billion reduction in proceeds from new secured
financings, reflecting a rebalancing of our secured and
unsecured debt portfolio.
• $433 million cash usage for the acquisition of common stock
under the authorized October 2005 share repurchase program.
• A partially offsetting $235 million decrease in net payments on
term and other debt reflecting lower debt maturity obligations.
For the year ended December 31, 2004, net cash used in
financing activities decreased $1.2 billion from 2003, primarily
as a result of the following:
• A $2.6 billion decrease in net payments of term and other debt.
• $889 million in proceeds received on the issuance of mandatory
redeemable preferred stock in 2003.
• A partially offsetting decrease of $404 million in proceeds from
the issuance of common stock and a decrease of $114 million
in net proceeds from secured financing.
• Lower pension plan contributions of $263 million, partially
offsetting the above cash outflows.
We expect 2006 operating cash flows to be at the high end of the
range of $1.2 billion to $1.5 billion, as compared to $1.4 billion in
2005. This expectation reflects cash generation from a decrease
in finance receivables that offsets cash usage from an increase
in equipment on operating leases, resulting in a neutral impact on
net operating cash flow. Since finance receivables and on-lease
equipment are expected to be leveraged at a 7:1 debt-to-equity
ratio, if these items collectively use or provide cash the overall
impact on our total cash flows should be minimal, since our debt
should also increase or decrease as appropriate to maintain our
current leverage.
For the year ended December 31, 2005, net cash from investing
activities decreased $498 million from 2004 primarily as a result
of the following:
• $247 million from the net purchases of short-term investments
which were intended to increase our return on available cash.
• Decrease of $143 million due to a lower net reduction of escrow
and other restricted investments due to the 2004 renegotiation of
certain secured borrowing arrangements and scheduled releases
from an escrow account of supporting interest payments on our
prior liability to a trust issuing preferred securities.
• Decrease of $86 million due to lower proceeds from divestitures
and investments, net, reflecting:
– 2005 proceeds of $105 million primarily consisting
of $96 million from the sale of our equity interest in
Integic Corporation.
– 2004 proceeds of $191 million primarily consisting of
$66 million from the ContentGuard sale, $79 million from
the ScanSoft sale and $36 million from a preferred
stock investment.
40
X e r o x A n n u a l R e p o r t 2 0 0 5
Customer Financing Activities and Debt: We provide equipment
financing to the majority of our customers. Because the finance
leases allow our customers to pay for equipment over time rather
than at the date of installation, we maintain a certain level of debt
to support our investment in these customer finance leases.
During the last four years we had established a series of financing
arrangements with a number of major financial institutions to
provide secured funding for our customer leasing activities in
several of the major countries in which we operate, specifically in
Canada, France, the Netherlands, the U.K. and U.S. While terms
and conditions vary somewhat between countries, in general
these arrangements call for the financial counterparty to provide
loans secured by the sales-type lease originations in the country
for which it has been contracted to be the funding source. Most
arrangements are transacted through bankruptcy remote special
purpose entities and the transfers of receivables and equipment
to these entities are generally intended to be true sales at law.
Under these arrangements, secured debt matches the terms of
the underlying finance receivables it supports, which eliminates
certain significant refinancing, pricing and duration risks
associated with our financing.
At December 31, 2005 and 2004, all of the lease receivables
and related secured debt are consolidated in our financial state-
ments because we are determined to be the primary beneficiary
of the arrangements and frequently the counterparties have
various types of recourse to us. The lease receivables sold
represent the collateral for the related secured debt and are
not available for general corporate purposes until the related
debt is paid off. Most of the secured financing arrangements
include over-collateralization of approximately 10% of the lease
amounts sold. All of these arrangements are subject to usual and
customary conditions of default including cross-defaults. In the
remote circumstance that an event of default occurs and remains
uncured, in general, the counterparty can cease providing funding
for new lease originations.
Information on restricted cash that is the result of these third-
party secured funding arrangements is included in Note 1 –
Restricted Cash and Investments to the Consolidated Financial
Statements and disclosure of the amounts for new funding and
debt repayments are included in the accompanying Consolidated
Statement of Cash Flows.
We also have arrangements in certain countries – Germany, Italy,
the Nordic Countries, Brazil and Mexico – in which third-party
financial institutions originate lease contracts directly with our
customers. In these arrangements, we sell and transfer title to the
equipment to these financial institutions and generally have no
continuing ownership rights in the equipment subsequent to its sale.
X e r o x C o r p o r a t i o n
In addition to these third-party arrangements, we also support
our customer finance leasing activities with cash generated from
operations and through capital markets offerings.
Refer to Note 4 – Receivables, Net in the Consolidated Financial
Statements for further information regarding our third-party
secured funding arrangements as well as a comparison of finance
receivables to our financing-related debt as of December 31,
2005 and 2004.
As of December 31, 2005 and 2004, debt secured by finance
receivables was approximately 41% and 44% of total debt,
respectively. Consistent with our objective to rebalance the ratio
of secured and unsecured debt, we expect payments on secured
loans will continue to exceed proceeds from new secured loans
in 2006. The following represents our aggregate debt maturity
schedule as of December 31, 2005:
Debt
Secured
by Finance
Receivables
$1,058
1,139
643
103
36
3
$2,982
Other
Secured
Debt
$ 15
185
307
7
3
34
$551
Unsecured
Debt
$
66
258
28
879
688
1,826
$3,745
Total
Debt
$1,139(1)
1,582
978
989
727
1,863
$7,278
(in millions)
2006
2007
2008
2009
2010
Thereafter
Total
(1) Quarterly secured and unsecured total debt maturities (in millions) for 2006 are
$353, $307, $256 and $223 for the first, second, third and fourth quarters,
respectively.
The following table summarizes our secured and unsecured debt
as of December 31, 2005 and 2004:
(in millions)
Term Loan
Debt secured by finance
receivables
Capital leases
Debt secured by other assets
Total Secured Debt
Senior Notes
Subordinated debt
Other Debt
Total Unsecured Debt
December 31,
2005
$ 300
December 31,
2004
$
300
2,982
38
213
3,533
2,862
19
864
3,745
4,436
58
235
5,029
2,936
19
2,140
5,095
Total Debt
$ 7,278
$10,124
X e r o x A n n u a l R e p o r t 2 0 0 5
41
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
Liquidity: We manage our worldwide liquidity using internal cash
management practices, which are subject to (1) the statutes,
regulations and practices of each of the local jurisdictions in
which we operate, (2) the legal requirements of the agreements
to which we are a party and (3) the policies and cooperation of
the financial institutions we utilize to maintain and provide cash
management services.
With $1.6 billion of cash, cash equivalents and short-term
investments, as of December 31, 2005, borrowing capacity
under our 2003 Credit Facility of approximately $700 million
and funding available through our secured funding programs,
we believe our liquidity (including operating and other cash flows
that we expect to generate) will be sufficient to meet operating
cash flow requirements as they occur and to satisfy all scheduled
debt maturities for at least the next twelve months. Our ability
to maintain positive liquidity going forward depends on our ability
to continue to generate cash from operations and access the
financial markets, both of which are subject to general economic,
financial, competitive, legislative, regulatory and other market
factors that are beyond our control. As of December 31, 2005,
we had an active shelf registration statement with $1.75 billion of
capacity that enables us to access the market on an opportunistic
basis and offer both debt and equity securities.
Credit Facility: The 2003 Credit Facility consists of a $300 million
term loan and a $700 million revolving credit facility, which
includes a $200 million sub-facility for letters of credit. Xerox
Corporation is the only borrower of the term loan. The revolving
credit facility is available, without sub-limit, to Xerox Corporation
and certain of its foreign subsidiaries, including Xerox Canada
Capital Limited, Xerox Capital (Europe) plc and other qualified
foreign subsidiaries (excluding Xerox Corporation, the “Overseas
Borrowers”). The 2003 Credit Facility matures on September 30,
2008. As of December 31, 2005, the $300 million term loan
and $15 million of letters of credit were outstanding and there
were no outstanding borrowings under the revolving credit facility.
Since inception of the 2003 Credit Facility in June 2003, there
have been no borrowings under the revolving credit facility.
The term loan and the revolving loans each bear interest at
LIBOR plus a spread that varies between 1.75% and 3.00% or,
at our election, at a base rate plus a spread that depends on
the then-current leverage ratio, as defined, in the 2003 Credit
Facility. This rate was 6.22% at December 31, 2005.
The 2003 Credit Facility contains affirmative and negative
covenants as well as financial maintenance covenants. Subject to
certain exceptions, we cannot pay cash dividends on our common
stock during the facility term, although we can pay cash dividends
on our preferred stock provided there is then no event of default.
In addition to other defaults customary for facilities of this type,
defaults on other debt, or bankruptcy, of Xerox, or certain of our
subsidiaries, and a change in control of Xerox, would constitute
events of default. At December 31, 2005, we were in compliance
with the covenants of the 2003 Credit Facility and we expect to
remain in compliance for at least the next twelve months.
Share Repurchase Program: In October 2005, the Board of
Directors authorized the repurchase of up to $500 million of the
Company’s common stock during a period of up to one year. In
addition, during January 2006, the Board of Directors authorized
an additional repurchase of $500 million of the Company’s
common stock to also occur during a period of up to one year.
Refer to Note 18 – Common Stock in the Consolidated Financial
Statements for further information.
Other Financing Activity
Financing Business: We currently fund our customer financing
activity through third-party funding arrangements, cash generated
from operations, cash on hand, capital markets offerings and
secured loans. In the United States, Canada, the Netherlands,
the U.K. and France, we are currently funding a significant portion
of our customer financing activity through secured borrowing
arrangements with GE, De Lage Landen Bank (“DLL”) and Merrill
Lynch. At the end of the third quarter of 2005, we repaid $120
million of secured debt through a transaction with our DLL Joint
Venture to purchase DLL’s parent’s 51% ownership interest in
the Belgium and Spain leasing operations, which were previously
sold to the joint venture in the fourth quarter of 2003. In connec-
tion with the purchase, the secured borrowings to DLL’s parent in
these operations were repaid and the related finance receivables
are no longer encumbered. Other than the repayment of the
secured debt, the effects from this transaction were immaterial.
In October 2005, we renegotiated our Loan Agreement with
GE, resulting in a reduction in applicable interest rates and the
elimination of the monthly borrowing requirement. The interest
rate reduction is applicable to existing and new loans. Additionally,
in October 2005, we finalized renegotiation of our Loan
Agreements with Merrill Lynch in France, resulting in an increase
in the size of the facility from €350 million to €420 million
($414 million to $497 million), lower applicable interest rates
and an extension for an additional 2 years at our option from
the current expiration date of July 2007. Refer to Note 4 to the
Consolidated Financial Statements for a more detailed discussion
of our customer financing arrangements.
42
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Loan Covenants and Compliance: At December 31, 2005, we
were in full compliance with the covenants and other provisions of
the 2003 Credit Facility, the Senior Notes and the Loan Agreement
and expect to remain in full compliance for at least the next twelve
months. Any failure to be in compliance with any material provi-
sion or covenant of the 2003 Credit Facility or the Senior Notes
could have a material adverse effect on our liquidity and operations.
Failure to be in compliance with the covenants in the Loan Agree-
ment, including the financial maintenance covenants incorporated
from the 2003 Credit Facility, would result in an event of termination
under the Loan Agreement and in such case GECC would not be
required to make further loans to us. If GECC were to make no
further loans to us and assuming a similar facility was not estab-
lished and that we were unable to obtain replacement financing
in the public debt markets, it could materially adversely affect our
liquidity and our ability to fund our customers’ purchases of our
equipment and this could materially adversely affect our results of
operations. We have the right at any time to prepay without penalty
any loans outstanding under or terminate the 2003 Credit Facility.
Capital Markets Offerings and Other: In August 2004, we issued
$500 million aggregate principal amount of Senior Notes due
2011 at par value and, in September 2004, we issued an addi-
tional $250 million aggregate principal amount Senior Notes
due 2011 at 104.25% of par. These notes, which are discussed
further in Note 11 – Debt in the Consolidated Financial Statements,
form a single series of debt. Interest on the Senior Notes accrues
at the annual rate of 6.875% and, as a result of the premium
we received on the second issuance of Senior Notes, have a
weighted average effective interest rate of 6.6%. The weighted
average effective interest rate associated with the Senior Notes
reflects our improved liquidity and ability to access the capital
markets on more favorable terms.
In December 2004, we completed the redemption of our liability
to the Xerox trust issuing trust preferred securities. In lieu of cash
redemption, holders of substantially all of the securities converted
$1.0 billion aggregate principal amount of securities into 113
million shares of our common stock. As a result of this conversion
and redemption, there is no remaining outstanding principal.
This redemption, which had no impact on diluted earnings
per share, is discussed further in Note 12 to the Consolidated
Financial Statements.
Credit Ratings: Our credit ratings as of December 31, 2005
were as follows:
Senior
Unsecured
Debt
Outlook
Comments
Moody’s (1), (2), (6) Ba2
Positive
S&P (3), (4)
BB-
Positive
Fitch (5)
BB+
Positive
The Moody’s rating was
upgraded from B1 in
August 2004. The outlook
was upgraded to positive
in September 2005.
The S&P rating on Senior
Secured Debt is BB-. The
outlook was upgraded
to positive in April 2005.
The Fitch rating was
upgraded from BB in
August 2005.
(1) In December 2003, Moody’s assigned to Xerox a first-time SGL-1 rating.
This rating was affirmed in August 2004.
(2) In August 2004, Moody’s upgraded the long-term senior unsecured debt
rating of Xerox from B1 to Ba2, a two-notch upgrade. The corporate rating
was upgraded to Ba1.
(3) In April 2005, S&P launched a short-term speculative-grade rating scale and
assigned to Xerox a first-time B-1 rating.
(4) In April 2005, S&P upgraded the long-term senior unsecured debt rating of
Xerox from B+ to BB-, a one-notch upgrade. The corporate rating was affirmed
as BB- and changed its Outlook from Stable to Positive.
(5) In August 2005, Fitch upgraded the senior unsecured debt of Xerox from BB
to BB+, and also upgraded the Trust Preferred securities from B+ to BB-, both
one-notch upgrades. The corporate rating Outlook was affirmed as Positive
and affirmed the Secured Bank Facility at BBB-.
(6) In September 2005, Moody’s changed its Outlook from Stable to Positive.
Our credit ratings, which are periodically reviewed by major
rating agencies, have substantially improved over the past two
years. As described in the above table, Moody’s and S&P have
made positive rating upgrades during the 2005 annual period.
In January 2006, S&P placed our rating on Credit-Watch Positive,
indicating a review of the credit with positive implications within
the coming 30 days. Even though as of February 2006, our
current credit rating still remains below investment grade, we
expect our management strategies will return the Company to
investment grade in the future.
X e r o x A n n u a l R e p o r t 2 0 0 5
43
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F
R E S U LT S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N
Contractual Cash Obligations and Other Commercial Commitments and Contingencies: At December 31, 2005, we had the following
contractual cash obligations and other commercial commitments and contingencies (in millions):
Long-term debt, including capital lease obligations (1)
Minimum operating lease commitments (2)
Liabilities to subsidiary trusts issuing preferred securities (3)
Purchase Commitments
Flextronics (4)
EDS Contracts (5)
Other (6)
Year 1
2006
$ 1,139
197
98
734
299
39
Years 2-3
Years 4-5
2007
2008
2009
2010
Thereafter
$ 1,582
165
–
$ 978
124
–
$ 989
102
–
$ 727
90
–
$ 1,863
197
626
–
290
34
–
282
31
–
138
1
–
–
–
–
–
–
Total Contractual cash obligations
$ 2,506
$ 2,071
$ 1,415
$ 1,230
$ 817
$ 2,686
(1) Refer to Note 11 to our Consolidated Financial Statements for interest payments by us as well as for additional information related to long-term debt (amounts above include
principal portion only).
(2) Refer to Note 6 to our Consolidated Financial Statements for additional information related to minimum operating lease commitments.
(3) Refer to Note 12 to our Consolidated Financial Statements for interest payments by us as well as for additional information related to liabilities to subsidiary trusts issuing
preferred securities (amounts above include principal portion only).
(4) Flextronics: In 2001, we outsourced certain manufacturing activities to Flextronics under a five-year agreement expiring on November 30, 2006, which we expect to extend for
at least an additional three-year period in accordance with existing contractual terms.
(5) EDS Contracts: We have an information management contract with Electronic Data Systems Corp. (“EDS”) to provide services to us for global mainframe system processing,
application maintenance and support, desktop services and helpdesk support, voice and data network management, and server management through June 30, 2009. There
are no minimum payments required under the contract. After July 1, 2006, we can terminate the current contract for convenience with six months’ notice, as defined in the
contract, with no termination fee and with payment to EDS for costs incurred as of the termination date. Should we terminate the contract for convenience, we have an option
to purchase the assets placed in service under the EDS contract.
(6) Other Purchase Commitments: We enter into other purchase commitments with vendors in the ordinary course of business. Our policy with respect to all purchase
commitments is to record losses, if any, when they are probable and reasonably estimable. We currently do not have, nor do we anticipate, material loss contracts.
Other Commercial Commitments
and Contingencies
Pension and Other Post-Retirement Benefit Plans: We sponsor
pension and other post-retirement benefit plans that require
periodic cash contributions. Our 2005 cash fundings for these
plans were $388 million for pensions and $112 million for other
post-retirement plans. Our anticipated cash fundings for 2006
are $106 million for pensions and $130 million for other
post-retirement plans. Cash contribution requirements for our
domestic tax-qualified pension plans are governed by the
Employment Retirement Income Security Act (“ERISA”) and the
Internal Revenue Code. Cash contribution requirements for our
international plans are subject to the applicable regulations in
each country. The expected 2006 pension contributions do not
include contributions to the domestic tax-qualified plans because
these plans have already exceeded the ERISA minimum funding
requirements for the plans’ 2005 plan year. However, once the
January 1, 2006 actuarial valuations and projected results as of
the end of the 2006 measurement year are available, the desir-
ability of additional contributions will be assessed. Based on these
results, we may voluntarily decide to contribute to these plans,
even though no contribution is required. In prior years, after making
this assessment, we decided to contribute $230 million and $210
million in April 2005 and April 2004, respectively, to our domestic
44
X e r o x A n n u a l R e p o r t 2 0 0 5
tax-qualified plans in order to make them 100 percent funded on
a current liability basis under the ERISA funding rules. Our other
post-retirement benefit plans are non-funded and are almost entirely
related to domestic operations. Cash contributions are made
each year to cover medical claims costs incurred in that year.
Fuji Xerox: We had product purchases from Fuji Xerox totaling
$1.5 billion, $1.1 billion and $871 million in 2005, 2004 and
2003, respectively. Our purchase commitments with Fuji Xerox
are in the normal course of business and typically have a lead
time of three months. We anticipate that we will purchase
approximately $1.9 billion of products from Fuji Xerox in 2006.
Related party transactions with Fuji Xerox are discussed in
Note 7 to the Consolidated Financial Statements.
Brazil Tax and Labor Contingencies: At December 31, 2005, our
Brazilian operations were involved in various litigation matters and
have received or been levied with numerous governmental assess-
ments related to indirect and other taxes as well as disputes
associated with former employees and contract labor. The total
amounts related to these unreserved contingencies, inclusive of
any related interest, were approximately $900 million. The tax
matters, which comprise a significant portion of the total contingen-
cies, principally relate to claims for taxes on the internal transfer
of inventory, municipal service taxes on rentals and gross
revenue taxes. We are disputing these tax and labor matters
and intend to vigorously defend our position. Based on the
opinion of legal counsel, we do not believe that the ultimate
resolution of these matters will materially impact our results of
operations, financial position or cash flows. In connection with
these proceedings, customary local regulations may require
us to make escrow cash deposits or post other security of up
to one-half of the total amount in dispute. As of December 31,
2005, we have made escrow cash deposits of $117 million for
matters we are disputing and there are liens on certain of our
Brazilian assets. Generally, any escrowed amounts would be
refundable and any liens would be removed to the extent the
matter is resolved in our favor. We routinely assess these matters
as to probability of ultimately incurring a liability against our
Brazilian operations and record our best estimate of the ultimate
loss in situations where we assess the likelihood of an ultimate
loss as probable of occurring.
Off-Balance-Sheet Arrangements
Although we generally do not utilize off-balance-sheet arrangements
in our operations, we enter into operating leases in the normal
course of business. The nature of these lease arrangements is
discussed in Note 6 to the Consolidated Financial Statements.
Additionally, we utilize special-purpose entities (“SPEs”) in
conjunction with certain financing transactions. The SPEs utilized
in conjunction with these transactions are consolidated in our
financial statements in accordance with applicable accounting
standards. These transactions, which are discussed further in
Note 4 to the Consolidated Financial Statements, have been
accounted for as secured borrowings with the debt and related
assets remaining on our balance sheets. Although the obligations
related to these transactions are included in our balance sheet,
recourse is generally limited to the secured assets and no other
assets of the Company.
Refer to Note 16 – Contingencies for further information regarding
our guarantees, indemnifications and warranty liabilities.
Financial Risk Management
We are exposed to market risk from foreign currency exchange
rates and interest rates, which could affect operating results,
financial position and cash flows. We manage our exposure to
these market risks through our regular operating and financing
activities and, when appropriate, through the use of derivative
financial instruments. These derivative financial instruments are
utilized to hedge economic exposures as well as reduce earnings
and cash flow volatility resulting from shifts in market rates.
Refer to Note 13 – Financial Instruments to the Consolidated
Financial Statements for further discussion on our financial
risk management.
X e r o x C o r p o r a t i o n
Assuming a 10% appreciation or depreciation in foreign currency
exchange rates from the quoted foreign currency exchange rates
at December 31, 2005, the potential change in the fair value of
foreign currency-denominated assets and liabilities in each entity
would not be significant because all material currency asset and
liability exposures were economically hedged as of December 31,
2005. A 10% appreciation or depreciation of the U.S. Dollar against
all currencies from the quoted foreign currency exchange rates
at December 31, 2005 would have a $582 million impact on our
cumulative translation adjustment portion of equity. The amount
permanently invested in foreign subsidiaries and affiliates, primarily
Xerox Limited, Fuji Xerox, Xerox Canada Inc. and Xerox do Brasil,
and translated into dollars using the year-end exchange rates,
was $5.8 billion at December 31, 2005, net of foreign currency-
denominated liabilities designated as a hedge of our net investment.
Interest Rate Risk Management: The consolidated weighted-
average interest rates related to our debt and liabilities to
subsidiary trusts issuing preferred securities for 2005, 2004 and
2003 approximated 6.0%, 5.8% and 6.0%, respectively. Interest
expense includes the impact of our interest rate derivatives.
Virtually all customer-financing assets earn fixed rates of interest.
As discussed above, a significant portion of those assets has been
pledged as collateral for secured financing arrangements and
the interest rates on a significant portion of those loans are fixed.
As of December 31, 2005, approximately $2.9 billion of our debt
carried variable interest rates, including the effect of pay-variable
interest rate swaps we are utilizing with the intent to reduce the
effective interest rate on our debt.
The fair market values of our fixed-rate financial instruments are
sensitive to changes in interest rates. At December 31, 2005, a
10% change in market interest rates would change the fair values
of such financial instruments by approximately $257 million.
Forward-Looking Statements
This Annual Report contains forward-looking statements and
information relating to Xerox that are based on our beliefs, as well
as assumptions made by and information currently available to us.
The words “anticipate,” “believe,” “estimate,” “expect,” “intend,”
“will,” “should” and similar expressions, as they relate to us, are
intended to identify forward-looking statements. Actual results
could differ materially from those projected in such forward-looking
statements. Information concerning certain factors that could
cause actual results to differ materially is included in our 2005
Annual Report on Form 10-K filed with the SEC. We do not intend
to update these forward-looking statements.
X e r o x A n n u a l R e p o r t 2 0 0 5
45
C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E
(in millions, except per-share data)
Year ended December 31,
Revenues
Sales
Service, outsourcing and rentals
Finance income
Total Revenues
Costs and Expenses
Cost of sales
Cost of service, outsourcing and rentals
Equipment financing interest
Research, development and engineering expenses
Selling, administrative and general expenses
Restructuring and asset impairment charges
Gain on affiliate’s sale of stock
Other expenses, net
Total Costs and Expenses
Income from Continuing Operations before
Income Taxes, Equity Income, Discontinued Operations
and Cumulative Effect of Change in Accounting Principle
Income tax (benefits) expenses
Equity in net income of unconsolidated affiliates
Income from Continuing Operations before Discontinued Operations
and Cumulative Effect of Change in Accounting Principle
Income from Discontinued Operations, net of tax
Cumulative Effect of Change in Accounting Principle, net of tax
Net Income
Less: Preferred stock dividends, net
Income Available to Common Shareholders
Basic Earnings per Share
Income from Continuing Operations
Basic Earnings per Share
Diluted Earnings per Share
Income from Continuing Operations
Diluted Earnings per Share
The accompanying notes are an integral part of these Consolidated Financial Statements.
2005
2004
2003
$ 7,400
7,426
875
$ 7,259
7,529
934
$ 6,970
7,734
997
15,701
15,722
15,701
4,695
4,207
326
943
4,110
366
–
224
4,545
4,295
345
914
4,203
86
–
369
4,346
4,307
362
962
4,249
176
(13)
876
14,871
14,757
15,265
830
(5)
98
933
53
(8)
978
(58)
965
340
151
776
83
–
859
(73)
436
134
58
360
–
–
360
(71)
$
920
$
786
$
289
$ 0.91
$ 0.96
$ 0.84
$ 0.94
$ 0.38
$ 0.38
$ 0.90
$ 0.94
$ 0.78
$ 0.86
$ 0.36
$ 0.36
46
X e r o x A n n u a l R e p o r t 2 0 0 5
C O N S O L I D A T E D B A L A N C E S H E E T S
(in millions, except share data in thousands)
December 31,
Assets
Cash and cash equivalents
Short-term investments
Total Cash, cash equivalents and short-term investments
Accounts receivable, net
Billed portion of finance receivables, net
Finance receivables, net
Inventories
Other current assets
Total Current assets
Finance receivables due after one year, net
Equipment on operating leases, net
Land, buildings and equipment, net
Investments in affiliates, at equity
Intangible assets, net
Goodwill
Deferred tax assets, long-term
Other long-term assets
Total Assets
Liabilities and Equity
Short-term debt and current portion of long-term debt
Accounts payable
Accrued compensation and benefits costs
Unearned income
Other current liabilities
Total Current liabilities
Long-term debt
Liabilities to subsidiary trusts issuing preferred securities
Pension and other benefit liabilities
Post-retirement medical benefits
Other long-term liabilities
Total Liabilities
Series C mandatory convertible preferred stock
Common stock, including additional paid-in-capital
Treasury stock, at cost
Retained earnings
Accumulated other comprehensive loss
Total Liabilities and Equity
Shares of common stock issued
Treasury stock
Shares of common stock outstanding
The accompanying notes are an integral part of these Consolidated Financial Statements.
X e r o x C o r p o r a t i o n
2005
2004
$ 1,322
244
$ 3,218
–
1,566
2,037
296
2,604
1,201
1,032
8,736
4,949
431
1,627
782
289
1,671
1,547
1,921
3,218
2,076
377
2,932
1,143
1,182
10,928
5,188
398
1,759
845
324
1,848
1,521
2,073
$21,953
$24,884
$ 1,139
1,043
621
191
1,352
$ 3,074
1,037
637
243
1,309
4,346
6,139
626
1,151
1,188
1,295
14,745
889
4,741
(203)
3,021
(1,240)
6,300
7,050
717
1,189
1,180
1,315
17,751
889
4,881
–
2,101
(738)
$21,953
$24,884
945,106
(13,917)
955,997
–
931,189
955,997
X e r o x A n n u a l R e p o r t 2 0 0 5
47
C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S
(in millions)
Year ended December 31,
Cash Flows from Operating Activities
Net income
Adjustments required to reconcile net income to cash flows from operating activities:
Depreciation and amortization
Provisions for receivables and inventory
Deferred tax (benefit) expense
Net gain on sales of businesses and assets
Undistributed equity in net income of unconsolidated affiliates
Loss on early extinguishment of debt
Income from discontinued operations
Restructuring and asset impairment charges
Cash payments for restructurings
Contributions to pension benefit plans
(Increase) decrease in inventories
Increase in equipment on operating leases
Decrease in finance receivables
(Increase) decrease in accounts receivable and billed portion of finance receivables
Decrease in other current and long-term assets
Increase in accounts payable and accrued compensation
Net change in income tax assets and liabilities
Net change in derivative assets and liabilities
Increase (decrease) in other current and long-term liabilities
Other, net
Net cash provided by operating activities
Cash Flows from Investing Activities
Purchases of short-term investments
Proceeds from sales of short-term investments
Cost of additions to land, buildings and equipment
Proceeds from sales of land, buildings and equipment
Cost of additions to internal use software
Proceeds from divestitures and investments, net
Acquisitions, net of cash acquired
Net change in escrow and other restricted investments
Net cash (used in) provided by investing activities
Cash Flows from Financing Activities
Cash proceeds from new secured financings
Debt payments on secured financings
Net cash payments on other debt
Proceeds from issuance of mandatory redeemable preferred stock
Preferred stock dividends
Proceeds from issuances of common stock
Payments to acquire treasury stock
Other
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
The accompanying notes are an integral part of these Consolidated Financial Statements.
48
X e r o x A n n u a l R e p o r t 2 0 0 5
2005
2004
2003
$
978
$
859
$
360
637
107
(15)
(97)
(54)
–
(53)
366
(214)
(388)
(162)
(248)
254
(34)
164
313
(211)
38
7
32
686
159
155
(61)
(89)
–
(83)
86
(187)
(409)
(38)
(234)
337
224
109
333
(68)
(23)
(79)
73
748
302
(70)
(1)
(37)
73
–
176
(345)
(672)
62
(166)
496
164
105
408
(3)
71
(37)
245
1,420
1,750
1,879
(386)
139
(181)
5
(56)
105
(1)
80
(295)
557
(1,879)
(1,187)
–
(58)
40
(433)
(2)
(2,962)
(59)
(1,896)
3,218
–
–
(204)
53
(48)
191
(12)
223
203
2,061
(1,906)
(1,422)
–
(83)
73
–
(16)
(1,293)
81
741
2,477
–
–
(197)
10
(53)
35
–
254
49
2,450
(2,181)
(4,044)
889
(57)
477
–
(4)
(2,470)
132
(410)
2,887
$ 1,322
$ 3,218
$ 2,477
C O N S O L I D A T E D S T A T E M E N T S O F C O M M O N
S H A R E H O L D E R S ’ E Q U I T Y
X e r o x C o r p o r a t i o n
(in millions, except share data in thousands)
Common
Stock
Shares
Common
Stock
Amount
Additional
Paid-In-
Capital
Treasury
Stock
Shares
Treasury
Stock
Amount
Retained
Earnings
Accumulated
Other
Compre-
hensive
Loss(1)
Total
Balance at December 31, 2002
738,273
$738
$2,001
–
$ –
$1,025
$(1,871)
$1,893
Net income
Translation adjustments
Minimum pension liability, net of tax
Unrealized gain on securities, net of tax
Unrealized gains on cash flow hedges,
net of tax
Comprehensive income
Stock option and incentive plans, net
Common stock offering
Series B convertible preferred stock dividends
($6.25 per share), net of tax
Series C mandatory convertible preferred
stock dividends ($3.23 per share)
9,530
46,000
9
46
41
405
Other
81
1
(2)
360
(41)
(30)
1
547
42
17
2
360
547
42
17
2
$968
50
451
(41)
(30)
–
Balance at December 31, 2003
793,884
$794
$2,445
–
–
$1,315
$(1,263)
$3,291
Net income
Translation adjustments
Minimum pension liability, net of tax
Unrealized gain on securities, net of tax
Realized gain on securities, net of tax
Unrealized gains on cash flow hedges,
net of tax
Comprehensive income
Stock option and incentive plans, net
Series B convertible preferred
stock conversion
Series B convertible preferred stock dividends
($2.54 per share)
Series C mandatory convertible preferred
stock dividends ($6.25 per share)
Conversion of liability to subsidiary trust
Other
Balance at December 31, 2004
Net income
Translation adjustments
Minimum pension liability, net of tax
Unrealized loss on securities, net of tax
Unrealized losses on cash flow hedges,
net of tax
Comprehensive income
Stock option and incentive plans, net
Series C mandatory convertible preferred
stock dividends ($6.25 per share)
Payments to acquire treasury stock
Cancellation of treasury stock
Other
859
(15)
(58)
453
86
2
(18)
859
453
86
2
(18)
2
2
$1,384
122
483
(15)
(58)
1,035
2
11,433
37,040
11
37
111
446
113,415
225
955,997
113
1
922
1
$956
$3,925
–
–
$2,101
$(738)
$6,244
978
(58)
(493)
(6)
(1)
978
(493)
(6)
(1)
(2)
(2)
$476
90
(58)
(433)
–
5,548
6
84
(17)
(213)
(30,502)
16,585
(433)
230
(16,585)
146
Balance at December 31, 2005
945,106
$945
$3,796
(13,917)
$(203)
$3,021
$(1,240)
$6,319
(1) As of December 31, 2005, Accumulated Other Comprehensive Loss is composed of cumulative translation adjustments of $(1,017),
cash flow hedging gains of $1 and minimum pension liabilities of $(224).
The accompanying notes are an integral part of these Consolidated Financial Statements.
X e r o x A n n u a l R e p o r t 2 0 0 5
49
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 1 – Summary of Significant
Accounting Policies
References herein to “we,” “us,” “our,” the “Company” and
Xerox refer to Xerox Corporation and its consolidated subsidiaries
unless the context specifically requires otherwise.
Description of Business and Basis of Presentation: We are a
technology and services enterprise and a leader in the global
document market, developing, manufacturing, marketing,
servicing and financing a complete range of document
equipment, solutions and services.
Certain reclassifications of prior-year amounts have been made
to conform to the current-year presentation. Effective July 1,
2005, we reclassified sustaining engineering costs from cost
of sales and cost of service, outsourcing and rentals to a new
line item in our Consolidated Statements of Income entitled
Research, development and engineering expenses (“R,D&E”).
This presentation aligns our external reporting presentation
to our internal management of these costs. The components
of R,D&E for all years presented are disclosed in Note 19 –
Research, Development and Engineering.
Basis of Consolidation: The Consolidated Financial Statements
include the accounts of Xerox Corporation and all of our controlled
subsidiary companies. All significant intercompany accounts
and transactions have been eliminated. Investments in business
entities in which we do not have control, but we have the ability
to exercise significant influence over operating and financial
policies (generally 20% to 50% ownership), are accounted for
using the equity method of accounting. Upon the sale of stock
of a subsidiary, we recognize a gain or loss in our Consolidated
Statements of Income equal to our proportionate share of the
corresponding increase or decrease in that subsidiary’s equity.
Operating results of acquired businesses are included in the
Consolidated Statements of Income from the date of acquisition.
We consolidate variable interest entities if we are deemed to be
the primary beneficiary of the entity. Operating results for variable
interest entities in which we are determined to be the primary
beneficiary are included in the Consolidated Statements of Income
from the date such determination is made.
For convenience and ease of reference, we refer to the
financial statement caption “Income from Continuing Operations
before Income Taxes, Equity Income, Discontinued Operations
and Cumulative Effect of Change in Accounting Principle” as
“pre-tax income,” throughout the notes to the Consolidated
Financial Statements.
Use of Estimates: The preparation of our Consolidated Financial
Statements, in accordance with accounting principles generally
accepted in the United States of America, requires that we make
estimates and assumptions that affect the reported amounts of
assets and liabilities, as well as the disclosure of contingent assets
and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting
period. Significant estimates and assumptions are used for, but
not limited to: (i) allocation of revenues and fair values in leases
and other multiple-element arrangements; (ii) accounting for
residual values; (iii) economic lives of leased assets; (iv) allowance
for doubtful accounts; (v) inventory valuation; (vi) restructuring
and related charges; (vii) asset impairments; (viii) depreciable
lives of assets; (ix) useful lives of intangible assets; (x) pension
and post-retirement benefit plans; (xi) income tax reserves and
valuation allowances and (xii) contingency and litigation reserves.
Future events and their effects cannot be predicted with certainty;
accordingly, our accounting estimates require the exercise of
judgment. The accounting estimates used in the preparation of
our Consolidated Financial Statements will change as new events
occur, as more experience is acquired, as additional information
is obtained and as our operating environment changes. Actual
results could differ from those estimates.
The following table summarizes certain significant charges that
require management estimates:
(in millions)
Year Ended December 31,
2005
2004
2003
Restructuring provisions and
asset impairments
Amortization of intangible assets
Provisions for receivables
Provisions for obsolete and
excess inventory
Provisions for litigation and
regulatory matters
Depreciation and obsolescence
of equipment on
operating leases
Depreciation of buildings
and equipment
Amortization of capitalized
software
Pension benefits –
net periodic benefit cost
Other post-retirement benefits –
net periodic benefit cost
Deferred tax asset valuation
$366
42
51
$ 86
38
86
$ 176
36
224
56
115
205
280
114
343
117
73
9
210
305
134
350
111
78
242
271
299
143
364
108
allowance provisions
(38)
12
(16)
50
X e r o x A n n u a l R e p o r t 2 0 0 5
Changes in Estimates: In the ordinary course of accounting
for items discussed above, we make changes in estimates
as appropriate, and as we become aware of circumstances
surrounding those estimates. Such changes and refinements
in estimation methodologies are reflected in reported results
of operations in the period in which the changes are made
and, if material, their effects are disclosed in the Notes to the
Consolidated Financial Statements.
New Accounting Standards and Accounting Changes:
During the two years ended December 31, 2005, the Financial
Accounting Standards Board (“FASB”) issued several pronounce-
ments of significance to the Company which are discussed in
detail below. In addition, the FASB issued several other pronounce-
ments, including standards on inventory (SFAS No. 151 “Inventory
Costs, an amendment of ARB 43, Chapter 4”), exchanges of
nonmonetary assets (SFAS No. 153 “Exchanges of Nonmonetary
Assets”) and accounting changes (SFAS No. 154 “Accounting
Changes and Error Corrections”), which we either currently
comply with or are not anticipating to have a significant impact
on our future financial condition or results of operations.
In June 2005, the FASB issued Staff Position No. FAS 143-1,
“Accounting for Electronic Equipment Waste Obligations”
(“FSP 143-1”), which provided guidance on the accounting for
obligations associated with the European Union (“EU”) Directive
on Waste Electrical and Electronic Equipment (the “WEEE
Directive”). FSP 143-1 provided guidance on how to account for
the effects of the WEEE Directive with respect to historical waste
and waste associated with products on the market on or before
August 13, 2005. As of December 31, 2005, the WEEE Directive
had been adopted into law by the EU member countries in which
we have significant operations, with the exception of the United
Kingdom. Accordingly, in 2005, we recorded an initial after-tax
charge of $18 ($26 pre-tax) in Other expenses, net in the
accompanying Consolidated Statement of Income representing
the disposal obligation primarily related to our leased equipment
population in service as of the date the EU member countries
adopted the WEEE Directive. The adoption of the WEEE Directive
by an EU member country created a legal disposal obligation
and accordingly we are now required to accrue the cost of that
obligation at the time the equipment is placed in service. We will
be required to record a similar charge for the United Kingdom
when it adopts the WEEE Directive, which is expected to be no
more than $10. The ongoing quarterly expense resulting from
compliance with the WEEE Directive associated with our leased
equipment will generally be charged to cost of sales when
equipment is placed in service and is not expected to have a
material effect on our financial condition or results of operations.
X e r o x C o r p o r a t i o n
In March 2005, the FASB issued Interpretation No. 47, “Accounting
for Conditional Asset Retirement Obligations – an interpretation
of FASB Statement No. 143” (“FIN 47”). FIN 47 requires an entity
to recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value can be reasonably estimated.
A conditional asset retirement obligation is a legal obligation to
perform an asset retirement activity in which the timing or method
of settlement are conditional upon a future event that may or
may not be within control of the entity. The adoption of FIN 47 in
2005 resulted in an after-tax charge of $8 ($12 pre-tax) and was
recorded as a cumulative effect of change in accounting principle.
This charge represents conditional asset retirement obligations
associated with leased facilities where we are required to remove
certain leasehold improvements and restore the facility to its
original condition at lease termination. Previously, we recorded
costs associated with this obligation upon lease termination when
the costs were known. On a prospective basis, this accounting
change requires recognition of these costs ratably over the lease
term. We believe that the adoption of this interpretation will not
have a material effect on our financial condition or results of oper-
ations. The pro forma effect of applying this guidance in all prior
periods presented, as well as the effect on our Consolidated
Balance Sheet, was not material.
Stock-Based Compensation: In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 123(R), “Share-
Based Payment” (“FAS 123(R)”), an amendment of FAS No. 123,
“Accounting for Stock-Based Compensation,” which requires com-
panies to recognize compensation expense using a fair-value-based
method for costs related to share-based payments, including stock
options. As permitted by the SEC, the requirements of FAS 123(R)
are effective for our fiscal year beginning January 1, 2006. Upon
adoption, we will elect to apply the modified prospective transition
method and therefore we will not restate the results of prior periods.
During May 2005, we approved the accelerated vesting of approx-
imately 3.6 million unvested employee stock options granted in
2004, that would have been scheduled to vest January 1, 2007, to
December 31, 2005. These accelerated options had a weighted
average exercise price of $13.71 as of the accelerated vesting date.
The primary purpose of this accelerated vesting was to eliminate
compensation expense we would recognize in our results of
operations upon the adoption of FAS 123(R). The acceleration is
expected to reduce our pre-tax stock option compensation expense
in 2006 that otherwise would have been recognized by approxi-
mately $31 or $0.02 per diluted share and, accordingly, increase
our 2005 pro forma expense disclosed below. After the effects
of the accelerated vesting, the implementation of FAS 123(R) is
expected to be immaterial. In addition, in 2005 in lieu of stock
options, we began granting time- and performance-based restricted
stock awards, which are already reflected as compensation expense
in our results of operations. Therefore, the acceleration of vesting
for substantially all previously awarded stock options effectively
completes the transition to the new stock-based award program.
X e r o x A n n u a l R e p o r t 2 0 0 5
51
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
FAS 123(R) also requires that the benefits of tax deductions
in excess of recognized compensation cost be reported as a
financing cash flow, rather than as an operating cash flow as
required under current literature. This requirement will reduce net
operating cash flows and increase net financing cash flows in
periods after the effective date. While we can not estimate what
those amounts will be in the future (because they depend on,
among other things, when employees exercise stock options),
the amount of operating cash flows recognized in 2005 for such
excess tax deductions was $12.
Pending the effective date of FAS 123(R), we do not recognize
compensation expense relating to employee stock options
because the exercise price is equal to the market price at the
date of grant. If we had elected to recognize compensation
expense using a fair-value approach, and therefore determined
the compensation based on the value as determined by the
modified Black-Scholes option pricing model, our pro forma
income and income per share would have been as follows:
(in millions, except per-share data)
2005
2004
2003
Net income – as reported
Add: Stock-based employee
compensation expense
included in reported net
income, net of tax
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of tax
Net income – pro forma
Basic EPS – as reported
Basic EPS – pro forma
Diluted EPS – as reported
Diluted EPS – pro forma
$ 978
$ 859
$ 360
25
13
10
(113)
(82)
(95)
$ 890
$0.96
0.87
$0.94
0.85
$ 790
$0.94
0.86
$0.86
0.80
$ 275
$0.38
0.27
$0.36
0.25
The pro forma periodic compensation expense amounts are not
representative of future amounts, as we began granting employees
restricted stock awards with time- and performance-based
restrictions in 2005 in lieu of stock options. As reflected in the
pro forma amounts in the previous table, the weighted-average
fair value of options granted in 2004 and 2003 was $8.38 and
$5.39, respectively. The fair values were estimated on the date
of grant using the following weighted average assumptions:
Risk-free interest rate
Expected life in years (1)
Expected price volatility
Expected dividend yield
2004
2003
3.2%
5.7
66.5%
–
3.3%
7.2
66.2%
–
(1) Options granted in 2004 expire eight years from date of grant, resulting in an
expected life shorter than previous grants.
52
X e r o x A n n u a l R e p o r t 2 0 0 5
Refer to Note 18 – Common Stock for additional disclosures
regarding our stock compensation programs.
Summary of Accounting Policies
Revenue Recognition: We generate revenue through the sale and
rental of equipment, service and supplies and income associated
with the financing of our equipment sales. Revenue is recognized
when earned. More specifically, revenue related to sales of our
products and services is recognized as follows:
Equipment: Revenues from the sale of equipment, including those
from sales-type leases, are recognized at the time of sale or at the
inception of the lease, as appropriate. For equipment sales that
require us to install the product at the customer location, revenue is
recognized when the equipment has been delivered to and installed
at the customer location. Sales of customer-installable products are
recognized upon shipment or receipt by the customer according
to the customer’s shipping terms. Revenues from equipment under
other leases and similar arrangements are accounted for by the
operating lease method and are recognized as earned over the
lease term, which is generally on a straight-line basis.
Service: Service revenues are derived primarily from maintenance
contracts on our equipment sold to customers and are recog-
nized over the term of the contracts. A substantial portion of
our products are sold with full-service maintenance agreements
for which the customer typically pays a base service fee plus a
variable amount based on usage. As a consequence, other than
the product warranty obligations associated with certain of our
low-end products in the Office segment, we do not have any
significant product warranty obligations, including any obligations
under customer satisfaction programs.
Revenues associated with outsourcing services as well as
professional and value-added services are generally recognized
as such services are performed. In those service arrangements
where final acceptance of a system or solution by the customer
is required, revenue is deferred until all acceptance criteria have
been met. Costs associated with service arrangements are
generally recognized as incurred. Initial direct costs of an arrange-
ment are capitalized and amortized over the contractual service
period. Long-lived assets used in the fulfillment of the arrangements
are capitalized and depreciated over the shorter of their useful
life or the term of the contract. Losses on service arrangements
are recognized in the period that the contractual loss becomes
probable and estimable.
Sales to Distributors and Resellers: We utilize distributors and
resellers to sell certain of our products to end users. We refer
to our distributor and reseller network as our two-tier distribution
model. Sales to distributors and resellers are recognized as
revenue when products are sold to such distributors and
resellers, as long as all requirements for revenue recognition
have been met. Distributors and resellers participate in various
cooperative marketing and other programs, and we record
provisions for these programs as a reduction to revenue when
the sales occur. We also similarly account for our estimates of
sales returns and other allowances when the sales occur based
on our historical experience.
Supplies: Supplies revenue generally is recognized upon shipment
or utilization by customer in accordance with sales terms.
Revenue Recognition for Leases: Our accounting for leases
involves specific determinations under SFAS No. 13, which
often involve complex provisions and significant judgments.
The two primary criteria of SFAS No. 13 which we use to classify
transactions as sales-type or operating leases are (1) a review
of the lease term to determine if it is equal to or greater than
75% of the economic life of the equipment and (2) a review of
the present value of the minimum lease payments to determine
if they are equal to or greater than 90% of the fair market value
of the equipment at the inception of the lease. Our sales-type
lease portfolios contain only normal credit and collection risks
and have no important uncertainties with respect to future costs.
Our leases in our Latin America operations have historically
been recorded as operating leases, given the cancellability of the
contract or because the recoverability of the lease investment
is deemed not to be predictable at lease inception.
The critical elements that we consider with respect to our lease
accounting are the determination of the economic life and the fair
value of equipment, including the residual value. For purposes of
determining the economic life, we consider the most objective
measure to be the original contract term, since most equipment
is returned by lessees at or near the end of the contracted term.
The economic life of most of our products is five years, since
this represents the most frequent contractual lease term for our
principal products and only a small percentage of our leases
have original terms longer than five years. There is no significant
after-market for our used equipment. We believe that five years is
representative of the period during which the equipment is expected
to be economically usable, with normal service, for the purpose
for which it is intended. We continually evaluate the economic
life of both existing and newly introduced products for purposes
of this determination. Residual values are established at lease
inception using estimates of fair value at the end of the lease
term. Our residual values are established with due consideration
to forecasted supply and demand for our various products,
product retirement and future product launch plans, end-of-lease
customer behavior, remanufacturing strategies, competition
and technological changes.
The vast majority of our leases that qualify as sales-type are
non-cancelable and include cancellation penalties approximately
equal to the full value of the lease receivables. A portion of our
business involves sales to governmental units. Governmental
units are those entities that have statutorily defined funding or
annual budgets that are determined by their legislative bodies.
X e r o x C o r p o r a t i o n
Certain of our governmental contracts may have cancellation
provisions or renewal clauses that are required by law, such as
1) those dependant on fiscal funding outside of a governmental
unit’s control, 2) those that can be cancelled if deemed in the best
interest of the governmental unit’s taxpayers or 3) those that must
be renewed each fiscal year, given limitations that may exist on
entering into multi-year contracts that are imposed by statute.
In these circumstances, we carefully evaluate these contracts to
assess whether cancellation is remote because of the existence
of substantive economic penalties upon cancellation or whether
the renewal is reasonably assured due to the existence of a
bargain renewal option. The evaluation of a lease agreement
with a renewal option includes an assessment as to whether
the renewal is reasonably assured based on the intent of such
governmental unit and pricing terms as compared to those of
short-term leases at lease inception. We further ensure that the
contract provisions described above are offered only in instances
where required by law. Where such contract terms are not legally
required, we consider the arrangement to be cancelable and
account for it as an operating lease.
Aside from the initial lease of equipment to our customers, we may
enter subsequent transactions with the same customer whereby
we extend the term. We evaluate the classification of lease exten-
sions of sales-type leases using the originally determined economic
life for each product. There may be instances where we enter into
lease extensions for periods that are within the original economic
life of the equipment. These are accounted for as sales-type leases
only when the extensions occur in the last three months of the
lease term and they otherwise meet the appropriate criteria of
SFAS No. 13. All other lease extensions of this type are accounted
for as direct financing leases or operating leases, as appropriate.
Revenue Recognition Under Bundled Arrangements: We sell most
of our products and services under bundled lease arrangements,
which typically include equipment, service, supplies and financing
components for which the customer pays a single negotiated
fixed minimum monthly payment for all elements over the con-
tractual lease term. These arrangements typically also include an
incremental, variable component for page volumes in excess of
contractual page volume minimums, which are often expressed
in terms of price per page. The fixed minimum monthly payments
are multiplied by the number of months in the contract term to
arrive at the total fixed minimum payments that the customer is
obligated to make (“fixed payments”) over the lease term. The
payments associated with page volumes in excess of the minimums
are contingent on whether or not such minimums are exceeded
(“contingent payments”). The minimum contractual committed
page volumes are typically negotiated to equal the customer’s
estimated page volume at lease inception. In applying our lease
accounting methodology, we only consider the fixed payments
for purposes of allocating to the relative fair-value elements of the
contract. Contingent payments, if any, are inherently uncertain and
therefore are recognized as revenue in the period when the cus-
tomer exceeds the minimum copy volumes specified in the contract.
X e r o x A n n u a l R e p o r t 2 0 0 5
53
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Revenues under bundled arrangements are allocated considering
the relative fair values of the lease and non-lease deliverables
included in the bundled arrangement based upon the estimated
relative fair values of each element. Lease deliverables include
maintenance and executory costs, equipment and financing,
while non-lease deliverables generally consist of the supplies and
non-maintenance services. Our revenue allocation for the lease
deliverables begins by allocating revenues to the maintenance
and executory costs plus profit thereon. The remaining amounts
are allocated to the equipment and financing elements. We perform
extensive analyses of available verifiable objective evidence of
equipment fair value based on cash selling prices during the
applicable period. The cash selling prices are compared to the
range of values included in our lease accounting systems. The
range of cash selling prices must be reasonably consistent with the
lease selling prices, taking into account residual values that accrue
to our benefit, in order for us to determine that such lease prices
are indicative of fair value. Our pricing interest rates, which are used
to determine customer lease payments, are developed based upon
a variety of factors including local prevailing rates in the market-
place and the customer’s credit history, industry and credit class.
Effective in 2004, our pricing rates are reassessed quarterly based
on changes in local prevailing rates in the marketplace and are
adjusted to the extent such rates vary by twenty-five basis points
or more, cumulatively, from the last rate in effect. The pricing
interest rates generally equal the implicit rates within the leases, as
corroborated by our comparisons of cash to lease selling prices.
Cash and Cash Equivalents: Cash and cash equivalents consist
of cash on hand, including money-market funds, and investments
with original maturities of three months or less.
Restricted Cash and Investments: Several of our secured
financing arrangements and derivative contracts, as well as other
material contracts, require us to post cash collateral or maintain
minimum cash balances in escrow. These cash amounts are
reported in our Consolidated Balance Sheets, depending on
when the cash will be contractually released. At December 31,
2005 and 2004, such restricted cash amounts were as follows
(in millions):
December 31,
2005
2004
Escrow and cash collections related
to secured borrowing arrangements
Collateral related to risk management
arrangements
Other restricted cash
Total
$ 254
$ 372
43
149
61
97
$ 446
$ 530
Of these amounts, $270 and $370 were included in Other current
assets and $176 and $160 were included in Other long-term
assets, as of December 31, 2005 and 2004, respectively.
54
X e r o x A n n u a l R e p o r t 2 0 0 5
Provisions for Losses on Uncollectible Receivables: The provi-
sions for losses on uncollectible trade and finance receivables
are determined principally on the basis of past collection
experience applied to ongoing evaluations of our receivables
and evaluations of the default risks of repayment. Allowances for
doubtful accounts on accounts receivable balances were $136
and $183, as of December 31, 2005 and 2004, respectively.
Allowances for doubtful accounts on finance receivables were
$229 and $276 at December 31, 2005 and 2004, respectively.
Inventories: Inventories are carried at the lower of average cost
or market. Inventories also include equipment that is returned at
the end of the lease term. Returned equipment is recorded at the
lower of remaining net book value or salvage value. Salvage value
consists of the estimated market value (generally determined
based on replacement cost) of the salvageable component parts,
which are expected to be used in the remanufacturing process.
We regularly review inventory quantities and record a provision for
excess and/or obsolete inventory based primarily on our estimated
forecast of product demand, production requirements and servic-
ing commitments. Several factors may influence the realizability
of our inventories, including our decision to exit a product line,
technological changes and new product development. The provision
for excess and/or obsolete raw materials and equipment
inventories is based primarily on near-term forecasts of product
demand and include consideration of new product introductions
as well as changes in remanufacturing strategies. The provision
for excess and/or obsolete service parts inventory is based
primarily on projected servicing requirements over the life of the
related equipment populations.
Land, Buildings and Equipment and Equipment on Operating
Leases: Land, buildings and equipment are recorded at cost.
Buildings and equipment are depreciated over their estimated
useful lives. Leasehold improvements are depreciated over the
shorter of the lease term or the estimated useful life. Equipment
on operating leases is depreciated to estimated residual value
over the lease term. Depreciation is computed using the
straight-line method. Significant improvements are capitalized
and maintenance and repairs are expensed. Refer to Notes
5 and 6 for further discussion.
Goodwill and Other Intangible Assets: Goodwill is tested for impair-
ment annually or more frequently if an event or circumstance
indicates that an impairment loss may have been incurred.
Application of the goodwill impairment test requires judgment,
including the identification of reporting units, assignment of
assets and liabilities to reporting units, assignment of goodwill
to reporting units, and determination of the fair value of each
reporting unit. We estimate the fair value of each reporting unit
using a discounted cash flow methodology. This requires us
to use significant judgment including estimation of future cash
flows, which is dependent on internal forecasts, estimation of
the long-term rate of growth for our business, the useful life
over which cash flows will occur, determination of our weighted
average cost of capital, and relevant market data.
Other intangible assets primarily consist of assets obtained in con-
nection with business acquisitions, including installed customer
base and distribution network relationships, patents on existing
technology and trademarks. We apply an impairment evaluation
whenever events or changes in business circumstances indicate
that the carry value of our intangible assets may not be recover-
able. Other intangible assets are amortized on a straight-line basis
over their estimated economic lives. The straight-line method
of amortization reflects an appropriate allocation of the cost of
the intangible assets to earnings in proportion to the amount
of economic benefits obtained annually by the Company.
Impairment of Long-Lived Assets: We review the recoverability of
our long-lived assets, including buildings, equipment, internal-use
software and other intangible assets, when events or changes in
circumstances occur that indicate that the carrying value of the
asset may not be recoverable. The assessment of possible impair-
ment is based on our ability to recover the carrying value of the
asset from the expected future pre-tax cash flows (undiscounted
and without interest charges) of the related operations. If these
cash flows are less than the carrying value of such asset, an
impairment loss is recognized for the difference between estimated
fair value and carrying value. Our primary measure of fair value is
based on discounted cash flows. The measurement of impairment
requires management to make estimates of these cash flows related
to long-lived assets, as well as other fair value determinations.
Treasury Stock: We account for repurchased common stock
under the cost method and include such Treasury stock as a
component of our Common shareholders’ equity. Retirement
of Treasury stock is recorded as a reduction of Common stock
and Additional paid-in-capital.
Research and Development Expenses: Research and
development costs are expensed as incurred.
Restructuring Charges: Costs associated with exit or disposed
activities, including lease termination costs and certain employee
severance costs associated with restructuring, plant closing or
other activity, are recognized when they are incurred. In those
geographies where we have either a formal severance plan or a
history of consistently providing severance benefits representing
a substantive plan, we recognize severance costs when they are
both probable and reasonably estimable.
Pension and Post-retirement Benefit Obligations: We sponsor
pension plans in various forms in several countries covering
substantially all employees who meet eligibility requirements.
Post-retirement benefit plans cover primarily U.S. employees for
retirement medical costs. As permitted by existing accounting
rules, we employ a delayed recognition feature in measuring
the costs and obligations of pension and post-retirement benefit
plans. This requires changes in the benefit obligations and
X e r o x C o r p o r a t i o n
changes in the value of assets set aside to meet those obligations
to be recognized not as they occur, but systematically and
gradually over subsequent periods. All changes are ultimately
recognized, except to the extent they may be offset by sub-
sequent changes. At any point, changes that have been identified
and quantified await subsequent accounting recognition as net
cost components and as liabilities or assets.
Several statistical and other factors that attempt to anticipate
future events are used in calculating the expense, liability and
asset values related to our pension and post-retirement benefit
plans. These factors include assumptions we make about the
discount rate, expected return on plan assets, rate of increase
in healthcare costs, the rate of future compensation increases,
and mortality, among others. Actual returns on plan assets are
not immediately recognized in our income statement, due to the
delayed recognition requirement. In calculating the expected
return on the plan asset component of our net periodic pension
cost, we apply our estimate of the long-term rate of return to the
plan assets that support our pension obligations, after deducting
assets that are specifically allocated to Transitional Retirement
Accounts (which are accounted for based on specific plan terms).
For purposes of determining the expected return on plan assets,
we utilize a calculated value approach in determining the value
of the pension plan assets, as opposed to a fair market value
approach. The primary difference between the two methods
relates to systematic recognition of changes in fair value over
time (generally two years) versus immediate recognition of
changes in fair value. Our expected rate of return on plan assets
is then applied to the calculated asset value to determine the
amount of the expected return on plan assets to be used in the
determination of the net periodic pension cost. The calculated
value approach reduces the volatility in net periodic pension cost
that results from using the fair market value approach.
The difference between the actual return on plan assets and the
expected return on plan assets is added to, or subtracted from,
any cumulative differences that arose in prior years. This amount
is a component of the unrecognized net actuarial (gain) loss
and is subject to amortization to net periodic pension cost over
the remaining service lives of the employees participating in the
pension plan.
The discount rate is used to present-value our future anticipated
benefit obligations. In estimating our discount rate, we consider
rates of return on high-quality fixed-income investments included
in various published bond indexes, adjusted to eliminate the
effects of call provisions and differences in the timing and amounts
of cash outflows related to the bonds, as well as the expected
timing of pension and other benefit payments. In the U.S. and the
U.K., which comprise approximately 81% of our projected benefit
obligation, we consider the Moody’s Aa Corporate Bond Index
and the International Index Company’s iBoxx Sterling Corporates
AA Cash Bond Index, respectively, in the determination of the
appropriate discount rate assumptions.
X e r o x A n n u a l R e p o r t 2 0 0 5
55
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
The Production segment includes black and white products which
operate at speeds over 90 pages per minute (“ppm”) and color
products which operate at speeds over 40 ppm, excluding 50
ppm products with an embedded controller. Products include the
Xerox iGen3 digital color production press, Nuvera, DocuTech,
DocuPrint, Xerox 2101 and DocuColor families, as well as older
technology light-lens products. These products are sold predom-
inantly through direct sales channels in North America and Europe
to Fortune 1000, graphic arts, government, education and other
public sector customers.
The Office segment includes black and white products which
operate at speeds up to 90 ppm and color devices, up to
40 ppm, as well as 50 ppm color devices with an embedded
controller. Products include the suite of CopyCentre, WorkCentre
and WorkCentre Pro digital multifunction systems, DocuColor
color multifunction products, color laser, solid ink color printers
and multifunction devices, monochrome laser desktop printers,
digital and light-lens copiers and facsimile products. These
products are sold through direct and indirect sales channels
in North America and Europe to global, national and mid-size
commercial customers as well as government, education and
other public sector customers.
The DMO segment includes our operations in Latin America,
Central and Eastern Europe, the Middle East, India, Eurasia,
Russia and Africa. This segment’s sales consist of office and
production including a large proportion of office devices and
printers which operate at speeds of 11-30 ppm. Management
serves and evaluates these markets on an aggregate geographic
basis, rather than on a product basis.
The segment classified as Other includes several units, none of
which met the thresholds for separate segment reporting. This
group primarily includes Xerox Supplies Business Group (predom-
inantly paper), Small Office/Home Office (“SOHO”), Wide Format
Systems, Xerox Technology Enterprises and value-added services,
royalty and license revenues. Other segment profit (loss) includes
the operating results from these entities, other less significant
businesses, our equity income from Fuji Xerox, and certain costs
which have not been allocated to the Production, Office and DMO
segments, including non-financing interest as well as other items
included in Other (income) expenses, net.
Foreign Currency Translation: The functional currency for most
foreign operations is the local currency. Net assets are translated
at current rates of exchange, and income, expense and cash
flow items are translated at average exchange rates for the
applicable period. The translation adjustments are recorded in
Accumulated other comprehensive loss. The U.S. dollar is used
as the functional currency for certain subsidiaries that conduct
their business in U.S. dollars or operate in hyperinflationary
economies. A combination of current and historical exchange
rates is used in remeasuring the local currency transactions
of these subsidiaries and the resulting exchange adjustments
are included in income. Aggregate foreign currency losses
were $5, $73 and $11 in 2005, 2004 and 2003, respectively,
and are included in Other expenses, net in the accompanying
Consolidated Statements of Income.
Note 2 – Segment Reporting
Our reportable segments are consistent with how we manage
the business and view the markets we serve. Our reportable
segments are Production, Office, Developing Markets Operations
(“DMO”) and Other. The Production and Office segments are
centered around strategic product groups which share common
technology, manufacturing and product platforms, as well as
classes of customers. During 2005, we implemented a new
financial reporting system which has enabled greater efficiencies
in financial reporting and provides enhanced analytical capabilities
including activity-based cost analysis on shared services and
internal cost allocations. We have used the new financial reporting
system to make changes in the allocation of certain segment
costs and expenses, including a reallocation of costs associated
with corporate and certain shared service functions. These
changes did not involve a change in the composition of our
reportable segments and did not impact segment revenue.
We have reclassified prior-period amounts to conform to the
current period’s presentation. The following table illustrates
the impact of these changes on annual segment operating profit
for 2004 and 2003 (in millions):
Operating Profit
Years Ended
Production
Office
DMO
Other
Total
2004
$123
(19)
(8)
(96)
2003
$ 65
48
–
(113)
$
–
$
–
56
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Selected financial information for our operating segments for each of the years ended December 31, 2005, 2004 and 2003,
respectively, was as follows (in millions):
2005(1)
Information about profit or loss:
Revenues
Finance income
Total Segment revenues
Interest expense (2)
Segment profit (loss) (3)
Equity in net income of unconsolidated affiliates
2004(1)
Information about profit or loss:
Revenues
Finance income
Total Segment revenues
Interest expense (2)
Segment profit (loss) (3)
Equity in net income of unconsolidated affiliates
2003 (1)
Information about profit or loss:
Revenues
Finance income
Total Segment revenues
Interest expense (2)
Segment profit (loss) (3)
Equity in net income of unconsolidated affiliates
Production
Office
DMO
Other
Total
$ 4,198
342
$ 7,106
512
$ 1,803
9
$ 1,719
12
$14,826
875
$ 4,540
$ 7,618
$ 1,812
$ 1,731
$15,701
$ 121
427
–
$ 179
819
–
$
8
64
4
$ 249
151
94
$
557
1,461
98
$ 4,238
352
$ 7,075
552
$ 1,697
10
$ 1,778
20
$14,788
934
$ 4,590
$ 7,627
$ 1,707
$ 1,798
$15,722
$ 114
511
–
$ 176
779
–
$
12
35
3
$ 406
(125)
148
$
708
1,200
151
$ 4,131
376
$ 7,048
594
$ 1,751
12
$ 1,774
15
$14,704
997
$ 4,507
$ 7,642
$ 1,763
$ 1,789
$15,701
$ 120
466
–
$ 197
790
1
$
34
172
6
$
$ 533
(440)
51
884
988
58
(1) Asset information on a segment basis is not disclosed, as this information is not separately identified and internally reported to our chief executive officer.
(2) Interest expense includes equipment financing interest as well as non-financing interest, which is a component of Other expenses, net.
(3) Depreciation and amortization expense is recorded in cost of sales, research, development and engineering expenses and selling, administrative and general expenses and is
included in the segment profit (loss) above. This information is neither identified nor internally reported to our chief executive officer. The separate identification of this
information for purposes of segment disclosure is impracticable, as it is not readily available and the cost to develop it would be excessive.
The following is a reconciliation of segment profit to pre-tax income (in millions):
Years Ended December 31,
Total Segment profit
Unallocated items:
Restructuring and asset impairment charges
Provisions for certain litigation matters (1)
Initial provision for WEEE Directive (“FSP 143-1”) (2)
Losses from Hurricane Katrina
2002 credit facility fee write-off
Other expenses, net
Allocated item:
Equity in net income of unconsolidated affiliates
Pre-tax income
2005
2004
$ 1,461
$ 1,200
2003
$ 988
(366)
(114)
(26)
(15)
–
(12)
(86)
–
–
–
–
2
(176)
(239)
–
–
(73)
(6)
(98)
(151)
(58)
$ 830
$ 965
$ 436
(1) 2005 provision for litigation includes $102 related to MPI arbitration panel ruling, including $13 for interest expense, and $12 related to other legal matters.
Refer to Note 16 – Contingencies for further discussion. The 2003 provision for litigation includes the $239 charge related to the court, approved settlement of the
Berger v. RIGP litigation discussed in Note 14 – Employee Benefit Plans.
(2) See Note 1 – “New Accounting Standards and Accounting Changes” for discussion of this charge.
X e r o x A n n u a l R e p o r t 2 0 0 5
57
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Geographic area data was as follows:
(in millions)
United States
Europe
Other Areas
Total
Revenues
Long-Lived Assets (1)
2005
2004
2003
2005
2004
2003
$ 8,388
5,226
2,087
$ 8,346
5,281
2,095
$ 8,547
4,863
2,291
$ 1,386
500
386
$ 1,427
585
434
$ 1,477
616
460
$ 15,701
$ 15,722
$ 15,701
$ 2,272
$ 2,446
$ 2,553
(1) Long-lived assets are comprised of (i) land, buildings and equipment, net, (ii) equipment on operating leases, net, (iii) internal use software, net and (iv) capitalized software
costs, net.
Note 3 – Short-Term Investments
As of December 31, 2005, we held $244 in marketable
securities that are classified within Short-term investments in our
Consolidated Balance Sheets. These securities are considered
available-for-sale and are carried at fair value based on quoted
market prices. Unrealized gains and losses, net of taxes, are
recorded within Accumulated other comprehensive loss, a
component of Common shareholders’ equity. The purchases
of Short-term investments for the year-ending December 31,
2005 were $386, including $2 of premiums which are amortized
as an offset to Interest income over the remaining term of the
investments. The cost of securities sold is based on the specific
identification method. Proceeds from sales of Short-term
investments for the year ended December 31, 2005 were
$139. No gains or losses were realized on these sales.
The following table summarizes the fair market values and unrealized losses of our Short-term investments as of December 31, 2005
(in millions):
Description of Securities
Corporate bonds
Auction rate municipal bonds
U.S. government agency securities
Total Debt Securities
Auction rate preferred securities
Total Short-term investments
Maturities
Less Than 12 Months
Maturities
12 Months or Greater
Fair
Value
$ 93
–
13
$106
Unrealized
Losses
$ –
–
–
$ –
Fair
Value
$ 51
45
19
$115
Unrealized
Losses
$ 1
–
–
$ 1
The contractual maturities of the available-for-sale debt securities
at December 31, 2005 are shown to the right. Expected maturities
will differ from contractual maturities because borrowers may
have the right to prepay and creditors may have the right to call
obligations. These securities are classified within current assets
because they are highly liquid, traded in active markets and are
available for use, if needed, for current operations.
(in millions)
Debt Securities:
Due in 1 year or less
Due after 1 year through 5 years
Due after 5 years through 10 years
Due after 10 years
Total Debt Securities
Auction rate preferred securities
Total Short-term investments
Total
Unrealized
Loses
$ 1
–
–
$ 1
–
$ 1
Fair
Value
$144
45
32
$221
23
$244
Fair Value
$106
70
–
45
$221
23
$244
58
X e r o x A n n u a l R e p o r t 2 0 0 5
On an ongoing basis, we evaluate our investments to determine if
a decline in fair value is other-than-temporary. In this determination,
we consider the duration that, and extent to which, market value
is below original cost, our intent and ability to hold to recovery
and the financial health of the issuer.
Note 4 – Receivables, Net
Finance Receivables: Finance receivables result from installment
arrangements and sales-type leases arising from the marketing of
our equipment. These receivables are typically collateralized by a
security interest in the underlying assets. Finance receivables, net
at December 31, 2005 and 2004 were as follows (in millions):
Gross receivables
Unearned income
Unguaranteed residual values
Allowance for doubtful accounts
Finance receivables, net
Less: Billed portion of finance
receivables, net
2005
2004
$ 9,449 $10,267
(1,619)
125
(276)
(1,458)
87
(229)
7,849
8,497
(296)
(377)
Current portion of finance receivables
not billed, net
(2,604)
(2,932)
Amounts due after one year, net
$ 4,949 $ 5,188
Contractual maturities of our gross finance receivables
subsequent to December 31, 2005 were as follows (including
those already billed of $296) (in millions):
2006
2007
2008
2009
2010
There-
after
Total
$3,633 $2,590 $1,812 $1,004
$371
$39 $9,449
Secured Funding Arrangements
GE Secured Borrowings: We have an agreement in the U.S. (the
“Loan Agreement”) under which GE Vendor Financial Services, a
subsidiary of GE, is our primary third-party equipment financing
provider, through the funding of loans secured by new lease
originations. The maximum potential level of borrowing under the
Loan Agreement is a function of the size of the portfolio of finance
receivables generated by us that meet GE’s funding requirements
and cannot exceed $5 billion in any event. In October 2005,
we renegotiated the Loan Agreement, resulting in a reduction
in applicable interest rates and the elimination of the monthly
borrowing requirement. The interest rate reduction is applicable
to existing and new loans.
Under this agreement, GE funds a significant portion of new
U.S. lease originations at over-collateralization rates, which vary
over time, but are expected to approximate 10% at the inception
of each funding. The secured loans are subject to interest rates
calculated at each loan funding at yield rates consistent with
average rates for similar market-based transactions as well
as our current debt ratings. Refer to Note 11 for further infor-
mation on interest rates. New lease originations, including the
bundled service and supply elements, are transferred to a wholly
owned consolidated subsidiary which receives funding from GE.
X e r o x C o r p o r a t i o n
The funds received under this agreement are recorded as secured
borrowings and together with the associated lease receivables
are included in our Consolidated Balance Sheet. We and GE intend
the transfers of the lease contracts to be “true sales at law” and
that the wholly owned consolidated subsidiary be bankruptcy
remote and have received opinions to that effect from outside legal
counsel. As a result, the transferred receivables are not available
to satisfy any of our other obligations. GE’s funding commitment
is not subject to our credit ratings. There are no credit rating
defaults that could impair future funding under this agreement.
This agreement contains cross-default provisions related to
certain financial covenants contained in the 2003 Credit Facility
and other significant debt facilities. Any cross-default would impair
our ability to receive subsequent funding until the default was cured
or waived but does not accelerate previous borrowings except
in the case of bankruptcy. However, in the event of a default, we
could be replaced as the maintenance service provider for the
associated equipment under lease.
We have similar long-term lease funding arrangements with
GE in both the U.K. and Canada. These agreements contain
similar terms and conditions as those contained in the U.S. Loan
Agreement with respect to funding conditions and covenants. The
final funding date for all facilities is currently December 2010.
France Secured Borrowings: In July 2003, we securitized $443 of
receivables in France using a three-year public secured financing
arrangement. The funds received in connection with this agree-
ment were recorded as secured borrowings. In September 2005,
we repaid the remaining balance associated with this arrange-
ment of $47. We also have an ongoing warehouse financing
facility in France with Merrill Lynch to fund new lease originations.
In October 2005, we amended this agreement resulting in an
increase in the size of the facility from €350 million to €420 million
($414 to $497 as of December 31, 2005), lower applicable
interest rates and an extension for an additional two years at our
option from the current expiration date of July 2007.
The DLL Secured Borrowings: In 2002, we formed a joint
venture with De Lage Landen Bank (“the DLL Joint Venture”)
which became our primary equipment financing provider for new
lease originations in the Netherlands through fundings from De
Lage Landen Bank. In 2003, the DLL Joint Venture was expanded
to include the leasing operations in Belgium and Spain. Our DLL
Joint Venture is consolidated, as we are deemed to be the primary
beneficiary of the Joint Venture’s financial results (Refer to Note
1 – “Basis of Consolidation”). In September 2005, we completed
a transaction with our DLL Joint Venture to purchase De Lage
Landen Bank’s 51% ownership interest in the Belgium and Spain
leasing operations. In connection with the purchase, the secured
borrowings from De Lage Landen Bank to these operations of
$120 were repaid and the related finance receivables are no
longer encumbered. Other than the repayment of the secured
debt, the effects from this transaction were immaterial.
X e r o x A n n u a l R e p o r t 2 0 0 5
59
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
The following table shows finance receivables and related secured debt as of December 31, 2005 and 2004:
(in millions, unless otherwise indicated)
Finance Receivables Encumbered by Loans:
Facility
Amount
Maximum
Facility
Amount(1)
Finance
Receivables
Secured
Finance
Debt Receivables
Secured
Debt
December 31, 2005
December 31, 2004
GE secured loans:
GE Loans – U.S.
GE Loans – U.K.
GE Loans – Canada
Total GE Encumbered
finance receivables, net
Merrill Lynch Loan – France
Asset-backed notes – France
DLL – Netherlands
$5 billion
£400 million
(U.S. $690)
Cdn. $850 million
(U.S. $730)
$8 billion
£600 million
(U.S. $1.0 billion)
Cdn. $2 billion
(U.S. $1.7 billion)
€420 million
(U.S. $497)
N/A
N/A
€420 million
(U.S. $497)
N/A
N/A
Total Encumbered finance receivables, net
Unencumbered finance receivables, net
Total Finance receivables, net (2)
(1) Subject to mutual agreement by the parties.
$ 1,888
637
$ 1,701
581
$ 2,711
771
$ 2,486
685
258
174
486
426
2,783
430
–
216
2,456
342
–
184
3,968
368
225
436
3,597
287
148
404
3,429
$ 2,982
4,997
$ 4,436
4,420
$ 7,849
3,500
$ 8,497
(2) Includes (i) billed portion of finance receivables, net (ii) finance receivables, net and (iii) finance receivables due after one year, net as included in the Consolidated Balance
Sheets as of December 31, 2005 and 2004.
As of December 31, 2005, $3,429 of Finance receivables,
net are held as collateral in various entities, as security for the
borrowings noted above. Total outstanding debt secured by
these receivables at December 31, 2005 was $2,982. The
entities are consolidated in our financial statements. Although
the transferred assets are included in our total assets, the
assets of the entities are not available to satisfy any of our other
obligations. We also have arrangements in Germany, Italy, the
Nordic countries, Brazil and Mexico in which third-party financial
institutions originate lease contracts directly with our customers.
In these transactions, we sell and transfer title of the equipment
to these financial institutions and have no continuing ownership
rights in the leased equipment subsequent to its sale.
Accounts Receivable Funding Arrangement: In 2004, we
completed a transaction with GE for a three-year $400 revolving
credit facility secured by our U.S. accounts receivable. This
arrangement is being accounted for as a secured borrowing
within our Consolidated Balance Sheets. Secured accounts
receivables and related debt associated with this arrangement
as of December 31, 2005 and 2004 were as follows (in millions):
Secured accounts receivable, net
Secured debt
2005
$313
$178
2004
$354
$200
60
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Note 5 – Inventories and Equipment on
Operating Leases, Net
Note 6 – Land, Buildings and
Equipment, Net
Inventories at December 31, 2005 and 2004 were as follows
(in millions):
Land, buildings and equipment, net at December 31, 2005 and
2004 were as follows (in millions):
Finished goods
Work-in-process
Raw materials
Total Inventories
2005
2004
$ 956
99
146
$ 895
65
183
$ 1,201
$ 1,143
Equipment on operating leases and similar arrangements
consists of our equipment rented to customers and depreciated
to estimated salvage value at the end of the lease term.
The transfer of equipment from our inventories to equipment
subject to an operating lease is presented in our Consolidated
Statements of Cash Flows in the operating activities section as a
non-cash adjustment. We recorded $56, $73 and $78 in inventory
write-down charges for the years ended December 31, 2005,
2004 and 2003, respectively. Equipment on operating leases
and the related accumulated depreciation at December 31, 2005
and 2004 were as follows (in millions):
Equipment on operating leases
Less: Accumulated depreciation
2005
2004
$ 1,262
(831)
$ 1,649
(1,251)
Equipment on operating leases, net
$ 431
$ 398
Depreciable lives generally vary from three to four years consistent
with our planned and historical usage of the equipment subject to
operating leases. Depreciation and obsolescence expense was
$205, $210 and $271 for the years ended December 31, 2005,
2004 and 2003, respectively. Our equipment operating lease
terms vary, generally from 12 to 36 months. Scheduled minimum
future rental revenues on operating leases with original terms of
one year or longer are (in millions):
2006
$386
2007
$212
2008
$130
2009
$60
2010
$27
Thereafter
$4
Total contingent rentals on operating leases, consisting principally
of usage charges in excess of minimum contracted amounts, for
the years ended December 31, 2005, 2004 and 2003 amounted
to $136, $137 and $235, respectively.
Land
Buildings and building
equipment
Leasehold improvements
Plant machinery
Office furniture and equipment
Other
Construction in progress
Estimated
Useful Lives
(Years)
2005
2004
$
51
$
53
25 to 50
Varies
5 to 12
3 to 15
4 to 20
1,163
326
1,637
967
76
83
1,167
313
1,667
1,072
74
96
Subtotal
Less: Accumulated depreciation
4,303
(2,676)
4,442
(2,683)
Land, buildings and equipment, net
$ 1,627
$ 1,759
Depreciation expense was $280, $305 and $299 for the years
ended December 31, 2005, 2004 and 2003, respectively. We
lease certain land, buildings and equipment, substantially all of
which are accounted for as operating leases. Total rent expense
under operating leases for the years ended December 31, 2005,
2004 and 2003 amounted to $267, $316, and $287, respec-
tively. Future minimum operating lease commitments that have
remaining non-cancelable lease terms in excess of one year at
December 31, 2005 were as follows (in millions):
2006
$197
2007
$165
2008
$124
2009
$102
2010
$90
Thereafter
$197
In certain circumstances, we sublease space not currently
required in operations. Future minimum sublease income under
leases with non-cancelable terms in excess of one year amounted
to $14 at December 31, 2005.
We have an information technology contract with Electronic
Data Systems Corp. (“EDS”) through June 30, 2009. Services
to be provided under this contract include support of global
mainframe system processing, application maintenance, desktop
and helpdesk support, voice and data network management
and server management. There are no minimum payments due
EDS under the contract. Payments to EDS, which are primarily
recorded in selling, administrative and general expenses, were
$305, $328 and $340 for the years ended December 31, 2005,
2004 and 2003, respectively.
X e r o x A n n u a l R e p o r t 2 0 0 5
61
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
In December 2003, STHQ Realty LLC was formed to finance
the acquisition of the Company’s headquarters in Stamford,
Connecticut. While the assets and liabilities of this special-
purpose entity are included in the Company’s Consolidated
Financial Statements, STHQ Realty LLC is a bankruptcy remote
separate legal entity. As a result, its assets of $42 at December
31, 2005, are not available to satisfy the debts and other
obligations of the Company.
Note 7 – Investments in Affiliates, at Equity
Investments in corporate joint ventures and other companies
in which we generally have a 20% to 50% ownership interest at
December 31, 2005 and 2004 were as follows (in millions):
Equity in net income of Fuji Xerox is affected by certain
adjustments to reflect the deferral of profit associated
with intercompany sales. These adjustments may result in
recorded equity income that is different from that implied
by our 25% ownership interest.
Equity income for 2004 included $38 related to our share of
a pension settlement gain recorded by Fuji Xerox subsequent
to a transfer of a portion of their pension obligation to the
Japanese government, in accordance with the Japan Welfare
Pension Insurance Law.
Condensed financial data of Fuji Xerox for the three calendar
years ended December 31, 2005 was as follows (in millions):
Fuji Xerox (1)
Investment in subsidiary trusts issuing
preferred securities
Other investments
2005
$725
2004
$ 772
42
15
39
34
Summary of Operations:
Revenues
Costs and expenses
Income before income taxes
Income taxes
Minorities’ interests
Investments in affiliates, at equity
$782
$ 845
Net income
$
2005
2004
2003
$10,009
9,406
$ 9,450
8,595
$ 8,430
8,011
603
215
8
380
855
331
18
419
194
34
$ 506
$ 191
(1) Fuji Xerox is headquartered in Tokyo and operates in Japan, China, Australia, New
Zealand and other areas of the Pacific Rim. Our investment in Fuji Xerox of $725
at December 31, 2005, differs from our implied 25% interest in the underlying
net assets, or $811, due primarily to our deferral of gains resulting from sales
of assets by us to Fuji Xerox, partially offset by goodwill related to the Fuji Xerox
investment established at the time we acquired our remaining 20% of Xerox Limited
from The Rank Group plc. Such gains would only be recognized if Fuji Xerox sold
a portion of the assets we previously sold to it or if we were to sell a portion of our
current ownership interest in Fuji Xerox.
Our equity in net income of our unconsolidated affiliates
for the three years ended December 31, 2005 was as follows
(in millions):
Fuji Xerox
Other investments
Total
2005
$90
8
$98
2004
$ 134
17
$ 151
2003
$41
17
$58
Balance Sheet Data:
Assets:
Current assets
Long-term assets
Total Assets
Liabilities and
Shareholders’ Equity:
Current liabilities
Long-term debt
Other long-term liabilities
Minorities’ interests in
equity of subsidiaries
Shareholders’ equity
Total Liabilities and
$ 3,454
4,168
$ 3,613
4,606
$ 3,273
4,766
$ 7,622
$ 8,219
$ 8,039
$ 2,991
434
936
$ 2,757
616
1,383
$ 2,594
443
2,391
17
3,244
104
3,359
118
2,493
Shareholders’ Equity
$ 7,622
$ 8,219
$ 8,039
62
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
In 2005, 2004 and 2003, we received dividends of $38, $50
and $20, respectively, which were reflected as a reduction in our
investment. Additionally, we have a technology agreement with
Fuji Xerox whereby we receive royalty payments for their use of
our Xerox brand trademark, as well as rights to access their
patent portfolio in exchange for access to our patent portfolio.
In 2005, 2004 and 2003, we earned royalty revenues under
this agreement of $123, $119 and $110, respectively, which
are included in Service, outsourcing and rental revenues in the
Consolidated Statements of Income. We also have arrangements
with Fuji Xerox whereby we purchase inventory from and sell
inventory to Fuji Xerox. Pricing of the transactions under these
arrangements is based upon negotiations conducted at arm’s
length. Certain of these inventory purchases and sales are
the result of mutual research and development arrangements.
Our purchase commitments with Fuji Xerox are in the normal
course of business and typically have a lead time of three months.
Purchases from and sales to Fuji Xerox for the three years ended
December 31, 2005 were as follows (in millions):
Sales
Purchases
2005
2004
$ 163
$ 1,517
$ 166
$ 1,135
2003
$ 149
$ 871
In addition to the payments described above, in 2005, 2004
and 2003, we paid Fuji Xerox $28, $27 and $33, respectively,
and Fuji Xerox paid us $9 in each of the three years ended
2005, respectively, for unique research and development.
As of December 31, 2005 and 2004, amounts due to Fuji Xerox
were $157 and $155, respectively.
Note 8 – Goodwill and Intangible Assets, Net
Goodwill:
The carrying amount of goodwill was $1,671, $1,848 and $1,722, for the three years ended December 31, 2005. The only changes
in goodwill for each of the three years ended December 31, 2005 related to foreign currency translation adjustments of $(177), $132
and $158, respectively, as well as a $6 other charge that was incurred in the Other segment in 2004. The following table presents the
carrying amount of goodwill, by operating segment, as of December 31, 2005 and 2004, respectively (in millions):
Balance as of December 31, 2005
Balance as of December 31, 2004
Production
$745
848
Office
$807
881
DMO
$ –
–
Other
$119
119
Total
$1,671
1,848
Intangible Assets, Net:
Intangible assets primarily relate to the Office operating segment. Intangible assets were comprised of the following as of December 31,
2005 and 2004 (in millions):
Installed customer base
Distribution network
Existing technology
Licensed technology
Trademarks
As of December 31, 2005
As of December 31, 2004
Weighted Average
Amortization Period
Carrying Accumulated
Amount Amortization
Net
Amount
Carrying Accumulated
Amount Amortization
Net
Amount
Gross
Gross
17 years
25 years
7 years
7 years
7 years
$ 226
123
105
28
23
$ 505
$ 72
30
89
5
20
$ 216
$ 154
93
16
23
3
$ 289
$ 218
123
105
28
23
$ 497
$ 58
25
74
1
15
$ 173
$ 160
98
31
27
8
$ 324
Amortization expense related to intangible assets was $42, $38, and $36 for the years ended December 31, 2005, 2004 and 2003,
respectively, and is expected to approximate $40 in 2006 and approximate $22 annually from 2007 through 2010. Amortization
expense is primarily recorded in Other expenses, net, with the exception of amortization expense associated with licensed technology,
which is recorded in Cost of sales and Cost of service, outsourcing and rentals, as appropriate.
X e r o x A n n u a l R e p o r t 2 0 0 5
63
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 9 – Restructuring Programs
We have engaged in a series of restructuring programs related
to downsizing our employee base, exiting certain activities,
outsourcing certain internal functions and engaging in other
actions designed to reduce our cost structure and improve
productivity. Management continues to evaluate our business
and, therefore, there may be supplemental provisions for new
plan initiatives as well as changes in estimates to amounts
previously recorded, as payments are made or actions are
completed. Asset impairment charges were also incurred in
connection with these restructuring actions for those assets
made obsolete as a result of these programs.
The restructuring and asset impairment charges in the Consolidated Statements of Income totaled $366, $86 and $176 in 2005, 2004
and 2003, respectively. Detailed information related to restructuring program activity during the three years ended December 31, 2005
is outlined below (in millions):
Restructuring Activity
and
and
Asset
Related Costs Other Costs Impairments(1)
Total
Legacy
Programs(2)
Ongoing Programs
Lease
Severance Cancellation
Ending Balance December 31, 2002
$ 241
$ 45
$
Restructuring Provision
Reversals of prior accruals
Net current-year charges(3)
Charges against reserve and currency
Ending Balance December 31, 2003
Restructuring Provision
Reversals of prior accruals
Net current-year charges(3)
Charges against reserve and currency
Ending Balance December 31, 2004
Restructuring Provision
Reversals of prior accruals
Net current-year charges(3)
Charges against reserve and currency(4)
186
(15)
171
(269)
7
(1)
6
(15)
$ 143
$ 36
$
95
(11)
84
(157)
8
–
8
(21)
–
–
–
–
–
–
1
–
1
(1)
$ 286
$ 137
193
(16)
177
(284)
12
(13)
(1)
(94)
Total
$ 423
205
(29)
176
(378)
$ 179
$ 42
$ 221
104
(11)
93
(179)
2
(9)
(7)
(11)
106
(20)
86
(190)
$
70
$ 23
$
–
$
93
$ 24
$ 117
371
(21)
350
(203)
12
(6)
6
(10)
15
–
15
(15)
398
(27)
371
(228)
1
(6)
(5)
(19)
399
(33)
366
(247)
Ending Balance December 31, 2005
$ 217
$ 19
$
–
$ 236
$
–
$ 236
(1) Charges associated with asset impairments represent the write-down of the related assets to their new cost basis and are recorded concurrently with the recognition of the
provision. Accordingly, no reserve is ever maintained for asset impairments.
(2) Legacy Programs includes the runoff activity of several predecessor restructuring programs which were initiated between 2000 and 2001.
(3) Represents amount recognized within the Consolidated Statements of Income for the years shown.
(4) Charges in 2005 associated with Legacy Programs include the reclassification of $9 to Other current and non-current liabilities reflecting the close-out of these programs due
to the immateriality of the remaining liability. The remaining liability primarily relates to our exit from facilities in Europe and the U.S., which are currently leased through 2009.
64
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Additional details about our restructuring programs are as follows
(in millions):
Reconciliation to Statements of Cash Flows
Years Ended December 31,
2005
2004
2003
Charges to reserve,
all programs
Pension curtailment,
special termination benefits
and settlements
Asset Impairments
Effects of foreign currency
and other non-cash
Cash payments for
restructurings
$ (247)
$ (190)
$ (378)
–
15
18
8
1
(6)
33
1
(1)
$ (214)
$ (187)
$ (345)
Restructuring – Ongoing Programs: Beginning in the fourth
quarter of 2002, we initiated a series of ongoing restructuring
initiatives designed to leverage cost savings resulting from
realized productivity improvements, realign and lower our overall
cost structure and outsource certain internal functions. These
initiatives primarily include severance actions and impact all major
geographies and segments. During 2003, we provided $177 for
ongoing restructuring programs, net of reversals of $16 related
to changes in estimates for severance costs from previously
recorded actions. The provision consisted of net charges of
$138 primarily related to the elimination of approximately
2,000 positions worldwide, $33 for pension settlements and
post-retirement medical benefit curtailments and $6 for lease
terminations. During 2004, we provided an additional $93 for
ongoing restructuring programs, net of reversals of $11 related
to changes in estimates for severance costs from previously
recorded actions. The additional provision consisted of a net
charge of $76 related to the elimination of approximately 1,900
positions primarily in North America and Latin America, $8 for
pension settlements, $8 for lease terminations and $1 for asset
impairments. During 2005, we provided an additional $371
for ongoing restructuring programs, net of reversals of $27
primarily related to changes in estimates in severance costs
from previously recorded actions. The additional provision in
2005 consisted of a net charge of $350 for severance costs,
primarily related to the elimination of approximately 3,900
positions worldwide, a net charge of $6 for lease terminations
and $15 for asset impairments. The initiatives in 2005 are
focused on cost reductions in service, manufacturing and
back-office support operations primarily within the Office and
Production segments. We expect to spend the majority of the
restructuring balance as of December 31, 2005 in 2006.
The following tables summarize the total amount of costs expected to be incurred in connection with these restructuring programs and
the cumulative amount incurred as of December 31, 2005:
Segment Reporting
(in millions)
Production
Office
DMO
Other
Total Provisions
Cumulative amount
incurred as of
December 31, 2004
Amount incurred for
the year ended
December 31, 2005
Cumulative amount
incurred as of
December 31, 2005
$ 255
198
97
122
$ 672
$ 150
175
22
24
$ 371
$ 405
373
119
146
$ 1,043
Total expected
to be incurred*
$ 407
374
123
150
$1,054
* The total amount of $1,054 represents the cumulative amount incurred through December 31, 2005 plus additional expected restructuring charges of approximately $11
related to initiatives identified to date that have not yet been recognized in the Consolidated Financial Statements as well as expected interest accretion on the reserve.
Major Cost Reporting
(in millions)
Severance and related costs
Lease cancellation and other costs
Asset impairments
Total Provisions
Cumulative amount
incurred as of
December 31, 2004
Amount incurred for
the year ended
December 31, 2005
Cumulative amount
incurred as of
December 31, 2005
$ 567
59
46
$ 672
$ 350
6
15
$ 371
$ 917
65
61
$ 1,043
Total expected
to be incurred*
$ 922
70
62
$1,054
X e r o x A n n u a l R e p o r t 2 0 0 5
65
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 10 – Supplementary Financial
Information
The components of other current assets and other current
liabilities at December 31, 2005 and 2004 were as follows
(in millions):
Other current assets
Deferred taxes
Restricted cash
Prepaid expenses
Financial derivative instruments
Other
2005
2004
$ 290
270
133
28
311
$ 289
370
142
125
256
Total Other current assets
$ 1,032
$ 1,182
Other current liabilities
Income taxes payable
Other taxes payable
Interest payable
Restructuring reserves
Financial derivative instruments
Product warranties
Liability to Xerox Capital LLC
Other
$
84
199
102
212
12
20
98
625
$ 183
234
113
93
46
22
–
618
Total Other current liabilities
$ 1,352
$ 1,309
The components of other long-term assets and other long-
term liabilities at December 31, 2005 and 2004 were as follows
(in millions):
Other long-term assets
Prepaid pension costs
Net investment in discontinued operations
Internal use software, net
Restricted cash
Financial derivative instruments
Debt issuance costs, net
Other
2005
2004
$ 829
420
198
176
–
52
246
$ 891
440
255
160
19
64
244
Total Other long-term assets
$ 1,921
$ 2,073
Other long-term liabilities
Deferred and other tax liabilities
Minorities’ interests in equity of subsidiaries
Financial derivative instruments
Product warranties
Other
$ 771
90
45
1
388
$ 862
80
43
1
329
Total Other long-term liabilities
$ 1,295
$ 1,315
66
X e r o x A n n u a l R e p o r t 2 0 0 5
Net Investment in Discontinued Operations: Our net investment in
discontinued operations is primarily related to the disengagement
from our former insurance holding company, Talegen Holdings, Inc.
(“Talegen”), and consists of our net investment in Ridge Reinsurance
Limited (“Ridge Re”) and a performance-based instrument relating
to the 1997 sale of The Resolution Group (“TRG”).
Ridge Re: We provide aggregate excess of loss reinsurance
coverage (the Reinsurance Agreement) to one of the former
Talegen units, TRG, through Ridge Re, a wholly owned subsidiary.
The coverage limit for this remaining Reinsurance Agreement is
$578. We have guaranteed that Ridge Re will meet all of its financial
obligations under the remaining Reinsurance Agreement. Ridge
Re maintains an investment portfolio in a trust that is required to
provide security with respect to aggregate excess of loss rein-
surance obligations under the remaining Reinsurance Agreement.
At December 31, 2005 and 2004, the balance of the investments
in the trust, consisting of U.S. government, government agency
and high-quality corporate bonds, was $504 and $544, respectively.
Our remaining net investment in Ridge Re was $83 and $82 at
December 31, 2005 and 2004, respectively. Based on Ridge Re’s
current projections of investment returns and reinsurance payment
obligations, we expect to fully recover our remaining investment.
The projected reinsurance payments are based on actuarial
estimates. We continue to evaluate potential strategies to transfer
our obligations under the remaining Reinsurance Agreement,
as well as the investments in the trust, to another insurance
company in an effort to completely exit from this business.
Performance-Based Instrument: In connection with the 1997 sale
of TRG, we received a $462 performance-based instrument as
partial consideration. Cash distributions are paid on the instrument,
based on 72.5% of TRG’s available cash flow as defined in the
sale agreement. For the years ended December 31, 2005 and
2004, we received cash distributions of $20 and $22, respectively.
The recovery of this instrument is dependent upon the sufficiency
of TRG’s available cash flows. Such cash flows are supported by
TRG’s ultimate parent via a subscription agreement whereby the
parent has agreed to purchase from TRG an established number
of shares of this instrument each year through 2017. Based on
current cash flow projections, we expect to fully recover the $345
remaining balance of this instrument.
Liability to Xerox Capital LLC: Refer to Note 12 for further
information.
Internal Use Software: Capitalized direct costs associated with
developing, purchasing or otherwise acquiring software for internal
use are amortized on a straight-line basis over the expected useful
life of the software, beginning when the software is implemented.
Useful lives of the software generally vary from 3 to 5 years.
Amortization expense, including applicable impairment charges,
was $92, $107 and $116 for the years ended December 31,
2005, 2004 and 2003, respectively.
X e r o x C o r p o r a t i o n
U.S. Operations
Weighted Average
Interest Rates at
December 31, 2005
2005
2004
Other U.S. Operations
Borrowings secured by
finance receivables (3)
Borrowings secured by
other assets
Subtotal
Total U.S. Operations
International Operations
Xerox Capital (Europe) plc:
Japanese yen due 2005
U.S. dollars due 2008(1)
Subtotal
Other International Operations
Pound Sterling secured
borrowings due
2007-2008 (3)
Euro secured borrowings
due 2005-2010 (3)
Canadian dollars secured
borrowings due
2005-2007 (3)
Other debt due 2005-2010
Subtotal
Total International Operations
Subtotal
Less current maturities
Total Long-term debt
4.78
$ 1,701 $ 2,486
5.67
220
1,921
5,895
257
2,743
7,913
–
–
6.06
3.73
5.49
5.86
–
–
–
581
526
174
62
1,343
1,343
97
25
122
685
839
426
103
2,053
2,175
7,238
10,088
(1,099)
(3,038)
$ 6,139 $ 7,050
(1) Certain debt instruments, totaling $140, were redeemed in 2005 prior to their
scheduled maturities.
(2) As of December 31, 2005, these senior notes were guaranteed by our wholly
Note 11 – Debt
Short-term borrowings at December 31, 2005 and 2004 were as
follows (in millions):
Current maturities of long-term debt
Notes payable
Total
2005
2004
$ 1,099
40
$ 3,038
36
$ 1,139
$ 3,074
We classify our debt based on the contractual maturity dates
of the underlying debt instruments or as of the earliest put date
available to the debt holders. We defer costs associated with debt
issuance over the applicable term or to the first put date, in the
case of convertible debt or debt with a put feature. These costs
are amortized as interest expense in our Consolidated Statement
of Income.
Long-term debt, including debt secured by finance receivables
at December 31, 2005 and 2004 was as follows (in millions):
U.S. Operations
Weighted Average
Interest Rates at
December 31, 2005
2005
2004
–% $
–
1.31
9.75
9.75
7.13
7.01
6.88
7.63
9.00
7.20
6.22
–
–
27
620
260
688
50
752
542
19
251
300
$
15
25
27
627
297
704
50
758
550
19
252
300
Xerox Corporation
Notes due 2006 (1)
Notes due 2007 (1)
Notes due 2008
Senior Notes due 2009 (2)
Euro Senior Notes due 2009
Senior Notes due 2010 (2)
Notes due 2011
Senior Notes due 2011 (2)
Senior Notes due 2013 (2)
Convertible Notes due 2014
Notes due 2016
2003 Credit Facility due 2008
Subtotal
Xerox Credit Corporation
Yen notes due 2005
Yen notes due 2007
Notes due 2008 (1)
Notes due 2012 (1)
Notes due 2013
Notes due 2014
Notes due 2018
Subtotal
3,509
3,624
owned subsidiary Xerox International Joint Marketing, Inc.
–
2.00
–
7.07
6.50
6.06
7.00
–
255
–
75
60
50
25
970
292
25
125
59
50
25
$ 465
$1,546
(3) Refer to Note 4 – Receivables, Net, for further discussion of borrowings secured
by finance receivables, net.
Scheduled payments due on long-term debt for the next five years
and thereafter are as follows (in millions):
2006
2007
2008
2009
2010
There-
after
Total
$1,099 $1,582
$978
$989
$727 $1,863 $7,238
X e r o x A n n u a l R e p o r t 2 0 0 5
67
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
The Senior Notes also contain negative covenants (but no financial
maintenance covenants) similar to those contained in the 2003
Credit Facility. However, they generally provide us with more flexi-
bility than the 2003 Credit Facility covenants, except that payment
of cash dividends on the Series C Mandatory Convertible Preferred
Stock is subject to the conditions that there is then no default
under the Senior Notes, that the fixed-charge coverage ratio (as
defined) is greater than 2.25 to 1.00, and that the amount of the
cash dividend does not exceed the then amount available under
the restricted payments basket (as defined). The Senior Notes are
guaranteed by our wholly owned subsidiary Xerox International
Joint Marketing, Inc.
Debt Repayments and Maturities: During 2005, we repaid
$140 of public unsecured debt prior to its scheduled maturity
in addition to $1,020 in scheduled public debt maturities.
Guarantees: At December 31, 2005, we have guaranteed $17
of indebtedness of our foreign subsidiaries. This debt is included
in our Consolidated Balance Sheet as of such date. In addition, as
of December 31, 2005, $32 of letters of credit have been issued
in connection with insurance guarantees.
Interest: Interest paid on our short-term debt, long-term debt and
liabilities to subsidiary trusts issuing preferred securities amounted
to $555, $710 and $867 for the years ended December 31,
2005, 2004 and 2003, respectively.
Interest expense and interest income for the three years ended
December 31, 2005 was as follows (in millions):
Years Ended December 31,
2005
2004
2003
Interest expense (1)
Interest income (2)
$ 557
(1,013)
$ 708
(1,009)
$ 884
(1,062)
(1) Includes Equipment financing interest expense, as well as non-financing interest
expense included in Other expenses, net in the Consolidated Statements of
Income.
(2) Includes Finance income, as well as other interest income that is included in
Other expenses, net in the Consolidated Statements of Income.
Equipment financing interest is determined based on an
estimated cost of funds applied against an estimated level
of debt required to support our financed receivables. The
estimated cost of funds is primarily based on our secured
borrowing rates. The estimated level of debt is based on an
assumed 7 to 1 leverage ratio of debt/equity as compared
to our average finance receivables. This methodology has
been consistently applied for all periods presented.
Credit Facility: In June 2003, we entered into the 2003 Credit
Facility. The 2003 Credit Facility consists of a fully drawn $300
term loan and a $700 revolving credit facility that includes a $200
letter of credit sub-facility. This facility expires on September 30,
2008. As of December 31, 2005, the $300 term loan and $15 of
letters of credit were outstanding and there were no outstanding
borrowings under the revolving credit facility. Since inception
of the 2003 Credit Facility in June 2003, there have been no
borrowings under the revolving credit facility. Xerox is the only
borrower of the term loan.
Subject to certain limits described in the following paragraph,
the obligations under the 2003 Credit Facility are secured by liens
on substantially all the assets of Xerox and each of our U.S. sub-
sidiaries that have a consolidated net worth from time to time of
$100 or more (the “Material Subsidiaries”), excluding Xerox Credit
Corporation (“XCC”) and certain other finance subsidiaries, and
are guaranteed by certain Material Subsidiaries. At December 31,
2005, Xerox is the only borrower under the 2003 Credit Facility.
Under the terms of certain of our outstanding public bond
indentures, the amount of obligations under the 2003 Credit
Facility that can be (1) secured by assets (the “Restricted Assets”)
of (a) Xerox and (b) our non-financing subsidiaries that have a
consolidated net worth of at least $100, without (2) triggering a
requirement to also secure those indentures, is limited to the
excess of (x) 20% of our consolidated net worth (as defined in the
public bond indentures) over (y) the outstanding amount of certain
other debt that is secured by the Restricted Assets. Accordingly,
the amount of 2003 Credit Facility debt secured by the Restricted
Assets will vary from time to time with changes in our consolidated
net worth. The amount of security provided under this formula
accrues ratably to the benefit of both the term loan and revolving
loans under the 2003 Credit Facility.
The term loan and the revolving loans bear interest at LIBOR plus
a spread that varies between 1.75% and 3.00% or, at our election,
at a base rate plus a spread that depends on the then-current
Leverage Ratio, as defined, in the 2003 Credit Facility. The
interest rate on the debt as of December 31, 2005 was 6.22%.
The 2003 Credit Facility contains affirmative and negative covenants
as well as financial maintenance covenants. Subject to certain
exceptions, we cannot pay cash dividends on our common stock
during the facility term, although we can pay cash dividends on
our preferred stock, provided there is then no event of default.
Among defaults customary for facilities of this type, defaults on
our other debt, bankruptcy of certain of our legal entities, or a
change in control of Xerox Corporation, would all constitute
events of default. At December 31, 2005, we were in compliance
with the covenants of the 2003 Credit Facility and we expect
to remain in compliance for at least the next twelve months.
68
X e r o x A n n u a l R e p o r t 2 0 0 5
A summary of the Net cash payments on other debt as shown on
the Consolidated Statements of Cash Flows for the three years
ended December 31, 2005 follows (in millions):
Cash proceeds (payments)
on notes payable, net
Net cash proceeds from
2005
2004
2003
$
4
$
(6) $
22
issuance of long-term debt (1)
50
974
1,580
Cash payments on
long-term debt
Total Net cash payments
(1,241)
(2,390)
(5,646)
on other debt
$(1,187) $(1,422) $(4,044)
(1) Includes payment of debt issuance costs.
Note 12 – Liability to Subsidiary Trusts
Issuing Preferred Securities
The Liability to Subsidiary Trusts Issuing Preferred Securities
included in our Consolidated Balance Sheets reflects the obliga-
tions to our subsidiaries that have issued preferred securities.
These subsidiaries are not consolidated in our financial state-
ments because we are not the primary beneficiary of the trusts.
As of December 31, 2005 and 2004, the components of our
liabilities to the trusts were as follows (in millions):
Trust I
Xerox Capital LLC (1)
Total
2005
$626
98
$724
2004
$629
88
$717
(1) Classified in Other current liabilities in the December 31, 2005 Consolidated
Balance Sheet.
Trust I: In 1997, Xerox Capital Trust I (“Trust I”) issued 650
thousand of 8.0% preferred securities (the “Preferred Securities”)
to investors for $644 ($650 liquidation value) and 20,103 shares
of common securities to us for $20. With the proceeds from
these securities, Trust I purchased $670 principal amount of
8.0% Junior Subordinated Debentures due 2027 of the Company
(“the Debentures”). The Debentures represent all of the assets
of Trust I. On a consolidated basis, we received net proceeds
of $637 which was net of fees and discounts of $13. Interest
expense, together with the amortization of debt issuance costs
and discounts, amounted to $54, $54 and $52 in 2005, 2004
and 2003, respectively. We have guaranteed (the “Guarantee”),
on a subordinated basis, distributions and other payments due
on the Preferred Securities. The Guarantee and our obligations
under the Debentures and in the indenture pursuant to which the
Debentures were issued and our obligations under the Amended
X e r o x C o r p o r a t i o n
and Restated Declaration of Trust governing the trust, taken
together, provide a full and unconditional guarantee of amounts
due on the Preferred Securities. The Preferred Securities accrue
and pay cash distributions semiannually at a rate of 8% per year
of the stated liquidation amount of one thousand dollars per
Preferred Security. The Preferred Securities are mandatorily
redeemable upon the maturity of the Debentures on February 1,
2027, or earlier to the extent of any redemption by us of any
Debentures. The redemption price in either such case will be one
thousand dollars per share plus accrued and unpaid distributions
to the date fixed for redemption.
Xerox Capital LLC: In 1996, Xerox Capital LLC issued 2 million
deferred preferred shares for Canadian (Cdn.) $50 ($42) to
investors and all of its common shares to us. The total proceeds
of Cdn. $63 ($52) were loaned to us. The deferred preferred
shares are mandatorily redeemable on February 28, 2006 for
Cdn. $90 (equivalent to $77 at December 31, 2005). Our liability
to the subsidiary trust at December 31, 2005 of $98 includes the
redeemable amount of deferred preferred shares of $77 as well
as our liability to the deconsolidated trust of $21. This liability
has been reclassified on the December 31, 2005 Consolidated
Balance Sheet from a long-term liability to current liabilities due
to the redemption date of February 28, 2006.
Note 13 – Financial Instruments
We are exposed to market risk from changes in foreign currency
exchange rates and interest rates, which could affect operating
results, financial position and cash flows. We manage our
exposure to these market risks through our regular operating
and financing activities and, when appropriate, through the use
of derivative financial instruments. These derivative financial
instruments are utilized to hedge economic exposures as well as
reduce earnings and cash flow volatility resulting from shifts in
market rates. As permitted, certain of these derivative contracts
have been designated for hedge accounting treatment under
SFAS No. 133. However, for certain of these instruments we
do not apply hedge accounting treatment and, accordingly, our
results of operations are exposed to some level of volatility. The
level of volatility will vary with the type and amount of derivative
hedges outstanding, as well as fluctuations in the currency and
interest rate market during the period.
X e r o x A n n u a l R e p o r t 2 0 0 5
69
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
We enter into limited types of derivative contracts, including
interest rate and cross-currency interest rate swap agreements,
foreign currency spot, forward and swap contracts and pur-
chased foreign currency options to manage interest rate and
foreign currency exposures. Our primary foreign currency market
exposures include the Japanese yen, Euro, British pound sterling,
Canadian dollar and Brazilian real. The fair market values of all
our derivative contracts change with fluctuations in interest rates
and/or currency rates and are designed so that any changes in
their values are offset by changes in the values of the underlying
exposures. Derivative financial instruments are held solely as risk
management tools and not for trading or speculative purposes.
By their nature, all derivative instruments involve, to varying
degrees, elements of market and credit risk not recognized in
our financial statements. The market risk associated with these
instruments resulting from currency exchange and interest
rate movements is expected to offset the market risk of the
underlying transactions, assets and liabilities being hedged.
We do not believe there is significant risk of loss in the event of
non-performance by the counterparties associated with these
instruments because these transactions are executed with a
diversified group of major financial institutions. Further, our policy
is to deal with counterparties having a minimum investment-grade-
or-better credit rating. Credit risk is managed through the
continuous monitoring of exposures to such counterparties.
Some of our derivative and other material contracts at
December 31, 2005 require us to post cash collateral or
maintain minimum cash balances in escrow. These cash amounts
are reported in our Consolidated Balance Sheets within Other
current assets or Other long-term assets, depending on when
the cash will be contractually released, as presented in Note 1
to the Consolidated Financial Statements.
Interest Rate Risk Management: We use interest rate swap agree-
ments to manage our interest rate exposure and to achieve a
desired proportion of variable and fixed-rate debt. These derivatives
may be designated as fair-value hedges or cash flow hedges,
depending on the nature of the risk being hedged. Virtually all
customer-financing assets earn fixed rates of interest and a
significant portion of those assets have been matched to secured
borrowings through third-party funding arrangements which gen-
erally bear fixed rates of interest. These borrowings are secured
by customer-financing assets and are designed to mature as we
collect principal payments on the financing assets which secure
them. The interest rates on a significant portion of those loans
are fixed. As a result, these funding arrangements create natural
match funding of the financing assets to the related debt.
At December 31, 2005 and 2004, we had outstanding single
currency interest rate swap agreements with aggregate notional
amounts of $2.1 billion and $2.8 billion, respectively. The net
liability fair values at December 31, 2005 and 2004 were
$40 and $37, respectively.
Fair Value Hedges: As of December 31, 2005 and 2004, pay variable/receive fixed-interest rate swaps with notional amounts of $1.8
billion and $2.4 billion, respectively, were designated and accounted for as fair-value hedges. The swaps were structured to hedge the
fair value of related debt by converting them from fixed-rate instruments to variable-rate instruments. No ineffective portion was recorded
to earnings during 2005 or 2004. The following is a summary of our fair value hedges at December 31, 2005 (in millions):
Debt Instrument
Senior Notes due 2010
Senior Notes due 2013
Notes due 2016
Senior Notes due 2011
Liability to Capital Trust I
Total
Year First
Designated
2003/2005
2003
2004
2004
2005
Notional
Amount
$ 550
250
250
250
450
$ 1,750
Net
Liability
Fair Value
Weighted-
Average
Interest
Rate Paid
Interest
Rate
Received
Basis
Maturity
$ (9)
(3)
(3)
(6)
(18)
$ (39)
7.39%
7.40%
7.17%
7.26%
6.34%
7.13%
7.63%
7.20%
6.88%
8.00%
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
2010
2013
2016
2011
2027
70
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Cash Flow Hedges: During 2005, pay fixed/receive variable-
interest rate swaps with notional amounts of £200 million ($345)
and a net liability fair value of $(1), associated with the Xerox
Finance Limited GE Capital borrowing, were designated and
accounted for as cash flow hedges. The swaps were structured
to hedge the LIBOR interest rate of the debt by converting it from
a variable-rate instrument to a fixed-rate instrument. No ineffective
portion was recorded to earnings during 2005.
Terminated Swaps: During 2005, we terminated interest rate
swaps with a notional value of $1.3 billion and a net fair liability
value of $29 which had previously been designated as fair-value
hedges of certain indebtedness. The fair-value adjustment to
these debt instruments will be amortized to interest expense over
the remaining term of the notes. During 2004, we terminated
interest rate swaps with a notional value of $1.1 billion and a net
fair asset value of $68. Interest rate swaps with a notional value
of $600 and a net fair asset value of $55 had previously been
designated as fair-value hedges against the Senior Notes due
2009. In 2005 and 2004, the amortization of these fair-value
adjustments reduced interest expense by $11 and $9, respec-
tively. The remaining derivatives terminated in 2005 and 2004
had not been previously designated as hedges and accordingly
those terminations had no impact on earnings as they were being
marked to market through earnings each period.
Purchases of Foreign-Sourced Inventory
• We generally utilize forward foreign exchange contracts
and purchased option contracts to hedge these anticipated
transactions. These contracts generally mature in six
months or less.
• Although these contracts are intended to economically hedge
foreign currency risks to the extent possible, the differences
between the contract terms of our derivatives and the
underlying forecasted exposures reduce our ability to obtain
hedge accounting. Accordingly, changes in value for these
derivatives are recorded directly through earnings.
During 2005, 2004 and 2003, we recorded net currency losses
of $5, $73 and $11, respectively. Net currency losses primarily
result from the mark-to-market of foreign exchange contracts
utilized to hedge foreign currency denominated assets and
liabilities, the re-measurement of foreign currency-denominated
assets and liabilities and the mark-to-market impact of economic
hedges of anticipated transactions for which we do not apply
cash flow hedge accounting treatment.
At December 31, 2005, we had outstanding forward exchange and
purchased option contracts with gross notional values of $2,927.
The following is a summary of the primary hedging positions and
corresponding fair values held as of December 31, 2005:
Foreign Exchange Risk Management: We may use certain
derivative instruments to manage the exposures associated
with the foreign currency exchange risks discussed below.
(in millions)
Issuance of Foreign Currency Denominated Debt
• We enter into cross-currency interest rate swap agreements
to swap the proceeds and related interest payments with a
counterparty. In return, we receive and effectively denominate
the debt in local functional currencies.
• We utilize forward exchange contracts to hedge the
currency exposure for interest payments on foreign currency
denominated debt.
• These derivatives may be designated as fair-value hedges
or cash flow hedges depending on the nature of the risk
being hedged.
Foreign Currency Denominated Assets and Liabilities
• We generally utilize forward foreign exchange contracts and
purchased option contracts to hedge these exposures.
• Changes in the value of these currency derivatives are recorded
in earnings together with the offsetting foreign exchange gains
and losses on the underlying assets and liabilities.
Currency Hedged (Buy/Sell)
U.S. Dollar/Euro
Japanese Yen/U.S. Dollar
Euro/U.S. Dollar
Canadian Dollar/Euro
Euro/U.K. Pound Sterling
Canadian Dollar/U.S. Dollar
Swedish Kronor/Euro
U.S. Dollar/U.K. Pound Sterling
U.S. Dollar/Canadian Dollar
Euro/Canadian Dollar
U.K. Pound Sterling/Euro
Swiss Franc/Euro
All Other
Total
Gross
Notional
Value
$ 634
467
225
205
199
166
147
129
118
98
93
93
353
$2,927
Fair Value
Asset
(Liability)
$10
2
(2)
(1)
2
–
1
3
–
1
(1)
(1)
2
$16
At December 31, 2005 and 2004, we had outstanding cross-
currency interest-rate swap agreements with aggregate notional
amounts of $127 and $597, respectively. The net (liability) asset
fair values at December 31, 2005 and 2004 were $(5) and
$44, respectively. There was only one contract outstanding at
December 31, 2005 and Japanese Yen was the currency hedged.
X e r o x A n n u a l R e p o r t 2 0 0 5
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N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Cash Flow Hedges: As of December 31, 2005, cross-currency
swaps with a notional amount of $127 were used to hedge the
currency exposure for interest payments and principal on half
of our Japanese Yen denominated debt of ¥30 billion ($255).
In addition, forward currency contracts were used to hedge the
currency exposure for interest payments on the remaining debt.
These combined strategies converted the hedged cash flows
to U.S. dollar denominated payments and qualified for cash flow
hedge accounting.
During 2004, certain forward contracts were used to hedge the
interest payments on Euro denominated debt of $377. The deriva-
tives were designated and accounted for as cash flow hedges.
No amount of ineffectiveness was recorded in the Consolidated
Statements of Income during 2005 or 2004 for our designated
cash flow hedges and all components of each derivative’s gain
or loss was included in the assessment of hedge effectiveness.
Accumulated Other Comprehensive Loss (“AOCL”): During 2005,
a $32 after-tax decrease in the fair value of cash flow hedges was
recorded in AOCL while an after-tax amount of $30 was transferred
to earnings as a result of scheduled payments and receipts on our
cash flow hedges. This resulted in an ending gain position relating
to the cash flow hedges in AOCL of $1 as of December 31, 2005.
During 2004, a $16 after-tax increase in the fair value of cash
flow hedges was recorded in AOCL while an after-tax amount
of $(14) was transferred to earnings as a result of scheduled
payments and receipts on our cash flow hedges. This resulted in
an ending gain position relating to the cash flow hedges in AOCL
of $3 as of December 31, 2004.
Fair Value of Financial Instruments: The estimated fair values of our financial instruments at December 31, 2005 and 2004 were as follows:
(in millions)
Carrying Amount
Fair Value
Carrying Amount
Fair Value
2005
2004
Cash and cash equivalents
Short-term investments
Accounts receivable, net
Short-term debt
Long-term debt
Short-term liabilities to trusts issuing
preferred securities (1)
Long-term liabilities to trusts issuing
preferred securities
$1,322
244
2,037
1,139
6,139
98
626
$1,322
244
2,037
1,134
6,312
96
642
(1) Recognized as a component of Other current liabilities within the Consolidated Balance Sheets.
$3,218
–
2,076
3,074
7,050
–
717
$3,218
–
2,076
3,093
7,442
–
738
The fair value amounts for Cash and cash equivalents and
Accounts receivable, net approximate carrying amounts due
to the short maturities of these instruments. The fair value of
Short- and Long-term debt, as well as Liabilities to subsidiary
trusts issuing preferred securities, was estimated based on
quoted market prices for publicly traded securities or on
the current rates offered to us for debt of similar maturities.
The difference between the fair value and the carrying value
represents the theoretical net premium or discount we would
pay or receive to retire all debt at such date.
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X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Note 14 – Employee Benefit Plans
We sponsor numerous pension and other post-retirement benefit plans, primarily retiree health, in our U.S. and international operations.
September 30 is the measurement date for most of our European plans and December 31 is the measurement date for all of our other
post-retirement benefit plans, including all of our domestic plans. Information regarding our benefit plans is presented below (in millions):
Change in Benefit Obligation
Benefit obligation, January 1
Service cost
Interest cost
Plan participants’ contributions
Plan amendments
Actuarial loss (gain)
Currency exchange rate changes
Curtailments
Special termination benefits
Benefits paid/settlements
Benefit obligation, December 31
Change in Plan Assets
Fair value of plan assets, January 1
Actual return on plan assets
Employer contribution
Plan participants’ contributions
Currency exchange rate changes
Transfers/divestitures
Benefits paid/settlements
Fair value of plan assets, December 31
Funded status (including under-funded and non-funded plans)
Unamortized transition (assets) obligations
Unrecognized prior service cost
Unrecognized net actuarial loss
Net amount recognized
Amounts recognized in the Consolidated Balance Sheets consist of:
Prepaid benefit cost
Accrued benefit liability
Intangible asset
Minimum pension liability included in AOCL
Net amount recognized
Change in minimum liability included in AOCL
Pension Benefits
Other Benefits
2005
2004
2005
2004
$ 10,028
234
581
11
30
527
(486)
(5)
–
(618)
$ 8,971
222
660
14
232
272
356
(2)
2
(699)
$ 1,662
19
90
15
44
(54)
4
–
–
(127)
$ 1,579
22
89
18
–
70
6
–
–
(122)
$ 10,302
$10,028
$ 1,653
$ 1,662
$ 8,110
933
388
11
(418)
38
(618)
$ 7,301
772
409
14
311
2
(699)
$
–
–
112
15
–
–
(127)
$
–
–
104
18
–
–
(122)
$ 8,444
$ 8,110
$
–
$
–
$ (1,858)
3
(28)
1,918
$ (1,918)
(1)
(23)
1,993
$(1,653)
–
(45)
410
$(1,662)
–
(112)
494
$
$
$
$
35
833
(1,081)
9
274
35
32
$
$
$
$
51
$(1,288)
$(1,280)
$
–
(1,288)
–
–
$
–
(1,280)
–
–
$(1,288)
$(1,280)
897
(1,092)
4
242
51
(20)
Information for benefit plans that are under-funded or non-funded on a Projected Benefit Obligation basis is presented below (in millions):
Aggregate projected benefit obligation
Aggregate fair value of plan assets
Pension Benefits
Other Benefits
2005
2004
2005
2004
$ 10,240
8,364
$ 9,959
8,019
$ 1,653
–
$ 1,662
–
X e r o x A n n u a l R e p o r t 2 0 0 5
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N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
The accumulated benefit obligation for all defined benefit pension
plans was $9,248 and $8,966 at December 31, 2005 and
2004, respectively.
Information for pension plans with an accumulated benefit obligation
in excess of plan assets is presented below (in millions):
Aggregate projected benefit obligation
Aggregate accumulated benefit obligation
Aggregate fair value of plan assets
$ 6,601
5,826
4,845
$ 6,464
5,727
4,668
2005
2004
Our domestic retirement defined benefit plans provide employees
a benefit, depending on eligibility, at the greater of (i) the benefit
calculated under a highest average pay and years of service
formula, (ii) the benefit calculated under a formula that provides
for the accumulation of salary and interest credits during an
employee’s work life, or (iii) the individual account balance from
the Company’s prior defined contribution plan (Transitional
Retirement Account or TRA).
(in millions)
2005
2004
2003
2005
2004
2003
Pension Benefits
Other Benefits
Components of Net Periodic Benefit Cost
Defined benefit plans
Service cost
Interest cost (1)
Expected return on plan assets (2)
Recognized net actuarial loss
Amortization of prior service cost
Recognized net transition (asset) obligation
Recognized curtailment/settlement loss (gain)
Net periodic benefit cost
Special termination benefits
Defined contribution plans
Total
$ 234
581
(622)
98
(3)
1
54
343
–
71
$ 222
660
(678)
104
(1)
(1)
44
350
2
69
$ 197
934
(940)
53
–
–
120
364
–
62
$ 20
90
–
31
(24)
–
–
117
–
–
$ 22
89
–
24
(24)
–
–
111
–
–
$ 26
91
–
13
(18)
–
(4)
108
–
–
$ 414
$ 421
$ 426
$117
$ 111
$ 108
(1) Interest cost includes interest expense on non-TRA obligations of $328, $312 and $273 and interest expense directly allocated to TRA participant accounts of
$253, $348 and $661 for the years ended December 31, 2005, 2004 and 2003, respectively.
(2) Expected return on plan assets includes expected investment income on non-TRA assets of $369, $330 and $279 and actual investment income on TRA assets of $253,
$348 and $661 for the years ended December 31, 2005, 2004 and 2003, respectively.
Settlement/curtailment losses and special termination benefits
were incurred as a result of our restructuring programs in all
periods presented. Refer to Note 9 for that portion included
in restructuring charges for each of the three years ended
December 31, 2005.
Pension plan assets consist of both defined benefit plan assets
and assets legally restricted to the TRA accounts. The combined
investment results for these plans, along with the results for our
other defined benefit plans, are shown above in the actual return
on plan assets caption. To the extent that investment results
relate to TRA, such results are charged directly to these accounts
as a component of interest cost.
74
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Plan Assets
Current Allocation and Investment Targets: As of the 2005 and 2004 measurement dates, the global pension plan assets were
$8.4 billion and $8.1 billion, respectively. These assets were invested among several asset classes. The amount and percentage of
assets invested in each asset class as of each of these dates is shown below:
(in millions)
Asset Category
Equity securities (1)
Debt securities (1)
Real estate
Other
Total
(1) None of the investments includes debt or equity securities of Xerox Corporation.
Investment Strategy: The target asset allocations for our
worldwide plans for 2005 were 54% invested in equities, 39%
invested in fixed income, 6% invested in real estate and 1%
invested in Other. The target asset allocations for our worldwide
plans for 2004 were 59% invested in equities, 34% invested in
fixed income, 6% invested in real estate and 1% invested in Other.
The pension assets outside of the U.S. as of the 2005 and 2004
measurement dates were $4.3 billion and $4.1 billion, respectively.
The target asset allocations for the U.S. pension plan include
64% invested in equities, 30% in fixed income, 5% in real estate
and 1% in other investments. Cash investments are sufficient
to handle expected cash requirements for benefit payments
and will vary throughout the year. The expected long-term rate
of return on the U.S. pension assets is 8.75%.
We employ a total return investment approach whereby a mix
of equities and fixed-income investments are used to maximize
the long-term return of plan assets for a prudent level of risk.
The intent of this strategy is to minimize plan expenses by
exceeding the interest growth in long-term plan liabilities. Risk
tolerance is established through careful consideration of plan
liabilities, plan funded status, and corporate financial condition.
This consideration involves the use of long-term measures that
address both return and risk. The investment portfolio contains
a diversified blend of equity and fixed-income investments.
Furthermore, equity investments are diversified across U.S and
non-U.S. stocks as well as growth, value, and small and large
capitalizations. Other assets such as real estate, private equity
and hedge funds are used to improve portfolio diversification.
Derivatives may be used to hedge market exposure in an efficient
and timely manner; however, derivatives may not be used to
leverage the portfolio beyond the market value of the underlying
investments. Investment risks and returns are measured and
monitored on an ongoing basis through annual liability
measurements and quarterly investment portfolio reviews.
Asset Value
Percentage of
Total Assets
2005
2004
2005
2004
$ 4,830
2,723
504
387
$ 4,753
2,592
464
301
57%
32
6
5
58%
32
6
4
$ 8,444
$ 8,110
100%
100%
Expected Long-Term Rate of Return: We employ a “building block”
approach in determining the long-term rate of return for plan assets.
Historical markets are studied and long-term relationships between
equities and fixed income are assessed. Current market factors
such as inflation and interest rates are evaluated before long-term
capital market assumptions are determined. The long-term portfolio
return is established giving consideration to investment diversifica-
tion and rebalancing. Peer data and historical returns are reviewed
periodically to assess reasonableness and appropriateness.
Contributions: We expect to contribute $106 to our worldwide
pension plans and $130 to our other post-retirement benefit plans
in 2006. The 2006 expected pension plan contributions do not
include any planned contribution for the domestic tax-qualified
plans because there are no required contributions to these plans
for the 2006 fiscal year. However, once the January 1, 2006
actuarial valuations and projected results as of the end of the
2006 measurement year are available, the desirability of addi-
tional contributions will be assessed. Based on these results,
we may voluntarily decide to contribute to these plans, even
though no contribution is required. In prior years, after making
this assessment, we decided to contribute $230 and $210 in
April 2005 and April 2004, respectively, to our domestic tax-
qualified plans in order to make them 100% funded on a current
liability basis under the ERISA funding rules.
Estimated Future Benefit Payments: The following benefit
payments, which reflect expected future service, as appropriate,
are expected to be paid (in millions):
Pension Benefits
Other Benefits
2006
2007
2008
2009
2010
Years 2011-2015
$ 731
580
531
591
667
3,437
$ 130
133
135
134
129
640
X e r o x A n n u a l R e p o r t 2 0 0 5
75
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Assumptions
Weighted-average assumptions used
to determine benefit obligations at the
plan measurement dates
Discount rate
Rate of compensation increase
Pension Benefits
Other benefits
2005
2004
2003
2005
2004
2003
5.2%
3.9
5.6%
4.0
5.8%
3.9
5.6%
–(1)
5.8%
–(1)
6.0%
–(1)
(1) Rate of compensation increase is not applicable to our other benefits, as compensation levels do not impact earned benefits.
Weighted-average assumptions used
to determine net periodic benefit cost
for years ended December 31
Discount rate
Expected return on plan assets
Rate of compensation increase
Pension Benefits
Other Benefits
2006
2005
2004
2003
2006
2005
2004
2003
5.2%
7.8
3.9
5.6%
8.0
4.0
5.8%
8.1
3.9
6.2%
8.3
3.9
5.6%
–(1)
–(2)
5.8%
–(1)
–(2)
6.0%
–(1)
–(2)
6.5%
–(1)
–(2)
(1) Expected return on plan assets is not applicable to our other benefits, as these plans are unfunded.
(2) Rate of compensation increase is not applicable to our other benefits, as compensation levels do not impact earned benefits.
Employee Stock Ownership Plan (“ESOP”) Benefits: In 1989, we
established an ESOP and sold to it 10 million shares of our Series
B Convertible Preferred Stock (the “Convertible Preferred”) for a
purchase price of $785. Each Convertible Preferred share was
convertible into 6 shares of our common stock. The Convertible
Preferred had a $1 par value and a guaranteed minimum value
of $78.25 per share and accrued annual dividends of $6.25 per
share, which were cumulative if earned. In May 2004, all 6.2
million of our Convertible Preferred shares were redeemed for 37
million common shares in accordance with the original conversion
provisions of the Convertible Preferred shares. The redemption
was accounted for through a transfer of $483 from preferred
stock to common stock and additional paid-in-capital. Dividends
were paid through the redemption date. The redemption had no
impact on net income or diluted earnings per share (“EPS”), as
such shares were previously included in our EPS computation in
accordance with the “if converted” methodology.
Information relating to the ESOP trust for each of the two years
ended December 31, 2004 was as follows (in millions):
Dividends declared on Convertible
Preferred Stock
Cash contribution to the ESOP
Compensation expense
2004
2003
$15
–
–
$ 41
14
8
Assumed healthcare cost trend rates at December 31
Healthcare cost trend rate assumed
for next year
Rate to which the cost trend rate is assumed
to decline (the ultimate trend rate)
Year that the rate reaches the ultimate
trend rate
2005
2004
10.9%
11.9%
5.2%
5.2%
2011
2011
Assumed healthcare cost trend rates have a significant effect on
the amounts reported for the healthcare plans. A one-percentage
point change in assumed healthcare cost trend rates would have
the following effects (in millions):
One-percentage
point increase
One-percentage
point decrease
Effect on total service
and interest cost
components
Effect on post-retirement
benefit obligation
$ 5
73
$ (4)
(64)
Berger Litigation: Our Retirement Income Guarantee Plan (“RIGP”)
represents the primary U.S. pension plan for salaried employees.
In 2003, we recorded a $239 provision for litigation relating to
the court-approved settlement of the Berger v. RIGP litigation. The
settlement is being paid from RIGP assets and has been reflected
in our 2005 and 2004 actuarial valuations. The obligation related
to this settlement has been included in plan amendments in the
change in the benefit obligation noted above.
76
X e r o x A n n u a l R e p o r t 2 0 0 5
Note 15 – Income and Other Taxes
Income (loss) before income taxes for the three years ended
December 31, 2005 were as follows (in millions):
Domestic income (loss)
Foreign income
Income before income taxes
2005
$386
444
$830
2004
$426
539
$965
2003
$ (299)
735
$ 436
Provisions (benefits) for income taxes for the three years ended
December 31, 2005 were as follows (in millions):
Federal income taxes
Current
Deferred
Foreign income taxes
Current
Deferred
State income taxes
Current
Deferred
Total
2005
2004
2003
$(94)
(59)
$ 26
114
$ 77
(132)
95
37
9
7
178
21
(19)
20
144
72
(17)
(10)
$ (5)
$ 340
$ 134
A reconciliation of the U.S. federal statutory income tax rate to
the consolidated effective income tax rate for the three years
ended December 31, 2005 was as follows:
U.S. federal statutory
income tax rate
Nondeductible expenses
Effect of tax law changes
Change in valuation allowance
for deferred tax assets
State taxes, net of
federal benefit
Audit and other tax return
adjustments
Tax-exempt income
Dividends on Series B
2005
2004
2003
35.0%
3.4
0.3
35.0%
3.4
(1.5)
35.0%
5.0
1.0
(4.6)
1.6
(25.5)
(0.7)
1.3
1.3
0.7
(0.7)
(3.8)
(2.7)
7.6
(1.0)
convertible preferred stock
–
(0.6)
(3.1)
Other foreign, including earnings
taxed at different rates
Other
(10.3)
0.2
(2.4)
(1.3)
(7.0)
(0.3)
Effective income tax rate
(0.6)%
35.2%
30.7%
On a consolidated basis, we paid a total of $186, $253 and
$207 in income taxes to federal, foreign and state jurisdictions
in 2005, 2004 and 2003, respectively.
X e r o x C o r p o r a t i o n
Total income tax expense (benefit) for the three years ended
December 31, 2005 was allocated as follows (in millions):
Income taxes on income
Common shareholders’
equity (1)
Total
2005
$ (5)
2004
$340
(43)
(20)
$ (48)
$320
2003
$134
123
$257
(1) For tax effects of items in accumulated other comprehensive loss and tax benefits
related to stock option and incentive plans.
IRS Audit Resolution: In June 2005, the 1996-1998 IRS audit
was finalized. As a result, we recorded an aggregate second-
quarter 2005 net income benefit of $343. $260 of this benefit,
which includes an after-tax benefit of $33 for interest ($54 pre-tax
benefit), is the result of a change in tax law that allowed us to
recognize a benefit for $1.2 billion of capital losses associated
with the disposition of our insurance group operations in those
years. The claim of additional losses and related tax benefits
required review by the U.S. Joint Committee on Taxation, which
was completed in June 2005. The benefit did not result in a
significant cash refund, but increased tax credit carryforwards
and reduced taxes otherwise due. While these benefits originated
from our discontinued operations, tax accounting rules require
the classification of benefits resulting from a change in tax law
to be classified within the continuing operations tax provision.
The $343 benefit also includes after-tax benefits of $83 related
to the favorable resolution of certain other tax matters. Of this
amount, $53 is related to our discontinued operations and is
reported within Income from discontinued operations in the
Consolidated Statements of Income.
The following is a summary of the aggregate (benefit) recorded
and where classified in the Consolidated Statements of Income
for the year ended December 31, 2005 (in millions):
Other expenses, net
Income tax (benefits) expenses
Income from discontinued
operations, net of tax
Resolution
Tax Law
Change
$ (54)
(206)
of Tax Aggregate
Benefits
Matters
$ (3)
(27)
$ (57)
(233)
–
(53)
(53)
Net income
$ (260)
$(83)
$ (343)
X e r o x A n n u a l R e p o r t 2 0 0 5
77
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Deferred Income Taxes
In substantially all instances, deferred income taxes have not
been provided on the undistributed earnings of foreign subsidi-
aries and other foreign investments carried at equity. The amount
of such earnings included in consolidated retained earnings at
December 31, 2005 was approximately $6.5 billion. These
earnings have been indefinitely reinvested and we currently do not
plan to initiate any action that would precipitate the payment of
income taxes thereon. It is not practicable to estimate the amount
of additional tax that might be payable on the foreign earnings.
Our March 31, 2001 sale of half of our ownership interest in Fuji
Xerox resulted in our investment no longer qualifying as a foreign
corporate joint venture. Accordingly, deferred taxes are required
to be provided on the undistributed earnings of Fuji Xerox, arising
subsequent to such date, as we no longer have the ability to
ensure indefinite reinvestment.
The tax effects of temporary differences that give rise to
significant portions of the deferred taxes at December 31, 2005
and 2004 were as follows (in millions):
Tax effect of future tax deductions
Research and development
Post-retirement medical benefits
Depreciation
Net operating losses
Other operating reserves
Tax credit carryforwards
Deferred compensation
Allowance for doubtful accounts
Restructuring reserves
Other
Valuation allowance
2005
2004
$ 1,173 $ 1,281
499
247
450
333
289
198
149
43
40
478
271
480
307
346
185
118
69
166
3,593
(590)
3,529
(567)
Total Deferred tax assets
$ 3,003 $ 2,962
Tax effect of future taxable income
Unearned income and installment sales
Other
$ (1,303) $(1,293)
(79)
(42)
Total Deferred tax liabilities
Total Deferred taxes, net
(1,345)
(1,372)
$ 1,658 $ 1,590
The above amounts are classified as current or long-term in
the Consolidated Balance Sheets in accordance with the asset
or liability to which they relate or, when applicable, based on
the expected timing of the reversal. Current deferred tax assets
at December 31, 2005 and 2004 amounted to $290 and
$289, respectively.
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X e r o x A n n u a l R e p o r t 2 0 0 5
The deferred tax assets for the respective periods were assessed
for recoverability and, where applicable, a valuation allowance
was recorded to reduce the total deferred tax asset to an amount
that will, more likely than not, be realized in the future. The
valuation allowance for deferred tax assets as of January 1, 2004
was $577. The net change in the total valuation allowance for the
years ended December 31, 2005 and 2004 was an increase of
$23 and a decrease of $10, respectively. The valuation allowance
relates primarily to certain net operating loss carryforwards,
tax credit carryforwards and deductible temporary differences
for which we have concluded it is more likely than not that these
items will not be realized in the ordinary course of operations.
Although realization is not assured, we have concluded that it
is more likely than not that the deferred tax assets for which
a valuation allowance was determined to be unnecessary will
be realized in the ordinary course of operations based on the
available positive and negative evidence, including scheduling
of deferred tax liabilities and projected income from operating
activities. The amount of the net deferred tax assets considered
realizable, however, could be reduced in the near term if actual
future income or income tax rates are lower than estimated, or
if there are differences in the timing or amount of future reversals
of existing taxable or deductible temporary differences.
At December 31, 2005, we had tax credit carryforwards of
$346 available to offset future income taxes, of which $247 are
available to carryforward indefinitely while the remaining $99 will
begin to expire, if not utilized, in 2006. We also had net operating
loss carryforwards for income tax purposes of $225 that will
expire in 2006 through 2024, if not utilized, and $2.2 billion
available to offset future taxable income indefinitely.
Note 16 – Contingencies
Guarantees, Indemnifications and Warranty Liabilities: Guarantees
and claims arise during the ordinary course of business from
relationships with suppliers, customers and nonconsolidated
affiliates when the Company undertakes an obligation to
guarantee the performance of others if specified triggering
events occur. Nonperformance under a contract could trigger
an obligation of the Company. These potential claims include
actions based upon alleged exposures to products, real estate,
intellectual property such as patents, environmental matters and
other indemnifications. The ultimate effect on future financial
results is not subject to reasonable estimation because con-
siderable uncertainty exists as to the final outcome of these
claims. However, while the ultimate liabilities resulting from such
claims may be significant to results of operations in the period
recognized, management does not anticipate they will have a
material adverse effect on the Company’s consolidated financial
position or liquidity. As of December 31, 2005, we have accrued
our estimate of liability incurred under our indemnification
arrangements and guarantees.
Indemnifications Provided as Part of Contracts and Agreements:
We are a party to the following types of agreements pursuant
to which we may be obligated to indemnify the other party with
respect to certain matters:
• Contracts that we entered into for the sale or purchase of
businesses or real estate assets, under which we customarily
agree to hold the other party harmless against losses arising
from a breach of representations and covenants, including
obligations to pay rent. Typically, these relate to such matters
as adequate title to assets sold, intellectual property rights,
specified environmental matters and certain income taxes
arising prior to the date of acquisition.
• Guarantees on behalf of our subsidiaries with respect to real
estate leases. These lease guarantees may remain in effect
subsequent to the sale of the subsidiary.
• Agreements to indemnify various service providers, trustees
and bank agents from any third-party claims related to their
performance on our behalf, with the exception of claims
that result from third party’s own willful misconduct or
gross negligence.
• Guarantees of our performance in certain sales contracts to our
customers and indirectly the performance of third parties with
whom we have subcontracted for their services. This includes
indemnifications to customers for losses that may be sustained
as a result of the use of our equipment at a customer’s location.
In each of these circumstances, our payment is conditioned on the
other party making a claim pursuant to the procedures specified
in the particular contract, which procedures typically allow us to
challenge the other party’s claims. In the case of lease guarantees,
we may contest the liabilities asserted under the lease. Further,
our obligations under these agreements and guarantees may be
limited in terms of time and/or amount, and in some instances,
we may have recourse against third parties for certain payments
we made.
Patent Indemnifications: In most sales transactions to resellers
of our products, we indemnify against possible claims of
patent infringement caused by our products or solutions. These
indemnifications usually do not include limits on the claims,
provided the claim is made pursuant to the procedures required
in the sales contract.
X e r o x C o r p o r a t i o n
Indemnification of Officers and Directors: Our corporate by-laws
require that, except to the extent expressly prohibited by law, we
must indemnify Xerox Corporation’s officers and directors against
judgments, fines, penalties and amounts paid in settlement, includ-
ing legal fees and all appeals, incurred in connection with civil or
criminal action or proceedings, as it relates to their services to
Xerox Corporation and our subsidiaries. Although the by-laws
provide no limit on the amount of indemnification, we may have
recourse against our insurance carriers for certain payments
made by us. However, certain indemnification payments may not
be covered under our directors’ and officers’ insurance coverage.
In addition, we indemnify certain fiduciaries of our employee
benefit plans for liabilities incurred in their service as fiduciary
whether or not they are officers of the Company.
Product Warranty Liabilities: In connection with our normal
sales of equipment, including those under sales-type leases, we
generally do not issue product warranties. Our arrangements
typically involve a separate full-service maintenance agreement
with the customer. The agreements generally extend over a period
equivalent to the lease term or the expected useful life under a
cash sale. The service agreements involve the payment of fees
in return for our performance of repairs and maintenance. As a
consequence, we do not have any significant product warranty
obligations including any obligations under customer satisfaction
programs. In a few circumstances, particularly in certain cash
sales, we may issue a limited product warranty if negotiated by
the customer. We also issue warranties for certain of our lower-end
products in the Office segment, where full-service maintenance
agreements are not available. In these instances, we record
warranty obligations at the time of the sale. Aggregate product
warranty liability expenses for the three years ended as of
December 31, 2005 were $45, $45 and $47, respectively.
Total product warranty liabilities as of December 31, 2005 and
2004 were $21 and $23, respectively.
Tax Related Contingencies
Brazil Tax and Labor Contingencies: At December 31, 2005, our
Brazilian operations were involved in various litigation matters
and have received or been levied with numerous governmental
assessments related to indirect and other taxes as well as
disputes associated with former employees and contract labor.
The total amounts related to these unreserved contingencies,
inclusive of any related interest, were approximately $900. The
tax matters, which comprise a significant portion of the total
contingencies, principally relate to claims for taxes on the internal
transfer of inventory, municipal service taxes on rentals and gross
revenue taxes. We are disputing these tax and labor matters and
intend to vigorously defend our position. Based on the opinion
of legal counsel, we do not believe that the ultimate resolution
of these matters will materially impact our results of operations,
financial position or cash flows. In connection with these
X e r o x A n n u a l R e p o r t 2 0 0 5
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N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
proceedings, customary local regulations may require us to make
escrow cash deposits or post other security of up to half of the
total amount in dispute. As of December 31, 2005 we have made
escrow cash deposits of $117 for matters we are disputing and
there are liens on certain of our Brazilian assets. Generally, any
escrowed amounts would be refundable and any liens would be
removed to the extent the matter is resolved in our favor. We
routinely assess these matters as to probability of ultimately
incurring a liability against our Brazilian operations and record our
best estimate of the ultimate loss in situations where we assess
the likelihood of an ultimate loss as probable of occurring.
General Tax Contingencies: We are subject to ongoing tax
examinations and assessments in various jurisdictions.
Accordingly, we may record incremental tax expense based
upon the probable outcomes of such matters. In addition, when
applicable, we adjust the previously recorded tax expense to
reflect examination results. Our ongoing assessments of the
probable outcomes of the examinations and related tax positions
require judgment and can materially increase or decrease our
effective tax rate, as well as impact our operating results.
Legal Matters
As more fully discussed below, we are involved in a variety of
claims, lawsuits, investigations and proceedings concerning
securities law, intellectual property law, environmental law,
employment law and the Employee Retirement Income Security
Act (“ERISA”). We determine whether an estimated loss from a
contingency should be accrued by assessing whether a loss is
deemed probable and can be reasonably estimated. We assess
our potential liability by analyzing our litigation and regulatory
matters using available information. We develop our views on
estimated losses in consultation with outside counsel handling
our defense in these matters, which involves an analysis of poten-
tial results, assuming a combination of litigation and settlement
strategies. Should developments in any of these matters cause
a change in our determination as to an unfavorable outcome and
result in the need to recognize a material accrual, or should any
of these matters result in a final adverse judgment or be settled
for significant amounts, they could have a material adverse effect
on our results of operations, cash flows and financial position in
the period or periods in which such change in determination,
judgment or settlement occurs.
Litigation Against the Company
In re Xerox Corporation Securities Litigation: A consolidated
securities law action (consisting of 17 cases) is pending in
the United States District Court for the District of Connecticut.
Defendants are the Company, Barry Romeril, Paul Allaire and G.
Richard Thoman. The consolidated action purports to be a class
action on behalf of the named plaintiffs and all other purchasers
of common stock of the Company during the period between
October 22, 1998 through October 7, 1999 (“Class Period”).
The amended consolidated complaint in the action alleges that in
violation of Section 10(b) and/or 20(a) of the Securities Exchange
Act of 1934, as amended (“1934 Act”), and SEC Rule 10b-5
thereunder, each of the defendants is liable as a participant in a
fraudulent scheme and course of business that operated as a
fraud or deceit on purchasers of the Company’s common stock
during the Class Period by disseminating materially false and
misleading statements and/or concealing material facts relating
to the defendants’ alleged failure to disclose the material negative
impact that the April 1998 restructuring had on the Company’s
operations and revenues. The amended complaint further alleges
that the alleged scheme: (i) deceived the investing public regard-
ing the economic capabilities, sales proficiencies, growth,
operations and the intrinsic value of the Company’s common
stock; (ii) allowed several corporate insiders, such as the named
individual defendants, to sell shares of privately held common
stock of the Company while in possession of materially adverse,
non-public information; and (iii) caused the individual plaintiffs and
the other members of the purported class to purchase common
stock of the Company at inflated prices. The amended consoli-
dated complaint seeks unspecified compensatory damages in
favor of the plaintiffs and the other members of the purported
class against all defendants, jointly and severally, for all damages
sustained as a result of defendants’ alleged wrongdoing, including
interest thereon, together with reasonable costs and expenses
incurred in the action, including counsel fees and expert fees.
On September 28, 2001, the court denied the defendants’ motion
for dismissal of the complaint. On November 5, 2001, the defen-
dants answered the complaint. On or about January 7, 2003,
the plaintiffs filed a motion for class certification. Xerox and the
individual defendants filed their opposition to that motion on June
28, 2005. The motion has been fully briefed, but has not been
argued before the court. The court has not issued a ruling. On
or about November 8, 2004, the International Brotherhood of
Electrical Workers Welfare Fund of Local Union No. 164 (“IBEW”)
filed a motion to intervene as a named plaintiff and class repre-
sentative. That motion has been fully briefed, but has not been
argued before the court. The court has not issued a ruling.
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X e r o x A n n u a l R e p o r t 2 0 0 5
Separately, on June 8, 2005, IBEW and Robert W. Roten moved to
substitute as lead plaintiffs and proposed class representatives.
That motion has been fully briefed, but has not been argued
before the court. The court has not issued a ruling. The parties
are currently engaged in discovery. The individual defendants and
we deny any wrongdoing and are vigorously defending the action.
Based on the stage of the litigation, it is not possible to estimate
the amount of loss or range of possible loss that might result
from an adverse judgment or a settlement of this matter.
Carlson v. Xerox Corporation, et al.: A consolidated securities
law action (consisting of 21 cases) is pending in the United States
District Court for the District of Connecticut against the Company,
KPMG and Paul A. Allaire, G. Richard Thoman, Anne M. Mulcahy,
Barry D. Romeril, Gregory Tayler and Philip Fishbach. On September
11, 2002, the court entered an endorsement order granting
plaintiffs’ motion to file a third consolidated amended complaint.
The defendants’ motion to dismiss the second consolidated
amended complaint was denied, as moot. According to the third
consolidated amended complaint, plaintiffs purport to bring this
case as a class action on behalf of an expanded class consisting
of all persons and/or entities who purchased Xerox common
stock and/or bonds during the period between February 17, 1998
through June 28, 2002 and who were purportedly damaged
thereby (“Class”). The third consolidated amended complaint sets
forth two claims: one alleging that each of the Company, KPMG,
and the individual defendants violated Section 10(b) of the 1934
Act and SEC Rule 10b-5 thereunder; the other alleging that the
individual defendants are also allegedly liable as “controlling
persons” of the Company pursuant to Section 20(a) of the 1934
Act. Plaintiffs claim that the defendants participated in a fraudu-
lent scheme that operated as a fraud and deceit on purchasers
of the Company’s common stock and bonds by disseminating
materially false and misleading statements and/or concealing
material adverse facts relating to various of the Company’s
accounting and reporting practices and financial condition. The
plaintiffs further allege that this scheme deceived the investing
public regarding the true state of the Company’s financial condi-
tion and caused the plaintiffs and other members of the alleged
Class to purchase the Company’s common stock and bonds at
artificially inflated prices, and prompted a SEC investigation that
led to the April 11, 2002 settlement which, among other things,
X e r o x C o r p o r a t i o n
required the Company to pay a $10 penalty and restate its financials
for the years 1997-2000 (including restatement of financials
previously corrected in an earlier restatement which plaintiffs
contend was improper). The third consolidated amended complaint
seeks unspecified compensatory damages in favor of the plain-
tiffs and the other Class members against all defendants, jointly
and severally, including interest thereon, together with reasonable
costs and expenses, including counsel fees and expert fees. On
December 2, 2002, the Company and the individual defendants
filed a motion to dismiss the complaint. On July 13, 2005, the
court denied the motion. On October 31, 2005, the defendants
answered the complaint. On January 19, 2006, plaintiffs filed
a motion for class certification. That motion has not been fully
briefed or argued before the court. The parties are engaged in
discovery. The individual defendants and we deny any wrongdoing
and are vigorously defending the action. Based on the stage of
the litigation, it is not possible to estimate the amount of loss or
range of possible loss that might result from an adverse judgment
or a settlement of this matter.
Florida State Board of Administration, et al. v. Xerox Corporation,
et al.: A securities law action brought by four institutional investors,
namely the Florida State Board of Administration, the Teachers’
Retirement System of Louisiana, Franklin Mutual Advisers and
PPM America, Inc., is pending in the United States District Court
for the District of Connecticut against the Company, Paul Allaire,
G. Richard Thoman, Barry Romeril, Anne Mulcahy, Philip Fishbach,
Gregory Tayler and KPMG. The plaintiffs bring this action individ-
ually on their own behalves. In an amended complaint filed on
October 3, 2002, one or more of the plaintiffs allege that each of
the Company, the individual defendants and KPMG violated Sections
10(b) and 18 of the 1934 Act, SEC Rule 10b-5 thereunder, the
Florida Securities Investors Protection Act, Fl. Stat. ss. 517.301,
and the Louisiana Securities Act, R.S. 51:712(A). The plaintiffs
further claim that the individual defendants are each liable as
“controlling persons” of the Company pursuant to Section 20 of
the 1934 Act and that each of the defendants is liable for common
law fraud and negligent misrepresentation. The complaint
generally alleges that the defendants participated in a scheme
and course of conduct that deceived the investing public by
disseminating materially false and misleading statements and/or
concealing material adverse facts relating to the Company’s
financial condition and accounting and reporting practices.
The plaintiffs contend that in relying on false and misleading
statements allegedly made by the defendants, at various times
from 1997 through 2000 they bought shares of the Company’s
common stock at artificially inflated prices. As a result, they
allegedly suffered aggregated cash losses in excess of $200.
X e r o x A n n u a l R e p o r t 2 0 0 5
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N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
The plaintiffs further contend that the alleged fraudulent scheme
prompted an SEC investigation that led to the April 11, 2002
settlement which, among other things, required the Company to
pay a $10 penalty and restate its financials for the years 1997-
2000 including restatement of financials previously corrected
in an earlier restatement which plaintiffs contend was false and
misleading. The plaintiffs seek, among other things, unspecified
compensatory damages against the Company, the individual
defendants and KPMG, jointly and severally, including prejudg-
ment interest thereon, together with the costs and disbursements
of the action, including their actual attorneys’ and experts’ fees.
On December 2, 2002, the Company and the individual defen-
dants filed a motion to dismiss all claims in the complaint that
are in common with the claims in the Carlson action. On July 13,
2005, the court denied the motion. On December 9, 2005, the
defendants moved to dismiss claims based on issues uniquely
related to plaintiffs. Plaintiffs filed their opposition to that motion
on January 31, 2006. That motion has not been fully briefed or
argued before the court. The parties are engaged in discovery.
The individual defendants and we deny any wrongdoing and
are vigorously defending the action. Based on the stage of the
litigation, it is not possible to estimate the amount of loss or
range of possible loss that might result from an adverse judgment
or a settlement of this matter.
In Re Xerox Corp. ERISA Litigation: On July 1, 2002, a class action
complaint captioned Patti v. Xerox Corp. et al. was filed in the
United States District Court for the District of Connecticut (Hartford)
alleging violations of the ERISA. Three additional class actions
(Hopkins, Uebele and Saba) were subsequently filed in the same
court making substantially similar claims. On October 16, 2002,
the four actions were consolidated as In Re Xerox Corporation
ERISA Litigation. On November 15, 2002, a consolidated amended
complaint was filed. A fifth class action (Wright) was filed in the
District of Columbia. It has been transferred to Connecticut and
consolidated with the other actions. The purported class includes
all persons who invested or maintained investments in the Xerox
Stock Fund in the Xerox 401(k) Plans (either salaried or union)
during the proposed class period, May 12, 1997 through November
15, 2002, and allegedly exceeds 50,000 persons. The defen-
dants include Xerox Corporation and the following individuals or
groups of individuals during the proposed class period: the Plan
Administrator, the Board of Directors, the Fiduciary Investment
Review Committee, the Joint Administrative Board, the Finance
Committee of the Board of Directors, and the Treasurer. The
complaint claims that all the foregoing defendants were fiduciaries
of the Plan under ERISA and, as such, were obligated to protect
the Plan’s assets and act in the interest of Plan participants.
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X e r o x A n n u a l R e p o r t 2 0 0 5
The complaint alleges that the defendants failed to do so and
thereby breached their fiduciary duties. Specifically, plaintiffs
claim that the defendants failed to provide accurate and complete
material information to participants concerning Xerox stock,
including accounting practices which allegedly artificially inflated
the value of the stock, and misled participants regarding the
soundness of the stock and the prudence of investing their retire-
ment assets in Xerox stock. Plaintiffs also claim that defendants
failed to invest Plan assets prudently, to monitor the other
fiduciaries and to disregard Plan directives they knew or should
have known were imprudent, and failed to avoid conflicts of
interest. The complaint does not specify the amount of damages
sought. However, it asks that the losses to the Plan be restored,
which it describes as “millions of dollars.” It also seeks other legal
and equitable relief, as appropriate, to remedy the alleged breaches
of fiduciary duty, as well as interest, costs and attorneys’ fees. We
filed a motion to dismiss the complaint. The plaintiffs subsequently
filed a motion for class certification and a motion to commence
discovery. Defendants have opposed both motions, contending
that both are premature before there is a decision on their motion
to dismiss. In the fall of 2004, the Court requested an updated
briefing on our motion to dismiss and update briefs were filed
in December of that year. We and the other defendants deny
any wrongdoing and are vigorously defending the action. Based
on the stage of the litigation, it is not possible to estimate the
amount of loss or range of possible loss that might result from
an adverse judgment or a settlement of this matter.
Digwamaje et al. v. IBM et al: A purported class action was filed
in the United States District Court for the Southern District of
New York on September 27, 2002. Service of the First Amended
Complaint on the Company was deemed effective as of December
6, 2002. On March 19, 2003, Plaintiffs filed a Second Amended
Complaint that eliminated a number of corporate defendants but
was otherwise identical in all material respects to the First Amended
Complaint. The defendants include Xerox and a number of other
corporate defendants who are accused of providing material assis-
tance to the apartheid government in South Africa from 1948
to 1994, by engaging in commerce in South Africa and with the
South African government and by employing forced labor, thereby
violating both international and common law. Specifically, plaintiffs
claim violations of the Alien Tort Claims Act, the Torture Victims
Protection Act and RICO. They also assert human rights violations
and crimes against humanity. Plaintiffs seek compensatory damages
in excess of $200 billion and punitive damages in excess of
$200 billion. The foregoing damages are being sought from all
defendants, jointly and severally. Xerox filed a motion to dismiss
the Second Amended Complaint. Oral argument of the motion
was heard on November 6, 2003. By Memorandum Opinion and
Order filed November 29, 2004, the court granted the motion to
dismiss. A clerk’s judgment of dismissal was filed on November 30,
2004. On December 27, 2004, the Company received a notice
of appeal dated December 24, 2004. On February 16, 2005,
the parties filed a stipulation withdrawing the December 24, 2004
appeal on the ground that the November 30, 2004 judgment
of dismissal was not appealable. On March 28, 2005, Plaintiffs
submitted a letter requesting permission to file a motion for leave
to file an amended and consolidated complaint. By Summary
Order filed April 6, 2005, the Court denied the request. In a
second Summary Order filed the same day, the Court amended
its November 29, 2004, Opinion and Order, which dismissed
the action, so as to render the Opinion and Order appealable and
plaintiffs filed a new appeal on May 3, 2005. On August 19, 2005,
plaintiffs-appellants filed their brief in the Second Circuit Court of
Appeals. On October 4, 2005, defendants-appellees filed their
brief in the Second Circuit Court of Appeals. Oral argument in the
Second Circuit Court of Appeals was held on January 24, 2006.
Xerox denies any wrongdoing and is vigorously defending the
action. Based upon the stage of the litigation, it is not possible to
estimate the amount of loss or range of possible loss that might
result from an adverse judgment or a settlement of this matter.
Arbitration between MPI Technologies, Inc. and Xerox Canada Ltd.
and Xerox Corporation: In an arbitration proceeding the hearing of
which commenced on January 18, 2005, MPI Technologies, Inc.
(“MPI”) sought damages from Xerox Corporation and Xerox Canada
Ltd. (“XCL”) for royalties owed under a license agreement made
as of March 15, 1994 between MPI and XCL (the “Agreement”)
and breach of fiduciary duty, breach of confidence, equitable
royalties and punitive damages and disgorgement of profits and
injunctive relief with respect to a claim of copyright infringement.
On September 9, 2005, the arbitration panel rendered its decision,
holding in part that the Agreement had been assigned to Xerox
and that no punitive damages should be granted, and awarded
MPI approximately $89, plus interest thereon. On December 12,
2005, the arbitration panel rendered its decision on the applicable
rate of pre-judgment interest. We have accrued the amount of the
$89 award, as well as $13 for pre- and post-judgment interest
thereon. On December 7, 2005, Xerox filed an application for
judicial review of the award with the Ontario Superior Court
seeking that the award be set aside in its entirety. The hearing is
scheduled for late June 2006. On December 29, 2005, MPI filed
an application for judicial recognition and enforcement of the
award. On agreement of the parties, that application has been
adjourned to be heard after the Xerox application to set aside the
award on a date to be set by the Ontario Superior Court. Pending
the determination of the application to set aside the award, Xerox
has deposited into escrow funds ordered owing in the award as
of the date the deposit was made.
X e r o x C o r p o r a t i o n
National Union Fire Insurance Company v. Xerox Corporation, et al.:
On October 24, 2003, a declaratory judgment action was filed in
the Supreme Court of the State of New York, County of New York
against the Company and several current and former officers
and/or members of the Board of Directors. Plaintiff claims that
it issued an Excess Directors & Officers Liability and Corporate
Reimbursement Policy to the Company in reliance on information
from the Company that allegedly misrepresented the Company’s
financial condition and outlook. The policy at issue provides for
$25 of coverage as a component of the Company reimbursement
portion of an insurance program that provides for up to $135
coverage (after deductibles and coinsurance and subject to other
policy limitations and requirements) over a three-year period.
However, $10 of the entire amount may be unavailable due to the
liquidation of one of the other insurers. Plaintiff seeks judgment
(i) that it is entitled to rescind the policy as void from the outset;
(ii) in the alternative, limiting coverage under the policy and
awarding plaintiff damages in an unspecified amount representing
that portion of any required payment under the policy that is
attributable to the Company’s and the individual defendants’
own misconduct; and (iii) for the costs and disbursement of the
action and such other relief as the court deems just and proper.
On December 19, 2003, the Company and individual defendants
moved to dismiss the complaint. On November 10, 2004, the
Court issued an opinion partially granting and partially denying
the motions. Among other things, the Court granted the motions
to dismiss all of the claims for rescission and denied plaintiff’s
request to replead. The Court denied the Company’s and some
of the individual defendants’ motions to dismiss certain claims
that seek to limit coverage based on particular provisions in the
policy and that at least in part related to settlement with the SEC.
Plaintiff filed notices of appeal on January 10, 2005 and February
11, 2005. By order entered on January 3, 2006, the Appellate
Division affirmed the portions of the Court’s November 10, 2004
decision which dismissed several of plaintiff’s claims and denied
leave to replead. On February 2, 2006, plaintiff moved for
reargument or for leave to appeal to the Court of Appeals. That
motion has not been fully briefed. The Appellate Division has not
issued a ruling. Separately, on February 22, 2005, the defendants
filed a motion seeking dismissal of any remaining claims in light
of Xerox’s representation that it will not seek coverage from
plaintiff for settlement payments to the SEC. By order dated July
12, 2005, the Court denied the motion. On August 23, 2005,
defendants moved for leave to reargue the February 22 motion
and separately moved for leave to renew the December 19, 2003
motions. Those motions have been fully briefed. The court has
not issued a ruling. The Company and the individual defendants
deny any wrongdoing and are vigorously defending the action.
X e r o x A n n u a l R e p o r t 2 0 0 5
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N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Warren, et al. v. Xerox Corporation: On March 11, 2004, the
United States District Court for the Eastern District of New
York entered an order certifying a nationwide class of all black
salespersons employed by Xerox from February 1, 1997 to the
present under Title VII of the Civil Rights Act of 1964, as amended,
and the Civil Rights Act of 1871. The suit was commenced on
May 9, 2001 by six black sales representatives. The plaintiffs
allege that Xerox has engaged in a pattern or practice of race
discrimination against them and other black sales representatives
by assigning them to less desirable sales territories, denying
them promotional opportunities, and paying them less than their
white counterparts. Although the complaint does not specify
the amount of damages sought, plaintiffs do seek, on behalf of
themselves and the classes they seek to represent, front and
back pay, compensatory and punitive damages, and attorneys’
fees. We deny any wrongdoing and are vigorously defending the
action. Based on the stage of the litigation, it is not possible to
estimate the amount of loss or range of possible loss that might
result from an adverse judgment or a settlement of this matter.
Compression Labs, Inc. v. Agfa et al. (including Xerox
Corporation): In April 2004, Compression Labs, Incorporated
(CLI) commenced an action in the United States District Court
for the Eastern District of Texas, Marshall Division against Xerox,
along with 27 other companies, seeking unspecified damages
for patent infringement, injunction and other ancillary relief.
According to CLI, the patent covers an aspect of a standard for
compressing full-color or gray-scale still images (JPEG). In July
2004, along with several of the other defendants in the above
named action, we filed a complaint against CLI in Federal Court in
Delaware, requesting a declaratory judgment of non-infringement
and invalidity; a finding of an implied license to use the patent; a
finding that CLI is estopped from enforcing the patent; damages
and relief under state law for deceptive trade practices, unfair
competition, fraud, negligent misrepresentation, equitable
estoppel and patent misuse; and relief under federal anti-trust
laws for CLI’s violation of Section 2 of the Sherman Act. On
February 16, 2005, the U.S. Multi-District Litigation Panel ordered
the subject lawsuit (along with all related lawsuits) be transferred
from the District Court of the Eastern District of Texas to the
District Court for the Northern District of California. All pre-trial
proceedings will occur in the Northern District of California and
the lawsuit will, if necessary, be transferred back to the Eastern
District of Texas for trial. Discovery for all related cases will
continue in the Northern District of California. On May 19, 2005
the judge recused herself from the litigation and a new judge
was assigned in August 2005. We deny any wrongdoing and
are vigorously defending this action. Based on the stage of the
litigation, it is not possible to estimate the amount of loss or
range of possible loss that might result from an adverse judgment
or a settlement of this matter.
84
X e r o x A n n u a l R e p o r t 2 0 0 5
Tesseron, Ltd. v. Xerox Corporation: On October 28, 2004, an
action was commenced by Tesseron, Ltd., in the United States
District Court for the Northern District of Ohio against Xerox
seeking unspecified damages for alleged infringement of seven
U.S. patents. Tesseron asserts that its patents cover Xerox’s
variable imaging software sold with Xerox’s production printing
systems. Xerox filed an answer on January 28, 2005. The parties
are currently engaged in discovery. We deny any wrongdoing and
intend to vigorously defend the action. Based upon the stage of
the litigation, it is not possible to estimate the amount of loss or
range of possible loss that might result from an adverse judgment
or a settlement of this matter.
Derivative Litigation Brought on Behalf of the Company:
Miller, et al. v. Allaire, et al.: Following the voluntary dismissal
without prejudice of In Re Xerox Derivative Actions in the Supreme
Court of the State of New York, County of New York, the plaintiffs
purportedly brought a substantially similar putative shareholder
derivative action in Connecticut Superior Court, Judicial District of
Stamford-Norwalk at Stamford in the name of and for the benefit
of the Company, which is named as a nominal defendant, and its
public shareholders against several current and former members
of the Board of Directors including William F. Buehler, B.R. Inman,
Antonia Ax:son Johnson, Vernon E. Jordan, Jr., Yotaro Kobayashi,
Hilmar Kopper, Ralph Larsen, George J. Mitchell, N.J. Nicholas,
Jr., John E. Pepper, Patricia Russo, Martha Seger, Thomas C.
Theobald, Paul Allaire, G. Richard Thoman, Anne Mulcahy and
Barry Romeril, and KPMG LLP. This action is based on substan-
tially the same allegations and seeks substantially the same relief
as the discontinued action. The complaint alleges that each of the
director defendants breached their fiduciary duties to the Company
and its shareholders by, among other things, ignoring indications
of a lack of oversight at the Company and the existence of flawed
business and accounting practices within the Company’s Mexican
and other operations; failing to have in place sufficient controls
and procedures to monitor the Company’s accounting practices;
knowingly and recklessly disseminating and permitting to be
disseminated, misleading information to shareholders and the
investing public; and permitting the Company to engage in
improper accounting practices. The plaintiffs further allege that
each of the director defendants breached his/her duties of due
care and diligence in the management and administration of the
Company’s affairs and grossly mismanaged or aided and abetted
the gross mismanagement of the Company and its assets. The
complaint also asserts claims of negligence, negligent misrepre-
sentation, breach of contract and breach of fiduciary duty against
KPMG. Additionally, plaintiffs claim that KPMG is liable to Xerox
for contribution, based on KPMG’s share of the responsibility for
any injuries or damages for which Xerox is held liable to plaintiffs
in related pending securities class action litigation. On behalf of
the Company, the plaintiffs seek a judgment declaring that the
director defendants violated and/or aided and abetted the breach
of their fiduciary duties to the Company and its shareholders;
awarding the Company unspecified compensatory damages
against the director defendants, individually and severally,
together with pre-judgment and post-judgment interest at the
maximum rate allowable by law; awarding the Company punitive
damages against the director defendants; awarding the Company
compensatory damages against KPMG; and awarding plaintiffs
the costs and disbursements of this action, including reasonable
attorneys’ and experts’ fees. Plaintiffs also demand injunctive
relief from the indemnification of six former officers for disgorge-
ments imposed pursuant to their respective settlements with the
SEC and related legal fees. On November 23, 2005, defendants
filed a motion to dismiss and a separate motion for partial summary
judgment. Those motions have not yet been fully briefed or argued
before the court. The individual defendants deny any wrongdoing.
Pall v. KPMG, et al.: On May 13, 2003, a shareholder commenced
a derivative action in the United States District Court for the
District of Connecticut against KPMG and four of its current or
former partners. The Company was named as a nominal defendant.
The plaintiff had filed an earlier derivative action against certain
current and former members of the Xerox Board of Directors and
KPMG. That action, captioned Pall v. Buehler, et al., was dismissed
for lack of jurisdiction. Plaintiff purports to bring this current
action derivatively on behalf and for the benefit of the Company
seeking damages allegedly caused to the Company by KPMG
and the named individual defendants. The plaintiff asserts claims
for contribution under the securities laws, negligence, negligent
misrepresentation, breach of contract, breach of fiduciary duty
and indemnification. The plaintiff seeks unspecified compensatory
damages (together with pre-judgment and post-judgment interest),
a declaratory judgment that defendants violated and/or aided
and abetted the breach of fiduciary and professional duties to the
Company, an award of punitive damages for the Company against
the defendants, plus the costs and disbursements of the action.
On November 7, 2003, the Company filed a limited motion to
dismiss the complaint on jurisdictional grounds and reserved its
right to seek dismissal on other grounds, if the court denies the
initial motion. KPMG and the individual defendants also filed limited
motions to dismiss on the same grounds. The motions have not
been fully briefed or argued before the court.
X e r o x C o r p o r a t i o n
Other Litigation:
Xerox Corporation v. 3Com Corporation, et al.: On April 28,
1997, we commenced an action in U.S. District Court for the
Western District of New York against Palm, formerly owned by
3Com Corporation, for infringement of the Xerox “Unistrokes”
handwriting recognition patent by the Palm Pilot using “Graffiti.”
Upon reexamination, the U.S. Patent and Trademark Office
confirmed the validity of all 16 claims of the original Unistrokes
patent. On June 6, 2000, the District Court found the Palm Pilot
with Graffiti did not infringe the Unistrokes patent claims, and on
October 5, 2000 the Court of Appeals for the Federal Circuit
reversed the finding of no infringement and sent the case back
to the lower court to continue toward trial on the infringement
claims. On December 20, 2001, the District Court granted
our motions on infringement and for a finding of validity, thus
establishing liability. In January 2003, Palm announced that it
would stop including Graffiti in its future operating systems. On
February 20, 2003, the Court of Appeals for the Federal Circuit
affirmed the infringement of the Unistrokes patent by Palm’s
handheld devices and remanded the validity issues to the District
Court for further analysis. On December 5, 2003 Palm moved
for sanctions, alleging that Xerox withheld production of material
information. Xerox has since responded to the motion denying the
basis of claims. On December 10, 2003 the District Court heard
oral arguments on summary judgment motions from both parties
directed solely to the issue of validity. A decision denying Xerox’s
motions and granting Palm’s motion of summary judgment for
invalidity (“SJ”) was granted on May 21, 2004. In June 2004, Palm
filed a motion requesting clarification of the grant of SJ, Xerox has
responded to that motion, and also filed a motion to reconsider
the SJ. On February 16, 2005, the District Court denied Xerox’s
motion to reconsider and granted Palm’s motion to clarify.
Pursuant to granting Palm’s motion, the District Court supple-
mented its decision of May 21, 2004. On June 10, 2005, Xerox
filed an appeal brief with the Court of Appeals for the Federal
Circuit, seeking reversal of the District Court’s holding of
invalidity. Xerox filed a reply brief to the Palm brief on the issue
of invalidity on November 7, 2005. An oral hearing is expected
to occur in March 2006.
Other Matters:
It is our policy to promptly and carefully investigate, often with
the assistance of outside advisers, allegations of impropriety that
may come to our attention. If the allegations are substantiated,
appropriate prompt remedial action is taken. When and where
appropriate, we report such matters to the U.S. Department of
Justice and to the SEC, and/or make public disclosure.
X e r o x A n n u a l R e p o r t 2 0 0 5
85
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 17 – Preferred Stock
As of December 31, 2005, we had one class of preferred stock
outstanding as well as one class of preferred stock purchase
rights. In total, we are authorized to issue approximately 22
million shares of cumulative preferred stock, $1.00 par value.
Series C Mandatory Convertible Preferred Stock: In 2003, we
issued 9.2 million shares of 6.25% Series C Mandatory Convertible
Preferred Stock with a stated liquidation value of $100 per share
for net proceeds of $889. The proceeds from these securities
were used to repay a portion of our indebtedness. Annual dividends
of $6.25 per share are cumulative and payable quarterly in cash,
shares of our common stock or a combination thereof.
On July 1, 2006, each share of Series C Mandatory Convertible
Preferred Stock will automatically convert into between 8.1301
and 9.7561 shares of our common stock, depending on the then
20-day average market price of our common stock. At any time
prior to July 1, 2006, holders may elect to convert each share
of Series C Mandatory Convertible Preferred Stock into 8.1301
shares of our common stock. If at any time prior to July 1, 2006,
the closing price per share of our common stock exceeds $18.45
for at least 20 trading days within a period of 30 consecutive
trading days, we may elect, subject to certain limitations, to
cause the conversion of all, but not less than all, the shares of
Series C Mandatory Convertible Preferred Stock then outstanding
for shares of our common stock at a conversion rate of 8.1301
shares of our common stock for each share of Series C Mandatory
Convertible Preferred Stock.
Preferred Stock Purchase Rights: We have a shareholder rights
plan designed to deter coercive or unfair takeover tactics and to
prevent a person or persons from gaining control of us without
offering a fair price to all shareholders. Under the terms of this
plan, one-half of one preferred stock purchase right (“Right”)
accompanies each share of outstanding common stock. Each full
Right entitles the holder to purchase from us one three-hundredth
of a new series of preferred stock at an exercise price of $250.
Within the time limits and under the circumstances specified in the
plan, the Rights entitle the holder to acquire either our common
stock, the stock of the surviving Company in a business combi-
nation, or the stock of the purchaser of our assets, having a value
of two times the exercise price. The Rights, which expire in April
2007, may be redeemed prior to becoming exercisable by action
of the Board of Directors at a redemption price of $.01 per Right.
The Rights are non-voting and, until they become exercisable,
have no dilutive effect on the earnings per share or book value
per share of our common stock.
India: In recent years we have become aware of a number of
matters at our Indian subsidiary, Xerox Modicorp Ltd., that
occurred over a period of several years, much of which occurred
before we obtained majority ownership of these operations in
mid-1999. These matters include misappropriations of funds and
payments to other companies that may have been inaccurately
recorded on the subsidiary’s books and certain improper pay-
ments in connection with sales to government customers.
These transactions were not material to the Company’s financial
statements. We have reported these transactions to the Indian
authorities, the U.S. Department of Justice and to the SEC. The
private Indian investigator engaged by the Indian Ministry of
Company Affairs has completed an investigation of these matters.
In February 2005, the Indian Ministry of Company Affairs provided
our Indian subsidiary with the investigator’s report which addresses
the previously disclosed misappropriation of funds and improper
payments and requested comments. The report included allega-
tions that Xerox Modicorp Ltd.’s senior officials and the Company
were aware of such activities. The report also asserted the need
for further investigation into potential criminal acts related to the
improper activities addressed by the report. The matter is now
pending in the Indian Ministry of Company Affairs. The Company
reported these developments and made a copy of the report
received by Xerox Modicorp Ltd. available to the U.S. Department
of Justice and the SEC.
On November 17, 2005, Xerox filed its 40-page Reply (plus
attachments) with the DCA. Xerox has sent copies of the Xerox
Reply to the SEC and DOJ in the United States. In our Reply, we
argue that the alleged violations of Indian Company Law by means
of alleged improper payments and alleged defaults/failures of
the Xerox Modicorp Ltd. Board of Directors were generally unsub-
stantiated and without any basis in law. Further, we stated that the
Report’s findings of other alleged violations were unsubstantiated
and unproven. The DCA (now called the “Ministry of Company
Affairs” or “MCA”) will consider our Reply and will let us know their
conclusions in the coming months. There is the possibility of fines
or criminal penalties if conclusive proof of wrongdoing is found. We
have told the DCA that Xerox’s conduct in voluntarily disclosing
the initial information and readily and willingly submitting to investi-
gation, coupled with the non-availability of earlier records, warrants
complete closure and early settlement. In January 2006, we
learned that the DCA has issued a “Show Cause Notice” to certain
former executives of Xerox Modicorp Ltd. seeking a response to
allegations of potential violations of the Indian Companies Act.
In March 2005, following the completion of a share buy-back
program that increased our controlling ownership interest in our
Indian subsidiary to approximately 89 percent from approximately
86 percent at year-end 2004, we changed the name of our Indian
subsidiary to Xerox India Ltd.
86
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Note 18 – Common Stock
We have 1.75 billion authorized shares of common stock, $1 par
value. At December 31, 2005, 125 million shares were reserved
for issuance under our incentive compensation plans, 90 million
shares were reserved for the conversion of the Series C Mandatory
Convertible Preferred Stock, 48 million shares were reserved
for debt to equity exchanges, and 2 million shares were reserved
for the conversion of convertible debt.
Stock-Based Compensation: We have a long-term incentive
plan whereby eligible employees may be granted restricted stock
units (“RSUs”), performance shares (“PSs”) and non-qualified
stock options.
In January 2005, we implemented changes in our stock-based
compensation programs designed to help us continue to attract
and retain employees and to better align employee interests with
those of our shareholders. With these changes, in lieu of stock
options we began granting PSs and expanded the use of RSUs.
Each of these awards is subject to settlement with newly issued
shares of our common stock. At December 31, 2005 and 2004,
38.9 million and 33.9 million shares, respectively, were available
for grant of options or awards.
Total compensation related to these programs was $40, $22 and
$15 for the years ended December 31, 2005, 2004 and 2003,
respectively. The related income tax benefit recognized was $16,
$8 and $7 for 2005, 2004 and 2003, respectively. A description
of each of our stock-based compensation programs follows:
Restricted Stock Units: Prior to 2005, the RSUs were generally subject to a three-year ratable vesting period from the date of grant
and entitled the holder to one share of common stock. In 2005, the terms of newly-issued RSUs were changed such that the entire
award vests three years from the date of grant. Compensation expense is based upon the grant date market price and is recorded over
the vesting period. A summary of the activity for RSUs as of December 31, 2005, 2004 and 2003, and changes during the years then
ended, is presented below (RSUs in thousands):
Nonvested Restricted Stock Units
Outstanding at January 1
Granted
Vested
Cancelled
Outstanding at December 31
2005
Weighted
Average
Grant Date
Fair Value
$13.86
16.89
15.01
16.21
15.69
Shares
2,804
3,750
(977)
(86)
5,491
2004
Weighted
Average
Grant Date
Fair Value
$10.46
13.70
9.72
19.14
13.86
Shares
2,180
2,539
(1,905)
(10)
2,804
2003
Weighted
Average
Grant Date
Fair Value
$14.08
7.90
12.60
30.36
10.46
Shares
2,352
1,657
(1,809)
(20)
2,180
At December 31, 2005, the aggregate intrinsic value of
RSUs outstanding was $79. The total intrinsic value of RSUs
vested during 2005, 2004 and 2003 was $13, $26 and $15,
respectively. The actual tax benefit realized for the tax deductions
for vested RSUs totaled $4, $9 and $5 for the years ended
December 31, 2005, 2004 and 2003, respectively.
At December 31, 2005, there was $39 of total unrecognized
compensation cost related to nonvested RSUs, which is expected
to be recognized ratably over a remaining weighted-average
contractual term of two years.
Performance Shares: We grant officers and selected executives
PSs whose vesting is contingent upon meeting pre-determined
Diluted Earnings per Share (EPS) and Cash Flow from Operations
targets. These shares entitle the holder to one share of common
stock, payable after a three-year period and the attainment of the
stated goals. If the cumulative three-year actual results for EPS
and Cash Flow from Operations exceed the stated targets, then
the plan participants have the potential to earn additional shares
of common stock. This overachievement can not exceed 50% for
officers and 25% for non-officers of the original grant.
X e r o x A n n u a l R e p o r t 2 0 0 5
87
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
A summary of the activity for PSs as of December 31, 2005,
and changes during the year then ended, is presented below
(shares in thousands):
Nonvested
Performance Shares
Outstanding at January 1
Granted
Vested
Cancelled
Shares
–
2,070
–
(18)
Outstanding at December 31
2,052
Weighted
Average
Weighted
Average
Remaining
Grant Date Contractual
Term
Fair Value
$14.87
–
14.87
14.87
2.0
At December 31, 2005, the aggregate intrinsic value of PSs
outstanding was $30.
For 2005, the PSs were accounted for as variable awards
requiring that the shares be adjusted to market value at each
reporting period. Commencing January 1, 2006, upon the
adoption of FAS 123(R), PSs will be recorded prospectively using
fair value determined as of the grant date. If the stated targets are
not met, any recognized compensation cost would be reversed.
As of December 31, 2005, there was $24 of total unrecognized
compensation cost related to nonvested PSs; this cost is
expected to be recognized ratably over the next two years.
Stock Options: Stock options generally vest over a period of three years and expire between eight and ten years from the date of grant.
We have not recognized compensation expense relating to employee stock options because the exercise price of the options was
equal to the market value of our common stock on the grant date. The following table provides information relating to the status of,
and changes in, stock options granted for each of the three years ended December 31, 2005 (stock options in thousands):
Employee Stock Options
Outstanding at January 1
Granted
Cancelled
Exercised
Outstanding at December 31
Exercisable at December 31
2005
2004
2003
Stock
Options
91,833
–
(10,291)
(5,235)
Average
Option
Price
$20.98
–
39.41
7.74
Stock
Options
97,839
11,216
(8,071)
(9,151)
Average
Option
Price
$21.46
13.71
32.24
7.28
Stock
Options
76,849
31,106
(6,840)
(3,276)
76,307
19.40
91,833
20.98
97,839
66,928(1)
65,199
58,652
Average
Option
Price
$25.58
9.50
20.58
6.36
21.46
(1) On January 1, 2006, an additional 8.1 million stock options became exercisable.
88
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Options outstanding and exercisable at December 31, 2005 were as follows (stock options in thousands):
Options Outstanding
Options Exercisable
Range of Exercise Prices
$4.75 to $6.98
7.13 to 10.69
10.70 to 15.27
16.91 to 22.88
25.38 to 32.16
42.83 to 60.95
Weighted
Average
Remaining
Number Contractual
Life
Outstanding
6,487
31,078
11,119
12,188
3,826
11,609
76,307
4.96
6.35
5.97
4.00
3.89
2.38
5.08
Weighted
Average
Exercise
Price
$ 4.87
9.12
13.66
21.77
26.37
55.79
Weighted
Average
Remaining
Number Contractual
Life
Exercisable
5,939
25,789
7,577
12,188
3,826
11,609
4.90
6.27
5.96
4.00
3.89
2.38
4.89
19.40
66,928
Weighted
Average
Exercise
Price
$ 4.85
9.29
13.65
21.77
26.37
55.79
20.70
At December 31, 2005, the aggregate intrinsic value of stock
options outstanding and stock options exercisable was $247 and
$204, respectively.
Note 19 – Research, Development and
Engineering (“R,D&E”)
R,D&E was $943, $914 and $962 for the three years ended
December 31, 2005, respectively. Research and development
(“R&D”) costs were $755 in 2005, $760 in 2004 and $868 in
2003. Sustaining engineering costs are incurred with respect to
ongoing product improvements or environmental compliance
after initial product launch. Our sustaining engineering costs were
$188, $154 and $94 for the three years ended December 31,
2005, respectively.
The following table provides information relating to stock option
exercises for the three years ended December 31, 2005:
(in millions)
Total Intrinsic Value
Cash Received
Tax Benefit Realized for
Tax Deductions
2005
$36
41
2004
$67
67
2003
$14
21
12
23
5
Treasury Stock: In October 2005, the Board of Directors authorized
the Company to repurchase up to $500 of common stock. The
stock is expected to be repurchased through the period ending
October 31, 2006, primarily through open-market purchases.
Repurchases are made in compliance with the Securities and
Exchange Commission’s Rule 10b-18, and are subject to market
conditions as well as applicable legal and other considerations.
During the fourth quarter of 2005, we repurchased 30,502,200
shares at an aggregate cost of $433, including associated fees
of $1. These treasury stock shares may be cancelled upon the
Board of Directors’ approval. In 2005, 16,585,300 repurchased
shares were cancelled and were recorded as a reduction to both
common stock of $17 and additional paid-in-capital of $213.
X e r o x A n n u a l R e p o r t 2 0 0 5
89
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Note 20 – Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share of common stock
(in millions, except shares in thousands):
Basic Earnings per Share:
Income from continuing operations before discontinued operations and cumulative
effect of change in accounting principle
Accrued dividends on:
Series B Convertible Preferred Stock, net
Series C Mandatory Convertible Preferred Stock
Adjusted income from continuing operations before discontinued operations and
cumulative effect of change in accounting principle
Income from discontinued operations, net
Cumulative effect of change in accounting principle, net
Adjusted net income available to common shareholders
Weighted Average Common Shares Outstanding
Basic Earnings per Share:
Income from continuing operations
Income from discontinued operations
Loss from cumulative effect of change in accounting principle
Basic Earnings per Share
Diluted Earnings per Share:
Income from continuing operations before discontinued operations and cumulative
effect of change in accounting principle
ESOP expense adjustment, net
Accrued dividends on Series C Mandatory Convertible Preferred Stock
Interest on Convertible securities, net
Adjusted income from continuing operations before discontinued operations and
cumulative effect of change in accounting principle
Income from discontinued operations, net
Cumulative effect of change in accounting principle, net
Adjusted net income available to common shareholders
Weighted Average Common Shares Outstanding
Common shares issuable with respect to:
Stock options and restricted stock
Series B Convertible Preferred Stock
Series C Mandatory Convertible Preferred Stock
Convertible securities
Adjusted Weighted Average Shares Outstanding
Diluted Earnings per Share:
Income from continuing operations
Income from discontinued operations
Loss from cumulative effect of change in accounting principle
Diluted Earnings per Share
90
X e r o x A n n u a l R e p o r t 2 0 0 5
2005
2004
2003
$ 933
$ 776
$ 360
–
(58)
875
53
(8)
(16)
(57)
703
83
–
(41)
(30)
289
–
–
$ 920
$ 786
$ 289
957,149
834,321
769,032
$ 0.91
0.06
(0.01)
$ 0.96
$ 0.84
0.10
–
$ 0.94
$ 933
–
–
1
$ 776
(6)
–
51
934
53
(8)
821
83
–
$0.38
–
–
$0.38
$ 360
(35)
(30)
–
295
–
–
$ 979
$ 904
$ 295
957,149
834,321
769,032
11,415
–
74,797
1,992
14,198
17,359
74,797
106,272
8,273
51,082
–
–
1,045,353 1,046,947
828,387
$ 0.90
0.05
(0.01)
$ 0.94
$ 0.78
0.08
–
$ 0.86
$0.36
–
–
$0.36
X e r o x C o r p o r a t i o n
The 2005, 2004 and 2003 computation of diluted earnings per
share did not include the effects of 36 million, 38 million and
63 million stock options, respectively, because their respective
exercise prices were greater than the corresponding market value
per share of our common stock.
In 2003, the following potentially dilutive securities were not included
in the computation of diluted EPS because to do so would have been
anti-dilutive (in thousands of shares on weighted-average basis):
Series C Mandatory Convertible Preferred Stock
Liability to subsidiary trust issuing
preferred securities – Trust II
Convertible subordinated debentures
Total
2003
43,656
113,426
1,992
159,074
All such securities were dilutive or converted to common stock
in 2005 and 2004.
ContentGuard: In March 2004, we sold all but 2% of our 75%
ownership interest in ContentGuard Inc, (“ContentGuard”) to
Microsoft Corporation and Time Warner Inc. for $66 in cash. The
sale resulted in a pre-tax gain of $109 as our investment reflected
the recognition of cumulative operating losses. The gain on
sale has been presented within the accompanying consolidated
statements of income considering the reporting requirements
related to discontinued operations of SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets.” The
revenues, operating results and net assets of ContentGuard were
immaterial for all periods presented. ContentGuard, which was
originally created out of research developed at the Xerox Palo
Alto Research Center (“PARC”), licenses intellectual property and
technologies related to digital rights management. During 2005,
we sold our remaining interest in ContentGuard.
Xerox Engineering Systems: In the second quarter of 2003,
we sold our Xerox Engineering Systems (“XES”) subsidiaries
in France and Germany for a nominal amount and recognized
a loss of $12.
Note 21 – Divestitures and Other Sales
During the three years ended December 31, 2005, the following
significant divestitures occurred:
Integic: In March 2005, we completed the sale of our entire equity
interest in Integic Corporation (“Integic”) for $96 in cash, net of
transaction costs. The sale resulted in a pre-tax gain of $93
($58 after-tax). Prior to this transaction, our investment in Integic
was accounted for using the equity method and was included in
Investments in affiliates, at equity within our Consolidated Balance
Sheets. The pre-tax gain is classified within Other (income)
expenses, net in the accompanying Consolidated Statements
of Income.
ScanSoft: In April 2004, we completed the sale of our ownership
interest in ScanSoft, Inc. (“ScanSoft”) to affiliates of Warburg
Pincus for approximately $79 in cash, net of transaction costs.
Prior to the sale, we beneficially owned approximately 15% of
ScanSoft’s outstanding equity interests. The sale resulted in a
pre-tax gain of $38. Prior to this transaction, our investment in
ScanSoft was accounted for as an “available for sale” investment.
The gain is classified within Other (income) expenses, net in the
accompanying Consolidated Statements of Income.
Note 22 – Financial Statements of
Subsidiary Guarantors
The Senior Notes due 2009, 2010, 2011 and 2013 are
guaranteed by Xerox International Joint Marketing, Inc. (“XIJM”)
(the “Guarantor Subsidiary”), which is wholly owned by Xerox
Corporation (the “Parent Company”). Effective December 31,
2005, one of the prior guarantors, Intelligent Electronics, Inc.,
was merged into the Parent Company based on an internal
reorganization. This resulted in a retroactive restatement of the
condensed consolidating financial information to reflect XIJM
as the sole guarantor subsidiary as of December 31, 2005. The
following supplemental financial information sets forth, on a con-
densed consolidating basis, statements of income, the balance
sheets and statements of cash flows for the Parent Company,
the Guarantor Subsidiary, the non-guarantor subsidiaries and
total consolidated Xerox Corporation and subsidiaries for the
years ended December 31, 2005, 2004 and 2003 and as of
December 31, 2005 and December 31, 2004.
X e r o x A n n u a l R e p o r t 2 0 0 5
91
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Condensed Consolidating Statements of Income
For the Year Ended December 31, 2005
Parent
Company
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
Eliminations*
Revenues
Sales
Service, outsourcing and rentals
Finance income
Intercompany revenues
Total Revenues
Costs and Expenses
Cost of sales
Cost of service, outsourcing and rentals
Equipment financing interest
Intercompany cost of sales
Research, development and engineering expenses
Selling, administrative and general expenses
Restructuring and asset impairment charges
Other (income) expenses, net
Total Costs and Expenses
Income from Continuing Operations before Income Taxes,
Equity Income, Discontinued Operations and
Cumulative Effect of Change in Accounting Principle
Income tax (benefits) expenses
Equity in net income of unconsolidated affiliates
Equity in net income of consolidated affiliates
Income from Continuing Operations before
Discontinued Operations and Cumulative Effect
of Change in Accounting Principle
Income from Discontinued Operations, net of tax
Cumulative Effect of Change in Accounting Principle,
net of tax
Net Income (Loss)
$3,292
4,006
313
1,178
8,789
2,034
2,253
152
1,044
865
2,289
167
(170)
8,634
155
(184)
5
584
928
53
(3)
$ –
–
–
–
–
–
–
–
–
–
–
–
(23)
(23)
23
9
–
8
22
–
–
$ 4,108
3,629
679
319
8,735
2,823
1,956
291
252
117
2,028
201
420
8,088
647
163
99
2
585
–
(5)
$
–
(209)
(117)
(1,497)
(1,823)
(162)
(2)
(117)
(1,296)
(39)
(207)
(2)
(3)
(1,828)
5
7
(6)
(594)
(602)
–
–
Total
Company
$ 7,400
7,426
875
–
15,701
4,695
4,207
326
–
943
4,110
366
224
14,871
830
(5)
98
–
933
53
(8)
$ 978
$ 22
$ 580
$ (602)
$
978
* The information primarily includes elimination entries necessary to consolidate Xerox Corporation, the parent, with the guarantor subsidiary and non-guarantor subsidiaries.
92
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Condensed Consolidating Balance Sheets
As of December 31, 2005
Assets
Cash and cash equivalents
Short-term investments
Total Cash, cash equivalents and
Short-term investments
Accounts receivable, net
Billed portion of finance receivables, net
Finance receivables, net
Inventories
Other current assets
Total Current assets
Finance receivables due after one year, net
Equipment on operating leases, net
Land, buildings and equipment, net
Investments in affiliates, at equity
Investments in and advances to
consolidated subsidiaries
Intangible assets, net
Goodwill
Other long-term assets
Total Assets
Liabilities and Equity
Short-term debt and current portion of
long-term debt
Accounts payable
Other current liabilities
Total Current liabilities
Long-term debt
Intercompany payables, net
Liabilities to subsidiary trusts issuing
preferred securities
Other long-term liabilities
Total Liabilities
Series C mandatory convertible preferred stock
Common shareholders’ equity
Parent
Company
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
Eliminations*
$
640
244
884
475
178
894
721
463
3,615
1,678
263
946
42
8,397
276
381
1,704
$
–
–
–
–
–
–
–
–
–
–
–
–
–
46
–
–
–
$
682
–
$
682
1,562
118
1,710
521
543
5,136
3,271
168
681
819
(19)
13
1,282
1,764
–
–
–
–
–
–
(41)
26
(15)
–
–
–
(79)
(8,424)
–
8
–
Total
Company
$ 1,322
244
1,566
2,037
296
2,604
1,201
1,032
8,736
4,949
431
1,627
782
–
289
1,671
3,468
$ 17,302
$ 46
$ 13,115
$ (8,510)
$ 21,953
$
1
537
925
1,463
3,516
1,829
626
2,660
10,094
889
6,319
$
–
–
28
28
–
(212)
–
–
(184)
–
230
$ 1,138
491
1,211
2,840
2,623
(1,595)
–
992
4,860
–
8,255
$
–
15
–
15
–
(22)
–
(18)
(25)
–
(8,485)
$ 1,139
1,043
2,164
4,346
6,139
–
626
3,634
14,745
889
6,319
Total Liabilities and Equity
$17,302
$ 46
$13,115
$(8,510)
$ 21,953
*The information primarily includes elimination entries necessary to consolidate Xerox Corporation, the parent, with the guarantor subsidiary and non-guarantor subsidiaries.
X e r o x A n n u a l R e p o r t 2 0 0 5
93
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Condensed Consolidating Statements of Cash Flows
For the Year Ended December 31, 2005
Parent
Company
$(1,018)
(290)
(496)
–
(1,804)
2,444
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
$
$ 2,438
(5)
(2,466)
(59)
(92)
774
–
–
–
–
–
–
–
Total
Company
$ 1,420
(295)
(2,962)
(59)
(1,896)
3,218
$ 640
$
$ 682
$ 1,322
Net cash (used in) provided by operating activities
Net cash used in investing activities
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
94
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Condensed Consolidating Statements of Income
For the Year Ended December 31, 2004
Parent
Company
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
Eliminations*
Revenues
Sales
Service, outsourcing and rentals
Finance income
Intercompany revenues
Total Revenues
Cost and Expenses
Cost of sales
Cost of service, outsourcing and rentals
Equipment financing interest
Intercompany cost of sales
Research, development and engineering expenses
Selling, administrative and general expenses
Restructuring and asset impairment charges
Other (income) expenses, net
Total Cost and Expenses
Income from Continuing Operations before Income Taxes,
Equity Income, Discontinued Operations and
Cumulative Effect of Change in Accounting Principle
Income tax expenses
Equity in net income of unconsolidated affiliates
Equity in net income of consolidated affiliates
Income from Continuing Operations before
Discontinued Operations and Cumulative Effect of
Change in Accounting Principle
Income from Discontinued Operations, net of tax
Cumulative Effect of Change in Accounting Principle,
net of tax
Net Income (Loss)
$3,263
4,119
314
1,004
8,700
2,040
2,312
106
914
822
2,363
51
(35)
8,573
127
94
15
728
776
83
–
$ –
–
–
–
–
–
–
–
–
–
–
–
(19)
(19)
19
7
–
8
20
–
–
$ 3,996
3,627
713
365
8,701
2,636
2,000
332
297
128
2,046
35
424
7,898
803
229
131
–
705
–
–
$
–
(217)
(93)
(1,369)
(1,679)
(131)
(17)
(93)
(1,211)
(36)
(206)
–
(1)
(1,695)
16
10
5
(736)
(725)
–
–
Total
Company
$ 7,259
7,529
934
–
15,722
4,545
4,295
345
–
914
4,203
86
369
14,757
965
340
151
–
776
83
–
$ 859
$ 20
$ 705
$ (725)
$
859
*The information primarily includes elimination entries necessary to consolidate Xerox Corporation, the parent, with the guarantor subsidiary and non-guarantor subsidiaries.
X e r o x A n n u a l R e p o r t 2 0 0 5
95
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Condensed Consolidating Balance Sheets
As of December 31, 2004
Parent
Company
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
Eliminations*
Assets
Cash and cash equivalents
Short-term investments
$ 2,444
–
$
Total Cash, cash equivalents and
Short-term investments
Accounts receivable, net
Billed portion of finance receivables, net
Finance receivables, net
Inventories
Other current assets
Total Current assets
Finance receivables due after one year, net
Equipment on operating leases, net
Land, buildings and equipment, net
Investments in affiliates, at equity
Investments in and advances to
consolidated subsidiaries
Intangible assets, net
Goodwill
Other long-term assets
Total Assets
Liabilities and Equity
Short-term debt and current portion of
long-term debt
Accounts payable
Other current liabilities
Total Current liabilities
Long-term debt
Intercompany payables, net
Liabilities to subsidiary trusts issuing
preferred securities
Other long-term liabilities
Total Liabilities
Series C mandatory convertible preferred stock
Common shareholders’ equity
–
–
–
–
–
–
–
–
–
–
–
–
–
36
–
–
–
$
774
–
$
774
1,696
171
2,351
511
664
6,167
4,089
166
777
862
(165)
8
1,459
2,512
–
–
–
–
–
–
(40)
53
13
–
–
–
(57)
(9,165)
–
8
–
Total
Company
$ 3,218
–
3,218
2,076
377
2,932
1,143
1,182
10,928
5,188
398
1,759
845
–
324
1,848
3,594
2,444
380
206
581
672
465
4,748
1,099
232
982
40
9,294
316
381
1,082
$ 18,174
$ 36
$ 15,875
$ (9,201)
$ 24,884
$
5
481
871
1,357
3,632
2,592
717
2,743
11,041
889
6,244
$
–
–
13
13
–
(184)
–
–
(171)
–
207
$ 3,069
517
1,317
4,903
3,418
(2,386)
–
956
6,891
–
8,984
$
–
39
(12)
27
–
(22)
–
(15)
(10)
–
(9,191)
$ 3,074
1,037
2,189
6,300
7,050
–
717
3,684
17,751
889
6,244
Total Liabilities and Equity
$ 18,174
$ 36
$ 15,875
$ (9,201)
$ 24,884
* The information primarily includes elimination entries necessary to consolidate Xerox Corporation, the parent, with the guarantor subsidiary and non-guarantor subsidiaries.
96
X e r o x A n n u a l R e p o r t 2 0 0 5
X e r o x C o r p o r a t i o n
Condensed Consolidating Statements of Cash Flows
For the Year Ended December 31, 2004
Net cash provided by operating activities
Net cash provided by investing activities
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and cash equivalents
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Parent
Company
$ 1,122
72
153
(2)
1,345
1,099
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
$
$ 628
131
(1,446)
83
(604)
1,378
–
–
–
–
–
–
–
Total
Company
$ 1,750
203
(1,293)
81
741
2,477
Cash and cash equivalents at end of year
$ 2,444
$
$ 774
$ 3,218
Condensed Consolidating Statements of Income
For the Year Ended December 31, 2003
Parent
Company
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
Eliminations*
Revenues
Sales
Service, outsourcing and rentals
Finance income
Intercompany revenues
Total Revenues
Cost and Expenses
Cost of sales
Cost of service, outsourcing and rentals
Equipment financing interest
Intercompany cost of sales
Research, development and engineering expenses
Selling, administrative and general expenses
Restructuring and asset impairment charges
Other expenses (income), net
Total Cost and Expenses
Income (Loss) from Continuing Operations before
Income Taxes, Equity Income, Discontinued Operations
and Cumulative Effect of Change in Accounting Principle
Income tax (benefits) expenses
Equity in net income of unconsolidated affiliates
Equity in net income of consolidated affiliates
Income (Loss) from Continuing Operations before
Discontinued Operations and Cumulative Effect of
Change in Accounting Principle
Income from Discontinued Operations, net of tax
Cumulative Effect of Change in Accounting Principle,
net of tax
Net Income (Loss)
$3,321
4,301
337
595
8,554
2,054
2,364
88
533
859
2,521
105
504
9,028
(474)
(108)
–
726
360
–
–
$ –
–
–
–
–
–
–
–
–
–
–
–
(18)
(18)
18
7
–
12
23
–
–
$ 3,649
3,636
750
427
8,462
2,438
1,965
364
342
116
1,919
71
371
7,586
876
224
61
–
713
–
–
Total
Company
$ 6,970
7,734
997
–
15,701
4,346
4,307
362
–
962
4,249
176
863
$
–
(203)
(90)
(1,022)
(1,315)
(146)
(22)
(90)
(875)
(13)
(191)
–
6
(1,331)
15,265
16
11
(3)
(738)
(736)
–
–
436
134
58
–
360
–
–
$ 360
$ 23
$ 713
$ (736)
$
360
* The information primarily includes elimination entries necessary to consolidate Xerox Corporation, the parent, with the guarantor subsidiary and non-guarantor subsidiaries.
X e r o x A n n u a l R e p o r t 2 0 0 5
97
N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
(Dollars in millions, except per-share data and unless otherwise indicated)
Condensed Consolidating Statements of Cash Flows
For the Year Ended December 31, 2003
Net cash provided by (used in) operating activities
Net cash (used in) provided by investing activities
Net cash (used in) provided by financing activities
Effect of exchange rate changes on cash and cash equivalents
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Parent
Company
$ 2,672
(475)
(2,769)
–
(572)
1,671
Guarantor
Subsidiary
Non-Guarantor
Subsidiaries
$
$ (793)
524
299
132
162
1,216
–
–
–
–
–
–
–
Total
Company
$ 1,879
49
(2,470)
132
(410)
2,887
Cash and cash equivalents at end of year
$ 1,099
$
$ 1,378
$ 2,477
Note 23 – Subsequent Events
In January 2006, the Board of Directors authorized an additional
repurchase of up to $500 of the Company’s common stock. The
Company expects the stock to be repurchased over the next 6-12
months, primarily through open-market purchases. Open-market
repurchases will be made in compliance with the Securities and
Exchange Commission’s Rule 10b-18, and are subject to market
conditions as well as applicable legal and other considerations.
Through February 16, 2006, we repurchased the following
through our authorized repurchase programs:
Common Stock
Shares
Aggregate
Costs
October 2005
Repurchase Program
35,213,032
$501*
January 2006
Repurchase Program
Total
3,556,168
38,769,200
52**
$553
*This amount included $1 of associated fees.
**This amount included an insignificant amount of associated fees.
98
X e r o x A n n u a l R e p o r t 2 0 0 5
R E P O R T S O F M A N A G E M E N T
X e r o x C o r p o r a t i o n
Management’s Responsibility for
Financial Statements
Management’s Report on Internal Control
Over Financial Reporting
Our management is responsible for the integrity and objectivity of
all information presented in this annual report. The consolidated
financial statements were prepared in conformity with accounting
principles generally accepted in the United States of America
and include amounts based on management’s best estimates
and judgments. Management believes the consolidated financial
statements fairly reflect the form and substance of transactions
and that the financial statements fairly represent the Company’s
financial position and results of operations.
The Audit Committee of the Board of Directors, which is
composed solely of independent directors, meets regularly with
the independent auditors, PricewaterhouseCoopers LLP, the
internal auditors and representatives of management to review
accounting, financial reporting, internal control and audit matters,
as well as the nature and extent of the audit effort. The Audit
Committee is responsible for the engagement of the independent
auditors. The independent auditors and internal auditors have
free access to the Audit Committee.
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is
defined in the rules promulgated under the Securities Exchange
Act of 1934. Under the supervision and with the participation
of our management, including our principal executive, financial
and accounting officers, we have conducted an evaluation of the
effectiveness of our internal control over financial reporting based
on the framework in “Internal Control – Integrated Framework”
issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
Based on the above evaluation, management has concluded
that our internal control over financial reporting was effective as
of December 31, 2005. Our management’s assessment of the
effectiveness of our internal control over financial reporting as of
December 31, 2005 has been audited by PricewaterhouseCoopers
LLP, an independent registered public accounting firm, as stated
in their report which is included herein.
Anne M. Mulcahy
Chief Executive Officer
Lawrence A. Zimmerman
Chief Financial Officer
Gary R. Kabureck
Chief Accounting Officer
X e r o x A n n u a l R e p o r t 2 0 0 5
99
R E P O R T O F I N D E P E N D E N T R E G I S T E R E D
P U B L I C A C C O U N T I N G F I R M
To the Board of Directors and Shareholders
of Xerox Corporation:
We have completed integrated audits of Xerox Corporation’s 2005
and 2004 consolidated financial statements and of its internal
control over financial reporting as of December 31, 2005 and an
audit of its 2003 consolidated financial statements in accordance
with the standards of the Public Company Accounting Oversight
Board (United States). Our opinions, based on our audits, are
presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets
and the related consolidated statements of income, cash flows
and common shareholders’ equity present fairly, in all material
respects, the financial position of Xerox Corporation and its
subsidiaries at December 31, 2005 and 2004, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2005 in conformity with
accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of
the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
of financial statements includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, and evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in
the accompanying Management’s Report on Internal Control
Over Financial Reporting, that the Company maintained effective
internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2005, based on criteria
established in Internal Control – Integrated Framework issued by
the COSO. The Company’s management is responsible for
maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express opinions on
management’s assessment and on the effectiveness of the
Company’s internal control over financial reporting based on our
audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal
control over financial reporting includes obtaining an under-
standing of internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinions.
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of
the company; (ii) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial state-
ments in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being
made only in accordance with authorizations of management and
directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
100
X e r o x A n n u a l R e p o r t 2 0 0 5
PricewaterhouseCoopers LLP
Stamford, Connecticut
February 17, 2006
Q U A R T E R LY R E S U LT S O F O P E R A T I O N S
( U N A U D I T E D )
X e r o x C o r p o r a t i o n
(in millions, except per-share data)
2005
Revenues
Costs and Expenses (1)
Income from Continuing Operations before Income Taxes,
Equity Income, Discontinued Operations and Cumulative Effect
of Change in Accounting Principle
Income tax expenses (benefits) (2)
Equity in net income of unconsolidated affiliates
Income from discontinued operations, net
Cumulative effect of change in accounting principle, net
Net Income
Basic Earnings per Share (3)
Diluted Earnings per Share (3)
2004
Revenues
Costs and Expenses (1)
Income from Continuing Operations before Income Taxes,
Equity Income, Discontinued Operations and Cumulative Effect
of Change in Accounting Principle
Income tax expenses
Equity in net income of unconsolidated affiliates (4)
Income from discontinued operations, net
Cumulative effect of change in accounting principle, net
Net Income
Basic Earnings per Share (3)
Diluted Earnings per Share (3)
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Full
Year
$ 3,771
3,482
$ 3,921
3,804
$ 3,759
3,682
$ 4,250
3,903
$15,701
14,871
289
116
37
–
–
117
(233)
20
53
–
$ 210
$ 423
$
77
29
23
–
(8)
63
347
83
18
–
–
$ 282
$ 0.20
$ 0.43
$ 0.05
$ 0.28
$ 0.20
$ 0.40
$ 0.05
$ 0.27
830
(5)
98
53
(8)
978
0.96
0.94
$
$
$
$ 3,827
3,625
$ 3,853
3,581
$ 3,716
3,553
$ 4,326
3,998
$15,722
14,757
202
67
30
83
–
272
91
27
–
–
163
62
62
–
–
328
120
32
–
–
$ 248
$ 208
$ 163
$ 240
$ 0.28
$ 0.23
$ 0.18
$ 0.26
$
$
965
340
151
83
–
859
0.94
$ 0.25
$ 0.21
$ 0.17
$ 0.24
$ 0.86
(1) Costs and expenses include restructuring and asset impairment charges of $85, $194, $17 and $70 for the first, second, third and fourth quarters of 2005, respectively, and
$6, $33, $23 and $24 for the first, second, third and fourth quarters of 2004, respectively. Also included are $93 from the 2005 first-quarter sale of our entire equity interest
in Integic (see Note 21) and $115 from the MPI arbitration panel ruling and probable losses for other legal matters incurred in the third quarter of 2005 (see Note 16). In
addition, a gain of $38 from the sale of our investment in ScanSoft was included in the second quarter of 2004.
(2) The 2005 second quarter included $343 of net income tax benefits related to the finalization of the 1996-1998 IRS audit, of which $233 was included in income taxes, $57
was included in other expenses, net and $53 was included in discontinued operations (see Note 15).
(3) The sum of quarterly earnings per share may differ from the full-year amounts due to rounding, or in the case of diluted earnings per share, because securities that are anti-
dilutive in certain quarters may not be anti-dilutive on a full-year basis.
(4) Equity in net income of unconsolidated affiliates for the third quarter of 2004 includes an after-tax $38 pension settlement benefit from Fuji Xerox.
X e r o x A n n u a l R e p o r t 2 0 0 5
101
F I V E Y E A R S I N R E V I E W
(in millions, except per-share data)
2005
2004
2003
2002
2001
Per-Share Data (1)
Income (Loss) from continuing operations before discontinued
operations and cumulative effect of change in accounting principle
Basic
Diluted
Earnings (Loss)
Basic
Diluted
Common stock dividends
Operations
Revenues
Sales
Service, outsourcing and rentals
Finance income
Research, development and engineering expenses (3)
Selling, administrative and general expenses
Income (Loss) from continuing operations before discontinued
operations and cumulative effect of change in accounting principle
Net income (loss) (1)
Financial Position
Cash, cash equivalents and short-term investments
Accounts and finance receivables, net
Inventories
Equipment on operating leases, net
Land, buildings and equipment, net
Investment in discontinued operations
Total Assets
Consolidated Capitalization
Short-term debt and current portion of long-term debt
Long-term debt
Total Debt
Minorities’ interests in equity of subsidiaries
Liabilities to subsidiary trusts issuing preferred securities
Series B convertible preferred stock
Series C mandatory convertible preferred stock
Common shareholders’ equity
Total Capitalization
Selected Data and Ratios
Common shareholders of record at year-end
Book value per common share
Year-end common stock market price
Employees at year-end
Gross margin
Sales gross margin
Service, outsourcing and rentals gross margin
Finance gross margin
Working capital
Current ratio
Cost of additions to land, buildings and equipment
Depreciation on buildings and equipment
$
$
$
$
0.91
0.90
0.96
0.94
–
0.84
0.78
0.94
0.86
–
$
$
$
$
0.38
0.36
0.38
0.36
–
0.11
0.10
0.02
0.02
–
$ 15,701
7,400
7,426
875
943
4,110
$ 15,722
7,259
7,529
934
914
4,203
$ 15,701
6,970
7,734
997
962
4,249
$ 15,849
6,752
8,097
1,000
980
4,437
$ (0.15)
(0.15)
$ (0.15)
(0.15)
0.05
$ 17,008
7,443
8,436
1,129
1,058
4,728
933
978
776
859
360
360
154
91
(92)
(94)
$ 1,566
9,886
1,201
431
1,627
420
21,953
$ 3,218
10,573
1,143
398
1,759
440
24,884
$ 2,477
10,972
1,152
364
1,827
449
24,591
$ 2,887
11,077
1,231
450
1,757
728
25,550
$ 3,990
11,574
1,364
804
1,999
749
27,746
1,139
6,139
7,278
90
626
–
889
6,319
3,074
7,050
10,124
80
717
–
889
6,244
4,236
6,930
11,166
102
1,809
499
889
3,291
4,377
9,794
14,171
73
1,793
508
–
1,893
6,637
10,107
16,744
73
1,787
470
–
1,797
$ 15,202
$ 18,054
$ 17,756
$ 18,438
$ 20,871
53,017
$
6.79
$ 14.65
55,220
55,152
$
6.53
$ 17.01
58,100
56,326
$
4.15
$ 13.80
61,100
$
$
57,300
2.56
8.05
67,800
59,830
$
2.49
$ 10.42
78,900
41.2%
36.6%
43.3%
62.7%
41.6%
37.4%
43.0%
63.1%
42.6%
37.6%
44.3%
63.7%
42.8%
38.2%
44.5%
59.9%
38.6%
31.3%
42.2%
59.5%
$ 4,390
2.0
181
280
$
$
$ 4,628
1.7
204
305
$
$
$ 2,666
1.4
197
299
$
$
$ 3,242
1.4
146
341
$
$
$ 2,340
1.2
219
402
$
$
(1) Net income (loss), as well as Basic and Diluted Earnings per Share for the years ended December 31, 2005, 2004, 2003 and 2002 exclude the effect of amortization of
goodwill in accordance with the adoption of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.” Amortization expense, net, related to
Goodwill was $59 in 2001.
(2) In March 2001, we sold half of our ownership interest in Fuji Xerox to Fuji Photo Film Co. Ltd. for $1.3 billion in cash. In connection with the sale, we recorded a pre-tax gain of
$773. As a result, our ownership percentage decreased from 50% to 25%.
(3) Effective July 1, 2005, we reclassified sustaining engineering costs from cost of sales and cost of service, outsourcing and rentals to a new line item in our Consolidated
Statements of Income entitled Research, Development and Engineering. This presentation aligns our external reporting presentation to our internal management of these costs.
102
X e r o x A n n u a l R e p o r t 2 0 0 5
O F F I C E R S
Anne M. Mulcahy
Chairman and Chief Executive Officer
Ursula M. Burns
Senior Vice President
President, Business Group Operations
Thomas J. Dolan
Senior Vice President
President, Xerox Global Services
James A. Firestone
Senior Vice President
President, Xerox North America
Michael C. Mac Donald
Senior Vice President
President, Global Accounts and
Marketing Operations
Jean-Noel Machon
Senior Vice President
President, Developing Markets Operations
Hector J. Motroni
Senior Vice President
Chief Staff Officer and Chief Ethics Officer
Brian E. Stern
Senior Vice President
Fuji Xerox Operational Support
Corporate Strategy and Alliances
Armando Zagalo de Lima
Senior Vice President
President, Xerox Europe
Lawrence A. Zimmerman
Senior Vice President and
Chief Financial Officer
X e r o x C o r p o r a t i o n
Quincy L. Allen
Vice President
President, Production Systems Group
Wim T. Appelo
Vice President
Paper, Supplies and
Supply Chain Operations
Business Group Operations
Harry R. Beeth
Vice President and Controller
Michael D. Brannigan
Vice President
President, United States Solutions Group
Xerox North America
Richard F. Cerrone
Vice President
Small and Medium Business
Business Group Operations
M. Stephen Cronin
Vice President
Chief of Staff
Developing Markets Operations
Patricia A. Cusick
Vice President and
Chief Information Officer
Business Group Operations
Kathleen S. Fanning
Vice President
Worldwide Tax
J. Michael Farren
Vice President
External and Legal Affairs,
General Counsel and
Corporate Secretary
Anthony M. Federico
Vice President
Chief Engineer
Business Group Operations
Emerson U. Fullwood
Vice President
Chief of Staff and Marketing
Xerox North America
D. Cameron Hyde
Vice President
General Manager
North American Agent Operations
Xerox North America
Gary R. Kabureck
Vice President and
Chief Accounting Officer
John M. Kelly
Vice President
Senior Vice President
and Chief Operating Officer
Xerox Global Services
James H. Lesko
Vice President
Investor Relations
John E. McDermott
Vice President
Corporate Strategy and Alliances
Ivy Thomas McKinney
Vice President and
Deputy General Counsel
Patricia M. Nazemetz
Vice President
Human Resources
Russell Y. Okasako
Vice President
Taxes
Rhonda L. Seegal
Vice President and Treasurer
Sophie V. Vandebroek
Vice President
Chief Technology Officer
and President
Xerox Innovation Group
Leslie F. Varon
Vice President
Finance and Operational Support
Xerox North America
Tim Williams
Vice President
President
Xerox Office Group
Business Group Operations
103
C O R P O R A T E I N F O R M A T I O N
How to Reach Us
Shareholder Information
Xerox Corporation
800 Long Ridge Road
PO Box 1600
Stamford, CT 06904
203 968-3000
Fuji Xerox Co., Ltd.
2-17-22 Akasaka
Minato-ku, Tokyo 107
Japan
81 3 3585-3211
Xerox Europe
Riverview
Oxford Road
Uxbridge
Middlesex
United Kingdom
UB8 1HS
44 1895 251133
Products and Service
www.xerox.com or by phone: 800 ASK-XEROX (800 275-9376)
Additional Information
The Xerox Foundation
203 968-4416
Contact: Evelyn Shockley, Manager
Diversity Programs and EEO-1 Reports
585 423-6157
www.xerox.com/diversity
Minority and Women Owned Business Suppliers
585 422-2295
www.xerox.com/supplierdiversity
Ethics Helpline
866 XRX-0001
(North America; International numbers on xerox.com)
e-mail: ethics@xerox.com
Environment, Health and Safety Progress Report
800 828-6571 prompts 1, 3
www.xerox.com/ehs/progressreport
Governance
www.xerox.com/investor (Corporate Governance)
Questions from Students and Educators
e-mail: nancy.dempsey@xerox.com
Xerox Innovation
www.xerox.com/innovation
Independent Auditors
PricewaterhouseCoopers LLP
300 Atlantic Street
Stamford, CT 06901
203 539-3000
This annual report is also available online
at www.xerox.com/investor
104
For investor information, including comprehensive earnings releases:
www.xerox.com/investor
Earnings releases are also available by mail by calling:
800 828-6396.
For shareholder services, call 800 828-6396 (TDD: 800 368-0328)
or 781 575-3222, or write to Computershare Trust Company, N.A.,
PO Box 43010, Providence, RI 02940-3010 or use e-mail
available at: www.computershare.com/equiserve
Annual Meeting
Wednesday, May 24, 2006, 10:00 a.m. EDT
Xerox Corporation Corporate Headquarters
800 Long Ridge Road
Stamford, Connecticut
Proxy material mailed by April 10, 2006, to shareholders of
record March 24, 2006.
Ann Pettrone, Manager, Investor Relations, ann.pettrone@xerox.com
Brian Walsh, Manager, Investor Relations, brian.walsh@xerox.com
Xerox Common Stock Prices and Dividends
New York Stock Exchange composite prices*
2005
High
Low
2004
High
Low
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$ 16.97
$ 15.25
$ 14.12
$ 15.03
14.44
13.09
13.11
12.41
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$ 15.30
$ 14.96
$ 14.37
$ 17.12
13.39
12.66
12.99
14.14
At its July 9, 2001, meeting, the company’s Board of Directors
eliminated the dividend on the common stock.
*Prices as of close of business
Stock Listed and Traded
Xerox common stock (XRX) is listed on the New York Stock
Exchange and the Chicago Stock Exchange. It is also traded on
the Boston, Cincinnati, Pacific Coast, Philadelphia, London and
Switzerland exchanges.
© 2006 Xerox Corporation. All rights reserved. XEROX®, DocuColor®, DocuPrint®,
DocuTech®, New Business of Printing®, Phaser®, WorkCentre®, iGen3® Xerox
Nuvera™, and 2101 are trademarks of Xerox Corporation in the U.S. and/or other
countries. DocuColor® is used under license.
Thank you to our customers who
participated in this report:
The Taylor Corporation,
The Dow Chemical Company and
The ConferenceWorks!
All of us at Xerox deeply appreciate
our relationships and look forward
to making them even stronger.
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Xerox Corporation
800 Long Ridge Road
PO Box 1600
Stamford, CT 06904
www.xerox.com
© 2006 Xerox Corporation. All rights reserved.
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