Xerox Holdings Corporation Annual Report 2008

FY2008 Annual Report · Xerox Holdings Corporation

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2008 Annual Report

of Printing®, Phaser®, WorkCentre®, iGen3®, iGen4™, and Xerox Nuvera® are trademarks of, or licensed to Xerox Corporation in the U.S.

and/or other countries. XMPie® is a trademark of XMPie Inc.

002CS18008

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“ Bottom line: yes, we are feeling
the impact of the recession;
yes, we are moving aggressively
to reduce costs, generate cash
and weather the storm; but no,
we are neither giving up on 2009
nor mortgaging our future by
compromising on investments that
will give us momentum as we come
out of the economic downturn.”

Anne M. Mulcahy
Chairman and Chief Executive Officer

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Financial overview

(in millions, except EPS)

Total revenue

Equipment sales

Post sale revenue

Net income

Adjusted net income*

Diluted earnings per share

Adjusted earnings per share*

2008

2007

$ 17,608

$ 17,228

4,679

4,753

12,929

12,475

230

985

0.26

1.10

1,135

1.19

Net cash provided by operating activities

939

1,871

Adjusted cash from core operations*

1,721

2,083

* See Page 7 for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting
Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP.

1
Financial Overview

2
Letter to Shareholders

8
Board of Directors

10
Our Business

25
Management’s Discussion and
Analysis of Financial Condition and
Results of Operations

47
Financial Statements

95
Officers

96
Shareholder Information

Financial overview

(in millions, except EPS)

Xerox 2008 Annual Report

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Dear fellow shareholders:

It will come as no surprise to you that Xerox shareholders
have been negatively impacted by the economic crisis that
has ricocheted around the world in recent months. Through
three quarters of 2008, we were on the path to another year
of solid performance. That trajectory changed dramatically
in the fourth quarter.

One example will make the point. Our developing markets
organization was on track to deliver another year of double-
digit revenue growth. Through the first three quarters of
2008, revenue was up 17 percent. Starting in mid-November,
the bottom fell out with breathtaking speed, resulting in
a fourth-quarter revenue decline of 14 percent in our
developing markets.

“ Although we are hardly immune
from the recessionary turmoil, we
are better positioned than most
to navigate through it.”

Some of the sudden shift was due to a rapid decline in the
Russian and Eastern European economies. But 11 points
of the 14-point decline was due to major – some would say
wild – shifts in currency in several developing markets.

Typically, we manage changes in currency through pricing,
but this currency decline was so swift and so significant that
pricing couldn’t catch up. I point this out not as an excuse, but
as an illustration of the roller-coaster nature of this economy.

“ The wonderful people I am privileged
to lead at Xerox are focused with
passion and grit on those things we
can control. This attitude and focus
helped us turn in credible performance
in a very difficult year.”

Although we are hardly immune from the recessionary turmoil,
we are better positioned than most to navigate through it.
Our value proposition is supported by the strength of our
financial position and the resiliency of our recurring revenue
stream that is driven by installs of Xerox technology and
multi-year contracts for Xerox services. More than 70 percent
of our revenue and 80 percent of our cash flow is generated
from our annuity-based business model, making for a solid
and reliable asset, especially in tough economies. Last year,
our annuity delivered $12.9 billion in revenue – up 4 percent
from 2007 – and helped us generate more than $1.7 billion
in adjusted cash from core operations* – or $1.36 per share in
adjusted free cash flow.*

* See Page 7 for the reconciliation of the difference between this financial measure that is not in
compliance with Generally Accepted Accounting Principles (GAAP) and the most directly
comparable financial measure calculated in accordance with GAAP.

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Given our cash flow, healthy cash balance – $1.2 billion at the
end of 2008 – and a $2 billion credit facility, we remain quite
confident in our financial position and have no need to access
the capital markets in the foreseeable future. It’s certainly an
advantaged position in this economy.

That’s all looking in the rear-view mirror. I don’t have to be
a psychic to know that you have little patience for that –
especially in these turbulent times. Neither do I. I’ve met with
many investors in recent months and I keep hearing three
questions asked over and over:

Although we are keenly aware that there is much we cannot
control, the wonderful people I am privileged to lead at Xerox
are focused with passion and grit on those things we can
control. This attitude and focus helped us turn in credible
performance in a very difficult year:

• What are you doing to confront the recession right now?

• What are you doing to make sure you come out of this crisis

with a full head of steam?

• Why should I continue to invest in Xerox?

• Total revenue for 2008 was $17.6 billion – that’s an increase

of $380 million, or 2 percent, over 2007.

Fair enough. Let me answer each of those questions as
candidly and succinctly as I can.

• Full-year net income was $230 million including a litigation
charge. Excluding this and certain other charges, adjusted
net income was $985 million.*

• We generated $939 million of operating cash flow. Adjusted

cash from core operations for the year was $1.7 billion.*

• Through the 5 percent of our revenue invested in innovation,

we continued to expand our portfolio of document
management technology and services – already the
broadest in the industry and in our history.

• And we continued to expand distribution, bringing the Xerox
brand to more businesses of any size all around the world.

The proof points are everywhere. The highly respected Gartner
organization lists us as a “Magic Quadrant” market leader in
managed print services, as well as for printers and multi function
systems that print, copy, fax and scan all in one device. Our new
offerings last year garnered some 230 awards from industry
groups and media around the world. I could go on, but you get
the point. Third parties are validating our progress and our
leadership in virtually every aspect of our business.

“ The highly respected Gartner
organization lists us as a “Magic
Quadrant” market leader in managed
print services, as well as for printers
and multi function systems.”

Actions to Minimize Impact of the Recession
We are doing everything possible to reduce cost – everything
that doesn’t mortgage our future. We took a $349 million
restructuring charge in the fourth quarter of 2008 that has
resulted in the elimination of about 3,400 jobs. We expect that
the restructuring will deliver $200 million in savings this year.

Xerox 2008 Annual Report

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2008 bonuses have been scaled back substantially and people
on bonus plans will receive no salary increases this year.
Expenses like training and travel have been significantly cut
back. External hiring has to be approved by me personally.

We’ve accelerated the consolidation of manufacturing
facilities around the world, stopped the production of
products made in very low volume, and consolidated
operations wherever we can. We’ve realigned our support
operations – including human resources, training, finance
and marketing – to achieve better synergy at lower cost.
We’ve streamlined product development and engineering by
combining two product development organizations into one.

So we are taking a long list of actions aimed at getting our
expenses aligned with the realities of faltering economies in
just about every corner of the globe. Our investments over
the years in Lean Six Sigma have given us a set of tools and
processes that simplify and reduce the cost of managing our
global operations. For us, it’s not an event, but a way of life.

The management team I’m privileged to lead is a seasoned
group that knows all about belt-tightening and is eager to
deliver the best possible shareholder value that conditions
allow. You place a lot of trust in us. It’s something we take
very seriously.

Emerging with a Full Head of Steam
At the same time, we are not mortgaging our future. We are
continuing to invest for growth and we are continuing to stick
to the fundamentals – starting with listening to our customers.
One of the things I’m proudest of is the customer-centric
culture we’ve developed at Xerox. We have a proven track
record that demonstrates that our customers increasingly see
us not as a vendor, but as a partner.

Net income

(millions)

1,210

1,135

985*

978

859

’04

’05

’06

’07

’08

230*

Post-sale revenue

(included in total revenue – millions)

11,242

11,182

11,438

12,929

12,475

’04

’05

’06

’07

’08

Color revenue

(included in total revenue – millions)

6,669

6,356

5,578

4,928

4,188

’04

’05

’06

’07

’08

* See Page 7 for the reconciliation of the difference between this financial measure that is not in
compliance with Generally Accepted Accounting Principles (GAAP) and the most directly
comparable financial measure calculated in accordance with GAAP.

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Net cash from
operating activities

(millions)

1,750

1,871

1,617

1,554*

1,420

939

’04

’05

’06

’07

’08

Gross margins

(percent)

41.6

41.2

40.6

40.3

38.9

’04

’05

’06

’07

’08

Selling, administrative
and general costs

(percent of revenue)

26.7

26.2

25.2

25.0

25.7

’04

’05

’06

’07

’08

Our combination of document services, affordable and
innovative color technology, and broader distribution to
businesses of any size positions us exceptionally well to attack
a $132 billion market. Here’s how:

We provide document services that help businesses work
faster and smarter with lower costs. Today businesses rely
on us to help reduce their infrastructure costs by optimizing
how they manage their document technology and handle
enterprise-wide printing needs. Also core to our document
services offerings is our expertise in converting paper to digital
and helping customers seamlessly track, edit, share and save
documents in any form.

In a world where 15.2 trillion pages are printed each year
and $650 billion in productivity is lost each year due to the
overload of information, our ability to simplify the way work
gets done helps customers save up to 30 percent on their
document management costs. That’s a figure that is getting
more and more attention as we speak to our customers these
days, many of whom are looking for ways to contain cost
and reduce paper. That may seem counter-intuitive coming
from a company known for putting marks on pages, but
it’s actually a sweet spot for us, especially in what we call
“document-intensive” industries like legal, healthcare, financial
services and education.

Increasingly we’re partnering with IT services companies
like CSC and HCL Technologies to integrate our strength in
document management with their capabilities in managing
enterprise-wide IT systems. And, we are the preferred global
imaging partner for IBM Managed Business Process Services,
a unit of IBM Global Technology Services. Under our worldwide
agreement, we’re scanning and imaging millions of
documents for IBM and their customers.

We provide affordable color printing systems that cut
through the clutter with high-impact communications. Xerox
continues to benefit from making color printing affordable
for businesses of any size. Revenue from color now represents
more than 41 percent of our total revenue.

Xerox 2008 Annual Report

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The billions of pages printed on Xerox color systems grew
24 percent last year, and total significantly more than any of
our competitors. In fact, according to estimates by InfoTrends,
a leading independent research firm, Xerox’s DocuColor®,
iGen3® and iGen4™ presses accounted for approximately
one-half of the total worldwide color pages printed by
high-speed digital systems.

By acquiring nine office technology dealers in the last two
years and launching 19 products in 2008 designed for small
and mid-size businesses (SMB), we have significantly increased
our penetration in the SMB marketplace. In fact, the number
of installs for our desktop printers and multifunction systems
grew 10 percent last year, largely due to more channels selling
the Xerox brand.

With the broadest portfolio of color printing systems on the
market, we continue to create new business opportunities in
production printing through color technology and systems
such as the Xerox iGen4™ Press and Xerox 700, both of which
launched in 2008.

This year we’ll shake up the industry even more with the
introduction of a color multifunction system that breaks down
the cost barrier of color printing in the office through exclusive
solid ink technology, which not only lessens the impact on a
business’ bottom line but also on the environment.

“ Our recurring revenue stream
represents more than 70 percent
of our total revenue. That gives us
some cushion in challenging economic
times and helps fuel the $1.7 billion
in cash that we expect to generate
this year from core operations.”

“ One of the things I’m proudest of is
the customer-centric culture we’ve
developed at Xerox. We have a proven
track record that demonstrates that
our customers increasingly see us not
as a vendor, but as a partner.”

We have more distribution channels to bring Xerox’s
technology and services to more businesses of any size,
anywhere around the world. For decades, we’ve had the
largest and best direct sales force in our industry. Currently
it’s over 7,500 strong – one of our crown jewels and an asset
that gives us a competitive advantage. That’s backed up by
Global Imaging Systems, our wholly-owned and growing
network of U.S. dealers, as well as an equally impressive
partnership with agents, concessionaires, resellers and more –
giving Xerox the largest, broadest and most professional
distribution network in our industry.

Bottom line: yes, we are feeling the impact of the recession;
yes, we are moving aggressively to reduce costs, generate
cash and weather the storm; but no, we are neither giving
up on 2009 nor mortgaging our future by compromising
on investments that will give us momentum as we come out
of the economic downturn.

The Case for Xerox as an Investment
We firmly believe that we will navigate through this set of
challenges and emerge stronger than ever. I say that for
several reasons.

We continue to enhance our leadership position in document
technology. Last year, Xerox inventors earned more than
600 U.S. utility patents. We currently hold more than 8,900
active patents in the U.S. and, together with our research
partner Fuji Xerox, we have received over 55,000 worldwide
patents in our history.

Our research leadership yields the best and broadest set of
offerings in our industry. Over the past three years, we have
launched more than 80 products – including 29 new products
last year with about the same number expected this year.

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Our distribution and services capacity is also the best and
broadest in our industry. Through our vast and growing
network of direct sales, agents, resellers, Global Imaging
partners and distributors, we do business in over 160 countries.
This is a huge competitive advantage, as customers depend
on us for global account management and increasingly
want to move documents around the world with speed, ease
and security.

We are proud of but not content with the competitive
advantage we have created in our industry. We know it’s a
never-ending battle but it’s one we’re eager to wage. We feel
the same way about corporate responsibility. Even in the worst
of times, we continue to make appropriate investments in
the communities in which we work and live. We continue to
be a leader in diversity in all its forms. We continue to fight
for a sustainable world and a greener planet.

Our strategic bets in the marketplace are paying off in
areas like color and document services. Color pages now
represent 18 percent of total pages printed on Xerox
technology, up from 12 percent in 2007. We lead the industry
in the number of color pages printed. In services, we generated
$3.5 billion in annuity revenue last year, a year-over-year
increase of 3 percent.

Our recurring revenue stream represents more than 70
percent of our total revenue. That gives us some cushion
in challenging economic times and helps fuel the $1.7 billion
in cash that we expect to generate this year from core
operations.

Our leadership team is battle-tested and results-driven.
They are an unusual mix of Xerox veterans, new leaders who
have recently emerged from the ranks and people who joined
us from other leading companies. They are all driven by one
goal – the success of Xerox measured by the value we deliver
to our shareholders.

Last but hardly least is the quality and dedication of our
workforce. Together with our technology and our distribution,
they provide the knowledge and the passion to bring value to
our customers. When I visit customers, it’s our people they
want to talk about. Customers sing the praises of Xerox people
and want to talk about their focus on solving problems, their
can-do attitude, and their desire to do whatever it takes to get
the job done. At the end of the day, Xerox people spell the
difference between failure and success.

So we are feeling good about where we are. There is a fair
amount of disruption in our industry – some of it brought on
by the economy but much of it brought on by Xerox. Over the
past few years, we have upped the ante considerably on the
technology we have brought to market. We have both built
and acquired new document services offerings. And we have
expanded our distribution.

We don’t have our heads in the sand about the challenges
we face, yet we believe we are better positioned than most
to meet the obstacles that 2009 will certainly bring our way.
There are likely to be winners and losers when the dust finally
settles. We feel confident we will be a winner.

Anne M. Mulcahy
Chairman and Chief Executive Officer

Note: Color results exclude Global Imaging Systems performance.

Non-GAAP Reconciliation

Adjusted Net Income/EPS
(in millions, except per share amounts)
Net Income – As Reported
Adjustments:
Q4 2008 Restructuring and asset impairment charges

Q4 2008 Equipment write-off

Q1 2008 Provision for litigation matters
Net Income – As Adjusted

Full-year 2008

Net Income
$ 230

240

491

$ 985

EPS
0.26

0.27

0.03

0.54

1.10

Adjusted Net Cash from Operating Activities/
Cash from Core Operations
(in millions)
Operating Cash – As Reported

Payments for securities litigation

Operating Cash – As Adjusted

Increase (decrease) in finance receivables

Increase in equipment on operating leases

Cash from Core Operations – As Adjusted

Full-year 2008
$ 939

Full-year 2007
$ 1,871

615

$ 1,554

(164)

331

$ 1,721

—

$ 1,871

(119)

331

$ 2,083

Adjusted Free Cash Flow/Free Cash Flow Per Share
(in millions, except per-share data, shares in thousands)
Operating Cash Flow – As Reported

Full-year 2008
$ 939

Payments for securities litigation, net

Capital expenditures

Internal-use software

Adjusted Free Cash Flow (FCF)
Adjusted Weighted Average Shares Outstanding
Adjusted Free Cash Flow Per Share

615

(206)

(129)

$ 1,219

895,542

$ 1.36

Xerox 2008 Annual Report

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Board of Directors

1. Anne M. Mulcahy
Chairman and Chief Executive Officer
Xerox Corporation
Norwalk, CT

6. Robert A. McDonaldA, B
Chief Operating Officer
The Procter & Gamble Company
Cincinnati, OH

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

2. Ursula M. Burns
President
Xerox Corporation
Norwalk, CT

3. Glenn A. BrittA, B
President and Chief Executive Officer
Time Warner Cable
Stamford, CT

4. Ann N. ReeseC, D
Executive Director
Center for Adoption Policy
Rye, NY

5. Vernon E. Jordan, Jr.**B, C
Senior Managing Director
Lazard Frères & Co., LLC
New York, NY
Of Counsel, Akin, Gump, Strauss,
Hauer & Feld, LLP
Washington, DC

7. Charles PrinceD
Chairman
Sconset Group
Vice Chairman and
Chairman of the Board of Advisors
Stonebridge International LLC
Retired Chairman and
Chief Executive Officer
Citigroup Inc.
New York, NY

8. Mary Agnes WilderotterD
Chairman and Chief Executive Officer
Frontier Communications Corporation
Stamford, CT

9. N. J. Nicholas, Jr.B, D
Investor
New York, NY

10. William Curt HunterA, C
Dean, Tippie College of Business
University of Iowa
Iowa City, IA

Richard J. Harrington*A
Retired President and
Chief Executive Officer
The Thomson Corporation
Stamford, CT

Our Business

Consolidated Statements of Cash Flows

Report of Independent Registered

Public Accounting Firm

Management’s Discussion and Analysis

Consolidated Statements of

of Financial Condition and Results of

Shareholders’ Equity

Quarterly Results of Operations

Operations

(Unaudited)

Consolidated Statements of Income

Financial Statements

Five Years in Review

Notes to the Consolidated

Consolidated Balance Sheets

Reports of Management

Shareholder Information

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* Not pictured
** Mr. Jordan is not standing for reelection at the

2009 Annual Meeting of Shareholders

3/24/09 1:59:23 PM

Xerox 2008 Annual Report

10
Our Business

49
Consolidated Statements of Cash Flows

25
Management’s Discussion and Analysis
of Financial Condition and Results of
Operations

47
Consolidated Statements of Income

48
Consolidated Balance Sheets

50
Consolidated Statements of
Shareholders’ Equity

51
Notes to the Consolidated
Financial Statements

90
Reports of Management

91
Report of Independent Registered
Public Accounting Firm

92
Quarterly Results of Operations
(Unaudited)

93
Five Years in Review

96
Shareholder Information

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Xerox 2008 Annual Report

Our Business

We are a $17.6 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.

Overview

References in this section to “we,” “us,” “our,” the “Company” and
“Xerox” refer to Xerox Corporation and its subsidiaries unless the
context specifically states or implies otherwise.

We provide the document industry’s broadest portfolio of
document systems and services for businesses of any size. Digital
systems include high-end printing and publishing systems; digital
presses, advanced and basic multifunctional devices (“MFD’s”)
which can print, copy, scan and fax; digital copiers; laser and solid
ink printers and fax machines. We provide software and workflow

solutions with which businesses can easily and affordably print
books, create personalized documents for their customers, and
scan and route digital information. Our services expertise is
unmatched and includes helping businesses develop online
document archives, analyzing how employees can most efficiently
share documents and knowledge in the office, operating in-house
print shops or mailrooms, and building Web-based processes for
personalizing direct mail, invoices, brochures and more. We also
offer software, support and supplies, such as toner, paper and ink.

We serve a $132 billion market
(in billions)

Production
$25

Services
$26

� $25 Production

We are the leading provider in the market that offers a complete family of monochrome and color
production systems, business development tools and workflow solutions. We are creating new
market opportunities in targeted application areas with digital printing as a complement to
traditional offset printing.

� $26 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.

� $81 Office

Office
$81

We are well positioned to capture growth by leading the transition to color and by reaching new
customers with our broad offerings and expanded distribution channels.

This estimate, and the market estimates that follow, are calculated by leveraging third-party forecasts
from firms such as International Data Corporation and InfoSource in conjunction with our assumptions
about our markets.

The document industry is transitioning to digital systems, to color,
and to an increased reliance on electronic documents. More and
more, businesses are creating and storing documents digitally and
using the Internet to exchange electronic documents. We believe

these trends play to the strengths of our product and service
offerings and represent opportunities for future growth in the $132
billion market we serve.

Our Strategy

Execute

on Growth

Initiatives

Expand

Distribution

Secure Future

Optimize

Technology

Leadership

Productivity

and

Infrastructure

We are well-positioned to lead in this large and growing market through:

Executing on Growth Initiatives

• Accelerating the transition to color – We have the broadest

color portfolio in the industry and leading technologies.

production.

– We are driving the New Business of Printing opportunity by

identifying applications which are suitable for digital

– Color is the fastest growing portion of our market and

estimated at $44 billion.

– Economic cost and quality improvements are driving the

transition from black-and-white to color.

– We continue to capture growth opportunities within the

black-and-white segment of our core markets, which we

estimate is a $62 billion market.

– Our leading business development tools, workflow and digital

technology, led by our market-making Xerox iGen®

technology, uniquely positions us to meet the increasing

demand for short-run, customized and quick-turnaround

offset quality printing.

Expanding our Distribution Channels

• We continue to expand our presence in the small and mid-size

business (“SMB”) market through the acquisition of Veenman

B.V. in the European market, as well as additional acquisitions

made by Global Imaging Systems, Inc. in the U.S. markets.

• Building on services leadership – We lead the industry with

end-to-end Document Management Services and we participate

• We are maintaining our investments in Developing Markets, a

in three areas of the outsourcing services market:

high-growth market opportunity.

– Infrastructure Outsourcing, where we help our customers to

reduce their enterprise spend through differentiated

technology, skills and automation.

Printing.

• We are capitalizing on our Graphic Arts coverage investments to

capture the opportunity associated with the New Business of

– Application Outsourcing, where we help our customers to

streamline their document intensive business processes

through automation and deployment of software

applications and tools.

– Business Process Outsourcing, where our customers

leverage our global delivery capability and proprietary

production imaging software to manage both high volume

standardized activities as well as lower volume complex

workflows.

• Driving the New Business of Printing® – We continue to

create new market opportunities with digital printing as a

complement to traditional offset printing through a market

Securing Future Technology Leadership

• Through advancing our heritage of innovation, we are yielding a

broad technology portfolio.

• We are capitalizing on breakthrough ink technologies such as

Solid Ink and Cured Gel Ink.

• Expanding our Document Management Technologies that

optimize the capabilities of our products and streamline

customers’ processes.

Optimizing Productivity and Infrastructure

• We are improving the efficiency and effectiveness of our

infrastructure and

transition we call the “New Business of Printing”.

• Optimizing our resources to support innovation and growth.

Xerox 2008 Annual Report

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Our Business

We are a $17.6 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.

Overview

References in this section to “we,” “us,” “our,” the “Company” and

solutions with which businesses can easily and affordably print

“Xerox” refer to Xerox Corporation and its subsidiaries unless the

books, create personalized documents for their customers, and

context specifically states or implies otherwise.

We provide the document industry’s broadest portfolio of

document systems and services for businesses of any size. Digital

systems include high-end printing and publishing systems; digital

presses, advanced and basic multifunctional devices (“MFD’s”)

which can print, copy, scan and fax; digital copiers; laser and solid

ink printers and fax machines. We provide software and workflow

scan and route digital information. Our services expertise is

unmatched and includes helping businesses develop online

document archives, analyzing how employees can most efficiently

share documents and knowledge in the office, operating in-house

print shops or mailrooms, and building Web-based processes for

personalizing direct mail, invoices, brochures and more. We also

offer software, support and supplies, such as toner, paper and ink.

We serve a $132 billion market

(in billions)

Production

$25

Services

$26

� $25 Production

We are the leading provider in the market that offers a complete family of monochrome and color

production systems, business development tools and workflow solutions. We are creating new

market opportunities in targeted application areas with digital printing as a complement to

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

traditional offset printing.

� $26 Services

business processes.

� $81 Office

Office

$81

We are well positioned to capture growth by leading the transition to color and by reaching new

customers with our broad offerings and expanded distribution channels.

This estimate, and the market estimates that follow, are calculated by leveraging third-party forecasts

from firms such as International Data Corporation and InfoSource in conjunction with our assumptions

about our markets.

The document industry is transitioning to digital systems, to color,

these trends play to the strengths of our product and service

and to an increased reliance on electronic documents. More and

offerings and represent opportunities for future growth in the $132

more, businesses are creating and storing documents digitally and

billion market we serve.

using the Internet to exchange electronic documents. We believe

Our Strategy

Execute
on Growth
Initiatives

Expand
Distribution

Secure Future
Technology
Leadership

Optimize
Productivity
and
Infrastructure

We are well-positioned to lead in this large and growing market through:

Executing on Growth Initiatives

• Accelerating the transition to color – We have the broadest

color portfolio in the industry and leading technologies.

– Color is the fastest growing portion of our market and

estimated at $44 billion.

– Economic cost and quality improvements are driving the

transition from black-and-white to color.

– We continue to capture growth opportunities within the
black-and-white segment of our core markets, which we
estimate is a $62 billion market.

• Building on services leadership – We lead the industry with

end-to-end Document Management Services and we participate
in three areas of the outsourcing services market:

– Infrastructure Outsourcing, where we help our customers to

reduce their enterprise spend through differentiated
technology, skills and automation.

– Application Outsourcing, where we help our customers to
streamline their document intensive business processes
through automation and deployment of software
applications and tools.

– Business Process Outsourcing, where our customers
leverage our global delivery capability and proprietary
production imaging software to manage both high volume
standardized activities as well as lower volume complex
workflows.

• Driving the New Business of Printing® – We continue to
create new market opportunities with digital printing as a
complement to traditional offset printing through a market
transition we call the “New Business of Printing”.

– We are driving the New Business of Printing opportunity by

identifying applications which are suitable for digital
production.

– Our leading business development tools, workflow and digital

technology, led by our market-making Xerox iGen®
technology, uniquely positions us to meet the increasing
demand for short-run, customized and quick-turnaround
offset quality printing.

Expanding our Distribution Channels

• We continue to expand our presence in the small and mid-size
business (“SMB”) market through the acquisition of Veenman
B.V. in the European market, as well as additional acquisitions
made by Global Imaging Systems, Inc. in the U.S. markets.

• We are maintaining our investments in Developing Markets, a

high-growth market opportunity.

• We are capitalizing on our Graphic Arts coverage investments to
capture the opportunity associated with the New Business of
Printing.

Securing Future Technology Leadership

• Through advancing our heritage of innovation, we are yielding a

broad technology portfolio.

• We are capitalizing on breakthrough ink technologies such as

Solid Ink and Cured Gel Ink.

• Expanding our Document Management Technologies that
optimize the capabilities of our products and streamline
customers’ processes.

Optimizing Productivity and Infrastructure

• We are improving the efficiency and effectiveness of our

infrastructure and

• Optimizing our resources to support innovation and growth.

Xerox 2008 Annual Report

Text.indd 11

3/18/09 5:58:35 PM

Our Business

Our Business Model Fundamentals

Acquisitions

Segment Information

Annuity
Model

Cash
Generation

Expanded
Earnings

One fundamental of our business model is our annuity model. Post
sale revenue growth is driven by increasing equipment installation
which increases the number of page-producing machines in the
field (“MIF”) and by expanding the document management
services we offer our customers. 73% of our 2008 total revenue

was post sale revenue that includes equipment maintenance and
consumable supplies, among other elements. We sell the majority
of our equipment through sales-type leases that we record as
equipment sale revenue. Equipment sales represented 27% of our
2008 total revenue.

Revenue stream

27%

� 73%

Approximately 73% of our revenue, “post sale” includes
annuity-based revenue from maintenance, services, supplies
and financing, as well as revenue from rentals and operating
lease arrangements.

� 27%

73%

The remaining 27% of our revenue comes from equipment
sales, from either lease arrangements that qualify as sales for
accounting purposes or outright cash sales.

$5,237

Our reportable segments are Production, Office and Other. We

present operating segment financial information in Note 2 –

Segment Reporting in the Consolidated Financial Statements,

which we incorporate by reference here. We have a very broad and

diverse base of customers by both geography and industry,

ranging from SMB 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.

To further strengthen our distribution capacity, in 2008 we

completed several acquisitions.

We acquired Veenman B.V. (“Veenman”), expanding our reach into

the small and mid-size business market in the Netherlands.

Veenman is the Netherlands’ leading independent distributor of

office printers, copiers and multifunction devices serving small and

mid-size businesses.

Global Imaging Systems, Inc. (“GIS”) acquired Saxon Business

Systems, an office equipment supplier with offices throughout

Florida and three smaller acquisitions: Better Quality Business

Systems, Precision Copier Service Inc. DBA Sierra Office Solutions

and Inland Business Systems of Chico.

Revenues by business segment

(in millions)

$2,543

� $9,828 Office

Our Office segment serves global, national and small to mid-

size commercial customers, as well as government, education

and other public sector customers.

� $5,237 Production

Our Production segment provides high-end digital

monochrome and color systems designed for customers in the

graphic communications industry and for large enterprises.

$9,828

� $2,543 Other

Our Other segment primarily includes revenue from paper

sales, wide-format systems, value-added services and Global

Imaging Systems network integration solutions and electronic

presentation systems.

The number of equipment installations and the growth in
document management services are key indicators of post sale
revenue trends. The mix of color pages is also a significant
indicator of post sale revenue trends because color pages use more
consumables per page than black-and-white. In addition,
expanding our market, particularly within the New Business of
Printing, is key to increasing pages and we have developed tools
and resources to be the leader in this large market opportunity.

Our consistent cash flow from operations is driven by recurring
revenues; this, along with modest capital investments, enables us
to provide a return to shareholders through:

• Expanding our distribution through acquisitions;

• Buying back shares under our share repurchase program and

• Maintaining our quarterly dividend.

We anticipate expanding our future earnings through:

• Modest revenue growth;

• Driving cost efficiencies to balance gross profit and expense;

• Leveraging our share repurchase and

• Making accretive acquisitions.

Xerox 2008 Annual Report

Text.indd 12

3/18/09 5:58:36 PM

Our Business Model Fundamentals

Acquisitions

Segment Information

To further strengthen our distribution capacity, in 2008 we
completed several acquisitions.

We acquired Veenman B.V. (“Veenman”), expanding our reach into
the small and mid-size business market in the Netherlands.
Veenman is the Netherlands’ leading independent distributor of
office printers, copiers and multifunction devices serving small and
mid-size businesses.

Global Imaging Systems, Inc. (“GIS”) acquired Saxon Business
Systems, an office equipment supplier with offices throughout
Florida and three smaller acquisitions: Better Quality Business
Systems, Precision Copier Service Inc. DBA Sierra Office Solutions
and Inland Business Systems of Chico.

Revenues by business segment
(in millions)

$2,543

Our reportable segments are Production, Office and Other. We
present operating segment financial information in Note 2 –
Segment Reporting in the Consolidated Financial Statements,
which we incorporate by reference here. We have a very broad and
diverse base of customers by both geography and industry,
ranging from SMB 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.

� $9,828 Office

Our Office segment serves global, national and small to mid-
size commercial customers, as well as government, education
and other public sector customers.

73%

The remaining 27% of our revenue comes from equipment

sales, from either lease arrangements that qualify as sales for

accounting purposes or outright cash sales.

$5,237

� $5,237 Production

Our Production segment provides high-end digital
monochrome and color systems designed for customers in the
graphic communications industry and for large enterprises.

$9,828

� $2,543 Other

Our Other segment primarily includes revenue from paper
sales, wide-format systems, value-added services and Global
Imaging Systems network integration solutions and electronic
presentation systems.

Our Business

Annuity

Model

Cash

Generation

Expanded

Earnings

One fundamental of our business model is our annuity model. Post

was post sale revenue that includes equipment maintenance and

sale revenue growth is driven by increasing equipment installation

consumable supplies, among other elements. We sell the majority

which increases the number of page-producing machines in the

of our equipment through sales-type leases that we record as

field (“MIF”) and by expanding the document management

equipment sale revenue. Equipment sales represented 27% of our

services we offer our customers. 73% of our 2008 total revenue

2008 total revenue.

Revenue stream

27%

� 73%

Approximately 73% of our revenue, “post sale” includes

annuity-based revenue from maintenance, services, supplies

and financing, as well as revenue from rentals and operating

lease arrangements.

� 27%

The number of equipment installations and the growth in

Our consistent cash flow from operations is driven by recurring

document management services are key indicators of post sale

revenues; this, along with modest capital investments, enables us

revenue trends. The mix of color pages is also a significant

to provide a return to shareholders through:

indicator of post sale revenue trends because color pages use more

consumables per page than black-and-white. In addition,

expanding our market, particularly within the New Business of

Printing, is key to increasing pages and we have developed tools

and resources to be the leader in this large market opportunity.

• Expanding our distribution though acquisitions;

• Buying back shares under our share repurchase program and

• Maintaining our quarterly dividend.

We anticipate expanding our future earnings through:

• Modest revenue growth;

• Driving cost efficiencies to balance gross profit and expense;

• Leveraging our share repurchase and

• Making accretive acquisitions.

Xerox 2008 Annual Report

Text.indd 13

3/18/09 5:58:36 PM

Our Business

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 cut sheet monochrome production systems
from 65 to 288 pages per minute (“ppm”), color production
systems from 40 to 110 ppm and a complete line of continuous
feed printers from 250 to 1,064 ppm. In addition, we offer a
variety of pre-press and post-press options and the industry’s
broadest set of workflow software.

With our Freeflow® digital workflow collection of software
technology solutions, our customers can improve all aspects of
their processes, from content creation and management to
production and fulfillment. Our digital technology, combined with
total document solutions and services that enable personalization
and printing on demand, delivers value that improves our
customers’ business results.

2008 Production Goals

Our 2008 goals for the Production segment were to continue to
strengthen our leadership position in monochrome and color and
to build on the power of digital printing. Our New Business of
Printing strategy complements the traditional offset market and
continues to transform our industry. We are enabling print
providers in graphic communications and large enterprises to profit
and grow by meeting their customers’ specific business needs with
just-in-time, one-to-one and e-based services – rather than simply
manufacturing a printed piece. Having the right business modelSM,
the right workflowSM and the right technologySM are fundamental
to this transformation.

We continued our application-focused approach to assist our
customers in implementing solutions in four major categories. This
approach provided our customers end-to-end applications for
Collaterals by Request, Books, Transactional/Promotional and
Direct Mail.

During the 2008 drupa tradeshow that is held every four years, we
announced 12 new offerings and 50 applications; building on our
heritage of innovation and our in-depth understanding of both the
printing industry and customer requirements.

We continued to increase installations of our flagship Digital Color
Production Presses. We are the industry leader in the number of
pages produced on digital production color presses, with our
flagship Xerox iGen4® Digital Production Press, iGen3® Digital
Production Press and DocuColor® Digital Presses. Over 325
customers have installed two or more iGen presses to meet their
increased demand.

In 2008, we continued to build on our unmatched product breadth,
world class market and business development tools and integrated
end-to-end applications. Below are some of the key
accomplishments that enabled us to achieve our goals:

Our 2008 Production Accomplishments

Right Business Model
Our commitment to our customers starts before technology is
discussed and extends long after a solution is installed. It includes
sharing with them resources, strategies and tools that will help
them grow their businesses with digital printing.

• ProfitAccelerator®: This robust set of tools and programs
designed to maximize our customers’ investment in digital
printing equipment expanded in 2008 and now includes more
than 80 tools. It brings together Xerox’s unparalleled experience
and expertise, world-class resources and industry-leading
support. Some of the newest additions include a “Value-Based
Pricing Guide,” the “Picture Me Profitable Kit” to assist customers
in pursuing the personalized photo products opportunity, and
the “ProfitQuick® Investment Planner” financial modeling tool
that will help customers increase productivity and achieve cost
and efficiency savings.

• New Business of Printing Services: Business Development

Services was created in direct response to customer demand and
provides both training and professional services to help print
providers increase page volume and revenue. Service offerings
are available to support Sales & Marketing, Workflow and
Application Development efforts, and are delivered at the
customers’ location or via the web. These offerings include
creating marketing and sales management plans, sales force
training, designing for digital, color management, implementing
direct mail/marketing campaigns, Transpromo applications and
more. The offerings are deployed by a dedicated team of Xerox
business development consultants and industry experts.

Right Workflow
We lead the digital production workflow market by helping
customers become more profitable – reducing costs, streamlining
operations and enabling new applications. Our FreeFlow Digital
Workflow Collection makes it easy for customers to complement
traditional offset printing through the integration of digital
printing into existing environments for efficient hybrid print
manufacturing. In 2008 we enhanced our collection to include:

• Xerox FreeFlow Process Manager®: Software that provides

automated, “touchless” file preparation and decision making to
automate prepress and eliminate manual production steps.

• Xerox FreeFlow Variable Information Suite: Software that

• Xerox DocuColor 5000AP: In July we launched a 50 ppm full-

delivers the maximum productivity for personalized and

color production system which provides excellent print

customized documents including the award winning specialty

resolution, color reproduction and reliability for a wide range of

effects that help print providers minimize document security

application and weights, all at rated speed.

concerns. These effects include MicroText marks, Correlation

Marks, Glossmark®, FlorescentMark, and InfraRed text.

• Automated Color Quality Suite: In May, we introduced the

Automated Color Quality Suite (“ACQS”) Press Matching System

• FreeFlow Print Server: A powerful print server that delivers

for our flagship Xerox iGen3 90 and 110 Digital Production

superior performance, advanced workflow interoperability,

Presses, offering high performance plus quality that match

state-of-the-art color management, and a common workflow for

offset printing. The new ACQS enables faster press set up,

Xerox production printers.

• FreeFlow Express to Print: A simple prepress automation tool

designed specifically for the light and mid production

environments. Easily add tabs, covers, inserts, barcodes, page

quicker time to production, greater color stability and

automated Pantone color matching. In November, we launched

this offering on the Xerox 8000AP and 7000AP, bringing these

new quality capabilities to these Digital Color Presses.

numbers and more and see changes through the robust visual

• Xerox 490/980 Color Continuous Feed Printing System: We

interface. Simple automation is provided with over 50 pre-built

launched the world’s fastest toner based full color roll fed printer

templates that make Express to Print easy to use and easy to

that produces up to 986 full color duplex images per minute in

install on a computer.

Right Technology

For more than two decades, we have delivered innovative

technologies that have revolutionized the production printing

industry. In 2008 we continued to bring innovative products to the

markets that included:

• Xerox iGen4 Digital Production Press: We unveiled in May at

drupa the new iGen4, the industry’s most productive and highest

quality cut sheet digital press. The iGen4 features advanced

color management that allows print providers to consistently

achieve and maintain offset and photo image quality. With new

patented technologies, the iGen4 automates many operator

May for Europe and part of developing markets and in November

for North America and the rest of developing markets. With its

Flash Fusing Technology, this system is ideal for the

Transactional/Promotional and Direct Mail market segments that

require high speed, high volume variable data printing.

• Xerox 650/1300 Continuous Feed Printing System: In

February, this new monochrome continuous feed printer was

made available worldwide. This monochrome roll feed printer

also leverages flash fusing technology to print a wide variety of

substrates up to 1300 images per minute. This system supports

numerous applications within the transactional/promotional and

direct mail segments and is ideal for books and manuals.

tasks for greater uptime. With productivity gains of 25-35

• Xerox Nuvera® 288 Digital Perfecting System: In October,

percent, the iGen4 increases the run-length to be break-even

the fastest cut sheet monochrome duplex printer in the market

with offset for greater press utilization and capacity. For

expanded its sheet feed capability up to 12.6” x 19.3” and added

commercial printers, photo finishers, book printers, direct mail

a new Roll Feed DocuConverter with Grain Rotation supporting a

houses and digital service providers, the iGen4 delivers a more

host of new applications. This system, with its benchmark image

efficient and cost-effective way to produce more pages and

quality, flexibility of substrates and reliability, enables

achieve greater profits.

applications such as book publishing.

• Xerox 700 Digital Color Press: We expanded our full color

• Xerox Nuvera 100/120/144 EA Digital Production Systems:

offerings with the launch of the Xerox 700 Digital Color Press at

With its Emulsion Aggregate (“EA”) toner for greater reliability

drupa in May. The Xerox 700 at 70 ppm offers enhanced color

and image quality, the Nuvera EA family expanded its portfolio

reproduction capabilities as well as an exceptional matte finish

of finishing alternatives. In October we announced the

that is winning over customers worldwide. A wide range of

availability of Xerox Tape Bind, CEM DocuConverter and C.P.

feeding and finishing options at an entry level price enables

Bourg/Watkiss Power Square 200® Booklet Maker. This modular,

print providers to adopt digital technology or expand their

scalable print engine also expands digital printing applications

digital printing business.

due to its high quality and flexibility of substrates.

Xerox 2008 Annual Report

Text.indd 14

3/18/09 5:58:37 PM

Our Business

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 cut sheet monochrome production systems

from 65 to 288 pages per minute (“ppm”), color production

systems from 40 to 110 ppm and a complete line of continuous

feed printers from 250 to 1,064 ppm. In addition, we offer a

variety of pre-press and post-press options and the industry’s

broadest set of workflow software.

With our Freeflow® digital workflow collection of software

technology solutions, our customers can improve all aspects of

their processes, from content creation and management to

production and fulfillment. Our digital technology, combined with

total document solutions and services that enable personalization

and printing on demand, delivers value that improves our

customers’ business results.

2008 Production Goals

Our 2008 goals for the Production segment were to continue to

strengthen our leadership position in monochrome and color and

to build on the power of digital printing. Our New Business of

Printing strategy complements the traditional offset market and

continues to transform our industry. We are enabling print

providers in graphic communications and large enterprises to profit

and grow by meeting their customers’ specific business needs with

just-in-time, one-to-one and e-based services – rather than simply

manufacturing a printed piece. Having the right business modelSM,

the right workflowSM and the right technologySM are fundamental

to this transformation.

We continued our application-focused approach to assist our

customers in implementing solutions in four major categories. This

approach provided our customers end-to-end applications for

Collaterals by Request, Books, Transactional/Promotional and

Direct Mail.

During the 2008 drupa tradeshow that is held every four years, we

announced 12 new offerings and 50 applications; building on our

heritage of innovation and our in-depth understanding of both the

printing industry and customer requirements.

We continued to increase installations of our flagship Digital Color

Production Presses. We are the industry leader in the number of

pages produced on digital production color presses, with our

flagship Xerox iGen4® Digital Production Press, iGen3® Digital

Production Press and DocuColor® Digital Presses. Over 325

customers have installed two or more iGen presses to meet their

increased demand.

In 2008, we continued to build on our unmatched product breadth,

world class market and business development tools and integrated

end-to-end applications. Below are some of the key

accomplishments that enabled us to achieve our goals:

Our 2008 Production Accomplishments

Right Business Model

Our commitment to our customers starts before technology is

discussed and extends long after a solution is installed. It includes

sharing with them resources, strategies and tools that will help

them grow their businesses with digital printing.

• ProfitAccelerator®: This robust set of tools and programs

designed to maximize our customers’ investment in digital

printing equipment expanded in 2008 and now includes more

than 80 tools. It brings together Xerox’s unparalleled experience

and expertise, world-class resources and industry-leading

support. Some of the newest additions include a “Value-Based

Pricing Guide,” the “Picture Me Profitable Kit” to assist customers

in pursuing the personalized photo products opportunity, and

the “ProfitQuick® Investment Planner” financial modeling tool

that will help customers increase productivity and achieve cost

and efficiency savings.

• New Business of Printing Services: Business Development

Services was created in direct response to customer demand and

provides both training and professional services to help print

providers increase page volume and revenue. Service offerings

are available to support Sales & Marketing, Workflow and

Application Development efforts, and are delivered at the

customers’ location or via the web. These offerings include

creating marketing and sales management plans, sales force

training, designing for digital, color management, implementing

direct mail/marketing campaigns, Transpromo applications and

more. The offerings are deployed by a dedicated team of Xerox

business development consultants and industry experts.

Right Workflow

We lead the digital production workflow market by helping

customers become more profitable – reducing costs, streamlining

operations and enabling new applications. Our FreeFlow Digital

Workflow Collection makes it easy for customers to complement

traditional offset printing through the integration of digital

printing into existing environments for efficient hybrid print

manufacturing. In 2008 we enhanced our collection to include:

• Xerox FreeFlow Process Manager®: Software that provides

automated, “touchless” file preparation and decision making to

automate prepress and eliminate manual production steps.

• Xerox FreeFlow Variable Information Suite: Software that

• Xerox DocuColor 5000AP: In July we launched a 50 ppm full-

delivers the maximum productivity for personalized and
customized documents including the award winning specialty
effects that help print providers minimize document security
concerns. These effects include MicroText marks, Correlation
Marks, Glossmark®, FlorescentMark, and InfraRed text.

• FreeFlow Print Server: A powerful print server that delivers
superior performance, advanced workflow interoperability,
state-of-the-art color management, and a common workflow for
Xerox production printers.

• FreeFlow Express to Print: A simple prepress automation tool

designed specifically for the light and mid production
environments. Easily add tabs, covers, inserts, barcodes, page
numbers and more and see changes through the robust visual
interface. Simple automation is provided with over 50 pre-built
templates that make Express to Print easy to use and easy to
install on a computer.

Right Technology
For more than two decades, we have delivered innovative
technologies that have revolutionized the production printing
industry. In 2008 we continued to bring innovative products to the
markets that included:

• Xerox iGen4 Digital Production Press: We unveiled in May at

drupa the new iGen4, the industry’s most productive and highest
quality cut sheet digital press. The iGen4 features advanced
color management that allows print providers to consistently
achieve and maintain offset and photo image quality. With new
patented technologies, the iGen4 automates many operator
tasks for greater uptime. With productivity gains of 25-35
percent, the iGen4 increases the run-length to be break-even
with offset for greater press utilization and capacity. For
commercial printers, photo finishers, book printers, direct mail
houses and digital service providers, the iGen4 delivers a more
efficient and cost-effective way to produce more pages and
achieve greater profits.

color production system which provides excellent print
resolution, color reproduction and reliability for a wide range of
application and weights, all at rated speed.

• Automated Color Quality Suite: In May, we introduced the

Automated Color Quality Suite (“ACQS”) Press Matching System
for our flagship Xerox iGen3 90 and 110 Digital Production
Presses, offering high performance plus quality that match
offset printing. The new ACQS enables faster press set up,
quicker time to production, greater color stability and
automated Pantone color matching. In November, we launched
this offering on the Xerox 8000AP and 7000AP, bringing these
new quality capabilities to these Digital Color Presses.

• Xerox 490/980 Color Continuous Feed Printing System: We

launched the world’s fastest toner based full color roll fed printer
that produces up to 986 full color duplex images per minute in
May for Europe and part of developing markets and in November
for North America and the rest of developing markets. With its
Flash Fusing Technology, this system is ideal for the
Transactional/Promotional and Direct Mail market segments that
require high speed, high volume variable data printing.

• Xerox 650/1300 Continuous Feed Printing System: In

February, this new monochrome continuous feed printer was
made available worldwide. This monochrome roll feed printer
also leverages flash fusing technology to print a wide variety of
substrates up to 1300 images per minute. This system supports
numerous applications within the transactional/promotional and
direct mail segments and is ideal for books and manuals.

• Xerox Nuvera® 288 Digital Perfecting System: In October,

the fastest cut sheet monochrome duplex printer in the market
expanded its sheet feed capability up to 12.6” x 19.3” and added
a new Roll Feed DocuConverter with Grain Rotation supporting a
host of new applications. This system, with its benchmark image
quality, flexibility of substrates and reliability, enables
applications such as book publishing.

• Xerox 700 Digital Color Press: We expanded our full color

offerings with the launch of the Xerox 700 Digital Color Press at
drupa in May. The Xerox 700 at 70 ppm offers enhanced color
reproduction capabilities as well as an exceptional matte finish
that is winning over customers worldwide. A wide range of
feeding and finishing options at an entry level price enables
print providers to adopt digital technology or expand their
digital printing business.

• Xerox Nuvera 100/120/144 EA Digital Production Systems:
With its Emulsion Aggregate (“EA”) toner for greater reliability
and image quality, the Nuvera EA family expanded its portfolio
of finishing alternatives. In October we announced the
availability of Xerox Tape Bind, CEM DocuConverter and C.P.
Bourg/Watkiss Power Square 200® Booklet Maker. This modular,
scalable print engine also expands digital printing applications
due to its high quality and flexibility of substrates.

Xerox 2008 Annual Report

Text.indd 15

3/18/09 5:58:38 PM

Our Business

Office

Xerox develops and manufactures a range of color and
black-and-white multifunction, printer, copier and fax products. Our
Office segment serves global, national and small to mid-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 95 ppm and color devices up
to 70 ppm, include our family of CopyCentre®, WorkCentre® and
WorkCentre Pro digital multifunction systems, Phaser® desktop
printers and MFD’s as well as DocuColor printer/copiers for the
specific needs of graphic intensive organizations and facsimile
products.

We offer a complete range of services and solutions in partnership
with independent software vendors that allow our customers to
analyze, streamline, automate, secure and track their digital
workflows, which we then use to identify the most efficient,
productive mix of office equipment and software for that business,
helping to reduce the customer’s document-related costs.

2008 Office Goals

Our 2008 Office goals were to drive to a leadership position in color
to extend our market reach, particularly in the SMB market and
continue to expand our Office Services and Solutions business. We
broadened our product line and complemented our industry-
leading product offerings with expanded distribution in order to
increase our machines-in-field (“MIF”) and capture more pages,
building the foundation for future post sale revenue growth.

We continued to drive color in our Office segment by significantly
enhancing our already strong color product portfolio, making color
more affordable, easier to use, faster and more reliable while
maintaining our leadership position in black-and-white. The
breadth of our product portfolio is unmatched. Our color-capable
laser devices provide an attractive color entry point, our patented
solid ink technology offers unmatched ease of use, vibrant color
image quality and economic color run costs, and our top of the line
color laser products provide superior image quality coupled with
industry-leading productivity and reliability. Below are some of the
key accomplishments that enabled us to achieve our goals:

2008 Office Accomplishments

• Phaser 6125: In February, we announced the Phaser 6125, a 12
ppm color, 16 ppm black-and-white printer. This product is an
extension of the Phaser 6130 line, and offers a small footprint,
strong processing capability and Emulsion Aggregate High
Quality (“EA-HQ”) toner technology for clear, crisp printing.

• Phaser 3635 MFP: Launched in May, the Phaser 3635MFP is a
35 ppm printer that provides advanced security options such as
image overwriting, encryption and authentication. This product
is designed for small and mid-size business workgroups, and
offers features like a color touchscreen user interface and robust
scanning features to promote ease-of-use and productivity.

• Phaser 5550: Launched in May, this 50 ppm printer offers

tabloid and letter/legal printing, as well as advanced software
features like PhaserSMART®. PhaserSMART is an online
troubleshooting tool that helps diagnose and solve potential
issues, prevent maintenance calls and increase reliability. This
product also offers duplex printing and optional additional
paper handling features.

• WorkCentre 5016/5020: In May, Xerox introduced its first

sub-$1,000 A3/tabloid MFD family in developing markets. The
16/20 ppm family offers basic copying, printing and scanning
capabilities for small workgroups that are price sensitive.

• WorkCentre 5222/5225/5230: In May, we introduced a new
25/30 ppm monochrome platform designed to help SMB and
enterprise workgroups increase productivity on an entry-level
device with high-end features such as our Extensible Interface
Platform, full-system common criteria certification, and booklet
making capabilities. In September, the 5200 series was
expanded with the addition of a 22 ppm configuration as well as
color scanning capability on the Workcentre 5225A/5230A
configurations.

• WorkCentre 5600 Series: We refreshed the 5600 series

monochrome platform with updated controller software to keep
pace with today’s ever changing IT standards and
protocols. With support for IPv6 and compatibility with
Microsoft’s Web Services on Devices, the WorkCentre 5600
series – with speeds ranging from 32 ppm to 87 ppm – becomes
even more powerful for IT professionals.

• WorkCentre Bookmark 40/55 Multifunction Copier/Printer: A
robust book copier at its core, it is the ideal solution for libraries,
universities, and other public vending environments. It features
an angled side panel support that protects books’ spines while
copying, and offers solid durability, ease-of-use and powerful
solutions for streamlining unique workflows.

• WorkCentre 7346 Multifunction Printer & EFI Workflows: In
May we introduced a high-end version of the WorkCentre 7300
series system featuring fast print speeds of up to 40 ppm in color
and 45 ppm in black-and-white for busy workgroups. The
WorkCentre 7300 series was also enhanced with optional EFI
workflow capabilities.

• Xerox 700 Digital Color Press: Launched in May, this light

An increasingly important part of our offering is value-added

production color device with an embedded controller brings

services, which utilizes our document industry knowledge and

productivity, excellent print quality and flexibility to those

looking to adopt digital technology or expand their digital

capabilities.

• Workcentre 4260: Launched in September, the WC 4260 is

Xerox’s fastest desktop multifunction system with speeds up to

55 ppm. It offers workflow tools such as ID Copy Card, Fax

Forward to Email, automatic two sided printing and competitive

security features. This product is designed to promote

productivity in small and medium business workgroups.

• Phaser 3300 MFP: Launched in September, the Phaser 3300

MFP offers print/copy speeds up to 30 ppm and offers

automatic two-sided printing. This product offers color scanning

to USB, email or the network. It is equipped with Xerox Scan to

PC Desktop® which allows users to send a document from the

MFP to their desktop for viewing, editing or storing.

Other

The Other segment primarily includes revenue from paper sales,

value-added services, wide-format systems and GIS network

integration solutions and electronic presentation systems.

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,

as well as to provide unique products that enhance the New

Business of Printing and color output.

experience. Our value-added services deliver solutions that

optimize our customers’ document output and infrastructure costs

while streamlining, simplifying, and digitizing their document-

intensive business processes. Through Xerox’s imaging centers, a

company can scan and digitize documents to create secure,

accessible and searchable online information archives, such as a

library of car-rental contracts or construction blueprints. Often our

value-added services solutions lead to larger managed services

contracts which include our equipment, supplies, service, and labor.

We report revenue from managed services contracts in the

Production or Office segments. In 2008, the combined value-

added services and managed services revenue, including

equipment, totaled $3.8 billion.

In our wide-format systems business, we offer document

processing products and devices designed to reproduce large

engineering and architectural drawings up to three feet by four

feet in size. In 2008 we launched:

• Xerox 8254E and 8264E Wide Format Printers: Introduced in

June, further enables customers to print robust, colorful large

format graphic applications on a broad range of substrates

quickly and easily.

• Xerox 6279 Wide Format Printer: This printer continues our

successful tradition in the CAD environment with its unsurpassed

ease of operation and benchmark image quality.

Xerox 2008 Annual Report

Text.indd 16

3/18/09 5:58:38 PM

Our Business

Office

Xerox develops and manufactures a range of color and

black-and-white multifunction, printer, copier and fax products. Our

Office segment serves global, national and small to mid-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 95 ppm and color devices up

to 70 ppm, include our family of CopyCentre®, WorkCentre® and

WorkCentre Pro digital multifunction systems, Phaser® desktop

printers and MFD’s as well as DocuColor printer/copiers for the

specific needs of graphic intensive organizations and facsimile

products.

We offer a complete range of services and solutions in partnership

with independent software vendors that allow our customers to

analyze, streamline, automate, secure and track their digital

workflows, which we then use to identify the most efficient,

• Phaser 3635 MFP: Launched in May, the Phaser 3635MFP is a

35 ppm printer that provides advanced security options such as

image overwriting, encryption and authentication. This product

is designed for small and mid-size business workgroups, and

offers features like a color touchscreen user interface and robust

scanning features to promote ease-of-use and productivity.

• Phaser 5550: Launched in May, this 50 ppm printer offers

tabloid and letter/legal printing, as well as advanced software

features like PhaserSMART®. PhaserSMART is an online

troubleshooting tool that helps diagnose and solve potential

issues, prevent maintenance calls and increase reliability. This

product also offers duplex printing and optional additional

paper handling features.

• WorkCentre 5016/5020: In May, Xerox introduced its first

sub-$1,000 A3/tabloid MFD family in developing markets. The

16/20 ppm family offers basic copying, printing and scanning

productive mix of office equipment and software for that business,

capabilities for small workgroups that are price sensitive.

helping to reduce the customer’s document-related costs.

2008 Office Goals

Our 2008 Office goals were to drive to a leadership position in color

to extend our market reach, particularly in the SMB market and

continue to expand our Office Services and Solutions business. We

broadened our product line and complemented our industry-

leading product offerings with expanded distribution in order to

increase our machines-in-field (“MIF”) and capture more pages,

building the foundation for future post sale revenue growth.

We continued to drive color in our Office segment by significantly

enhancing our already strong color product portfolio, making color

more affordable, easier to use, faster and more reliable while

maintaining our leadership position in black-and-white. The

breadth of our product portfolio is unmatched. Our color-capable

laser devices provide an attractive color entry point, our patented

solid ink technology offers unmatched ease of use, vibrant color

image quality and economic color run costs, and our top of the line

color laser products provide superior image quality coupled with

industry-leading productivity and reliability. Below are some of the

key accomplishments that enabled us to achieve our goals:

2008 Office Accomplishments

• Phaser 6125: In February, we announced the Phaser 6125, a 12

ppm color, 16 ppm black-and-white printer. This product is an

extension of the Phaser 6130 line, and offers a small footprint,

strong processing capability and Emulsion Aggregate High

Quality (“EA-HQ”) toner technology for clear, crisp printing.

• WorkCentre 5222/5225/5230: In May, we introduced a new

25/30 ppm monochrome platform designed to help SMB and

enterprise workgroups increase productivity on an entry-level

device with high-end features such as our Extensible Interface

Platform, full-system common criteria certification, and booklet

making capabilities. In September, the 5200 series was

expanded with the addition of a 22 ppm configuration as well as

color scanning capability on the Workcentre 5225A/5230A

configurations.

• WorkCentre 5600 Series: We refreshed the 5600 series

monochrome platform with updated controller software to keep

pace with today’s ever changing IT standards and

protocols. With support for IPv6 and compatibility with

Microsoft’s Web Services on Devices, the WorkCentre 5600

series – with speeds ranging from 32 ppm to 87 ppm – becomes

even more powerful for IT professionals.

• WorkCentre Bookmark 40/55 Multifunction Copier/Printer: A

robust book copier at its core, it is the ideal solution for libraries,

universities, and other public vending environments. It features

an angled side panel support that protects books’ spines while

copying, and offers solid durability, ease-of-use and powerful

solutions for streamlining unique workflows.

• WorkCentre 7346 Multifunction Printer & EFI Workflows: In

May we introduced a high-end version of the WorkCentre 7300

series system featuring fast print speeds of up to 40 ppm in color

and 45 ppm in black-and-white for busy workgroups. The

WorkCentre 7300 series was also enhanced with optional EFI

workflow capabilities.

• Xerox 700 Digital Color Press: Launched in May, this light
production color device with an embedded controller brings
productivity, excellent print quality and flexibility to those
looking to adopt digital technology or expand their digital
capabilities.

• WorkCentre 4260: Launched in September, the WC 4260 is

Xerox’s fastest desktop multifunction system with speeds up to
55 ppm. It offers workflow tools such as ID Copy Card, Fax
Forward to Email, automatic two sided printing and competitive
security features. This product is designed to promote
productivity in small and medium business workgroups.

• Phaser 3300 MFP: Launched in September, the Phaser 3300

MFP offers print/copy speeds up to 30 ppm and offers
automatic two-sided printing. This product offers color scanning
to USB, email or the network. It is equipped with Xerox Scan to
PC Desktop® which allows users to send a document from the
MFP to their desktop for viewing, editing or storing.

Other

The Other segment primarily includes revenue from paper sales,
value-added services, wide-format systems and GIS network
integration solutions and electronic presentation systems.

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,
as well as to provide unique products that enhance the New
Business of Printing and color output.

An increasingly important part of our offering is value-added
services, which utilizes our document industry knowledge and
experience. Our value-added services deliver solutions that
optimize our customers’ document output and infrastructure costs
while streamlining, simplifying, and digitizing their document-
intensive business processes. Through Xerox’s imaging centers, a
company can scan and digitize documents to create secure,
accessible and searchable online information archives, such as a
library of car-rental contracts or construction blueprints. Often our
value-added services solutions lead to larger managed services
contracts which include our equipment, supplies, service, and labor.
We report revenue from managed services contracts in the
Production or Office segments. In 2008, the combined value-
added services and managed services revenue, including
equipment, totaled $3.8 billion.

In our wide-format systems business, we offer document
processing products and devices designed to reproduce large
engineering and architectural drawings up to three feet by four
feet in size. In 2008 we launched:

• Xerox 8254E and 8264E Wide Format Printers: Introduced in
June, further enables customers to print robust, colorful large
format graphic applications on a broad range of substrates
quickly and easily.

• Xerox 6279 Wide Format Printer: This printer continues our

successful tradition in the CAD environment with its unsurpassed
ease of operation and benchmark image quality.

Xerox 2008 Annual Report

Text.indd 17

3/18/09 5:58:39 PM

Our Business

Revenue

We sell the majority of our products and services under bundled
lease arrangements, in which our customers pay a monthly amount
for the equipment, maintenance, services, supplies and financing
over the course of the lease agreement. These arrangements are
beneficial to our customers and to us since, in addition to
customers receiving a bundled offering, these arrangements allow
us to maintain the customer relationship for future sales of
equipment and services.

We analyze these arrangements to determine whether the
equipment component meets certain accounting requirements such
that the equipment fair value should be recorded as a sale at lease

inception, that is, a sales-type lease. We allocate the remaining
portion of the monthly minimum payments to the various elements
of the lease based on fair value – service, maintenance, supplies and
financing – that we generally recognize over the term of the lease
agreement, and that we report as “post sale revenue”. In those
arrangements that do not qualify as sales-type leases, which have
increased as a result of our services-led strategy, we recognize
revenue over the term of the lease agreement, whether rental or
operating lease, and report it in “post sale revenue.” Our accounting
policies for revenue recognition for leases and bundled
arrangements are included in Note 1 – Summary of Significant
Accounting Policies in the Consolidated Financial Statements in our
2008 Annual Report.

Revenues by geography
(in millions)

$2,475

� $9,122 U.S.
� $6,011 Europe
� $2,475 Other Areas

$6,011

Revenues by geography based on the location of the unit reporting
the revenue and includes exports sales. About 50% of our revenue
is generated from customers outside the U.S.

$9,122

Research and Development

Our R&D is strategically coordinated with Fuji Xerox, which

invested $788 million in R&D in 2008, $672 million in 2007

and $660 million in 2006.

Investment in R&D is critical for competitiveness in our fast-paced

Our R&D drives innovation and customer value by:

markets where more than two-thirds of our equipment sales are

from products launched during the past two years. Research

• Creating new differentiated products and services;

activities are conducted in the United States, Canada and Europe –

• Enabling cost competitiveness through disruptive products and

often in collaboration with Fuji Xerox Co., Ltd. (“Fuji Xerox”).

services;

• Enabling new ways to serve customers and

• Creating new business opportunities that drive future growth

and reach new customers.

R,D&E expenses

(in millions)

$884

$912

$922

$134

$750

$148

$764

$161

$761

R&D

Sustaining Engineering

’08

’07

’06

To ensure our success, we have aligned our R&D investment

indistinguishable from offset, the Xerox Nuvera 288 Digital

portfolio with our growth initiatives of accelerating the transition

Perfecting System which boasts the fastest (288 duplex

to color, enhancing customer value by building on our services

impressions per minute) digital duplex monochrome cut-sheet

leadership and by driving the New Business of Printing . 2008 R&D

printer in the industry, and Xerox’s proprietary Solid Ink technology

spending focused primarily on the development of high-end

for the office are examples of the type of breakthrough technology

business applications to drive the New Business of Printing,

we have developed and that we expect will drive future growth.

extending our color capabilities, expanding our services offerings

Sustaining engineering expenses, which are the hardware

and delivering lower-cost platforms and customer productivity

engineering and software development costs we incur after we

enablers. The Xerox iGen family, advanced next-generation digital

launch a product, are included in our R,D&E expenses.

printing presses that produce photographic-quality prints

Xerox 2008 Annual Report

Text.indd 18

3/18/09 5:58:40 PM

Our Business

Revenue

We sell the majority of our products and services under bundled

lease arrangements, in which our customers pay a monthly amount

for the equipment, maintenance, services, supplies and financing

over the course of the lease agreement. These arrangements are

beneficial to our customers and to us since, in addition to

customers receiving a bundled offering, these arrangements allow

us to maintain the customer relationship for future sales of

equipment and services.

inception, that is, a sales-type lease. We allocate the remaining

portion of the monthly minimum payments to the various elements

of the lease based on fair value – service, maintenance, supplies and

financing – that we generally recognize over the term of the lease

agreement, and that we report as “post sale revenue”. In those

arrangements that do not qualify as sales-type leases, which have

increased as a result of our services-led strategy, we recognize

revenue over the term of the lease agreement, whether rental or

operating lease, and report it in “post sale revenue.” Our accounting

policies for revenue recognition for leases and bundled

We analyze these arrangements to determine whether the

arrangements are included in Note 1 – Summary of Significant

equipment component meets certain accounting requirements such

Accounting Policies in the Consolidated Financial Statements in our

that the equipment fair value should be recorded as a sale at lease

2008 Annual Report.

Revenues by geography

(in millions)

$2,475

� $9,122 U.S.

� $6,011 Europe

� $2,475 Other Areas

$6,011

Revenues by geography based on the location of the unit reporting

the revenue and includes exports sales. About 50% of our revenue

$9,122

is generated from customers outside the U.S.

Research and Development

Our R&D is strategically coordinated with Fuji Xerox, which
invested $788 million in R&D in 2008, $672 million in 2007
and $660 million in 2006.

Investment in R&D is critical for competitiveness in our fast-paced
markets where more than two-thirds of our equipment sales are
from products launched during the past two years. Research
activities are conducted in the United States, Canada and Europe –
often in collaboration with Fuji Xerox Co., Ltd. (“Fuji Xerox”).

Our R&D drives innovation and customer value by:

• Creating new differentiated products and services;

• Enabling cost competitiveness through disruptive products and

services;

• Enabling new ways to serve customers and

• Creating new business opportunities that drive future growth

and reach new customers.

R,D&E expenses
(in millions)

$884

$912

$922

$134

$750

$148

$764

$161

$761

R&D

Sustaining Engineering

’08

’07

’06

To ensure our success, we have aligned our R&D investment
portfolio with our growth initiatives of accelerating the transition
to color, enhancing customer value by building on our services
leadership and by driving the New Business of Printing . 2008 R&D
spending focused primarily on the development of high-end
business applications to drive the New Business of Printing,
extending our color capabilities, expanding our services offerings
and delivering lower-cost platforms and customer productivity
enablers. The Xerox iGen family, advanced next-generation digital
printing presses that produce photographic-quality prints

indistinguishable from offset, the Xerox Nuvera 288 Digital
Perfecting System which boasts the fastest (288 duplex
impressions per minute) digital duplex monochrome cut-sheet
printer in the industry, and Xerox’s proprietary Solid Ink technology
for the office are examples of the type of breakthrough technology
we have developed and that we expect will drive future growth.
Sustaining engineering expenses, which are the hardware
engineering and software development costs we incur after we
launch a product, are included in our R,D&E expenses.

Xerox 2008 Annual Report

Text.indd 19

3/18/09 5:58:41 PM

Our Business

Patents, Trademarks and Licenses

We are a technology company. Including our Xerox Palo Alto
Research Center (“PARC”) and XMPie subsidiaries, we were
awarded 609 U.S. utility patents in 2008. We were ranked 31st on
the list of companies that were awarded the most U.S. patents
during the year and would have been ranked about 27th with the
inclusion of PARC and XMPie patents. Including our research
partner Fuji Xerox Co., Ltd (“Fuji Xerox”), we were awarded over 940
U.S. utility patents in 2008. Our patent portfolio evolves as new
patents are awarded to us and as older patents expire. As of
December 31, 2008, we held approximately 8,900 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 license or assign our patents to
others, in return for revenue and/or access to their patents. Most
patent licenses expire concurrently with the expiration of the last
patent identified in the license. In 2008, we added 11 agreements
to our portfolio of patent licensing agreements, and either we or
PARC was a licensor in all 11 of the agreements. We are also a
party to a number of cross-licensing agreements with companies
that hold substantial patent portfolios, including Canon, Microsoft,
IBM, Hewlett Packard, Océ, Sharp, Samsung and Seiko Epson.
These agreements vary in subject matter, scope, compensation,
significance and time.

In the U.S., we own approximately 570 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.

Our brand is a valuable resource and continues to be ranked among the
top percentile of the most valuable global brands.

Competition

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 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 improve our existing offerings. Our key competitors
include Canon, Ricoh, Hewlett-Packard, and, in certain areas of the
business, Pitney Bowes, Kodak, Océ, 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, 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.

Marketing and Distribution

We manage our business based on the principal business segments
described earlier. However, we have organized the marketing, selling
and distribution of our products and solutions according to
geography and channel type. We sell our products and solutions
directly to customers through our worldwide sales force and through

a network of independent agents, dealers, value-added resellers,
systems integrators and the Web. In the U.S. GIS continues to
expand its network of office technology suppliers to serve an ever-
expanding base of small and mid-size businesses. We utilize our
direct sales force to address our customers’ more advanced
technology, solutions and services requirements, and use cost-
effective indirect distribution channels for basic product offerings.

In large enterprises, we follow a services-led approach that enables
us to address two basic challenges facing large enterprises:

• How to optimize infrastructure to be both cost effective and

globally consistent.

• How to improve the value proposition and communication with

their customers.

In response to these needs, we offer a go-to-market approach that
leads with the largest direct sales and service delivery force in the
industry available on a globally consistent manner. This can range
from hardware, software or services in whatever combination is
necessary to meet the needs of that customer.

We market our Phaser line of color and monochrome laser-class
and solid ink printers primarily through office information
technology resellers, who typically access our products through
distributors. We continue to expand our distribution partnerships in
North America through additional information technology resellers
and by enhancing our network of independent agents. We also
continued to increase product offerings available through a
two-tiered distribution model in Europe and developing markets.

We operate in over 160 countries worldwide. We develop, manufacture,

market and support document management systems, supplies and

services through a variety of distribution channels around the world.

� North American Operations

� Developing Markets

North American Operations includes the United States and

Developing Markets supports more than 130 countries.

Canada.

� Xerox Europe

Xerox Europe covers 17 countries across Europe.

� Fuji Xerox

Fuji Xerox, an unconsolidated entity of which we own 25%,

develops, manufactures and distributes document

management systems, supplies and services.

Our reselling relationship with key partners contributed to our

which streamline our customers’ workflows enabling them to

market coverage expansion and new business penetration.

reduce costs, improve operational efficiencies and drive new

Through our global reseller alliance with Fujifilm, we distribute our

business opportunities.

production products and solutions to graphic communications

customers as well as photo specialty markets spanning Retail,

Professional Lab and Processing Center businesses. In 2008, we

signed additional country-level contracts with Fujifilm Graphics

Systems in Europe and developing markets to extend Xerox digital

production systems reach to new commercial print customers and

prospects. We continue to use our alliances to integrate “best in

class” information technologies and services to deliver improved

workflow and document output management enabling our

customers to accelerate profitable revenue growth in their

businesses. Through the world-class Xerox Business Partner

Program we are able to deliver an extensive portfolio of products

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 which we refer to collectively as Xerox Limited. Xerox

Limited enters into distribution agreements with unaffiliated third

parties to provide distribution of our products in many of the

countries located in these regions, and previously entered into

agreements with unaffiliated third parties providing distribution of

our products in 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

Xerox 2008 Annual Report

Text.indd 20

3/18/09 5:58:41 PM

Our Business

Patents, Trademarks and Licenses

We are a technology company. Including our Xerox Palo Alto

Research Center (“PARC”) and XMPie subsidiaries, we were

awarded 609 U.S. utility patents in 2008. We were ranked 31st on

the list of companies that were awarded the most U.S. patents

during the year and would have been ranked about 27th with the

inclusion of PARC and XMPie patents. Including our research

partner Fuji Xerox Co., Ltd (“Fuji Xerox”), we were awarded over 940

U.S. utility patents in 2008. Our patent portfolio evolves as new

patents are awarded to us and as older patents expire. As of

December 31, 2008, we held approximately 8,900 design and

utility U.S. patents. These patents expire at various dates up to 20

In the U.S., we are party to numerous patent-licensing agreements

and, in a majority of them, we license or assign our patents to

others, in return for revenue and/or access to their patents. Most

patent licenses expire concurrently with the expiration of the last

patent identified in the license. In 2008, we added 11 agreements

to our portfolio of patent licensing agreements, and either we or

PARC was a licensor in all 11 of the agreements. We are also a

party to a number of cross-licensing agreements with companies

that hold substantial patent portfolios, including Canon, Microsoft,

IBM, Hewlett Packard, Océ, Sharp, Samsung and Seiko Epson.

These agreements vary in subject matter, scope, compensation,

significance and time.

years or more from their original filing dates. While we believe that

In the U.S., we own approximately 570 trademarks, either

our portfolio of patents and applications has value, in general no

registered or applied for. These trademarks have a perpetual life,

single patent is essential to our business or any individual segment.

subject to renewal every ten years. We vigorously enforce and

In addition, any of our proprietary rights could be challenged,

protect our trademarks.

invalidated, or circumvented or may not provide significant

competitive advantages.

Our brand is a valuable resource and continues to be ranked among the

top percentile of the most valuable global brands.

Competition

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 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 improve our existing offerings. Our key competitors

a network of independent agents, dealers, value-added resellers,

systems integrators and the Web. In the U.S. GIS continues to

expand its network of office technology suppliers to serve an ever-

expanding base of small and mid-size businesses. We utilize our

direct sales force to address our customers’ more advanced

technology, solutions and services requirements, and use cost-

effective indirect distribution channels for basic product offerings.

In large enterprises, we follow a services-led approach that enables

us to address two basic challenges facing large enterprises:

include Canon, Ricoh, Hewlett-Packard, and, in certain areas of the

• How to optimize infrastructure to be both cost effective and

business, Pitney Bowes, Kodak, Océ, Konica-Minolta and Lexmark.

globally consistent.

We believe that our brand recognition, reputation for document

knowledge and expertise, innovative technology, breadth of

product offerings, global distribution channels, 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.

Marketing and Distribution

• How to improve the value proposition and communication with

their customers.

In response to these needs, we offer a go-to-market approach that

leads with the largest direct sales and service delivery force in the

industry available on a globally consistent manner. This can range

from hardware, software or services in whatever combination is

necessary to meet the needs of that customer.

We market our Phaser line of color and monochrome laser-class

and solid ink printers primarily through office information

technology resellers, who typically access our products through

We manage our business based on the principal business segments

distributors. We continue to expand our distribution partnerships in

described earlier. However, we have organized the marketing, selling

North America through additional information technology resellers

and distribution of our products and solutions according to

and by enhancing our network of independent agents. We also

geography and channel type. We sell our products and solutions

continued to increase product offerings available through a

directly to customers through our worldwide sales force and through

two-tiered distribution model in Europe and developing markets.

We operate in over 160 countries worldwide. We develop, manufacture,
market and support document management systems, supplies and
services through a variety of distribution channels around the world.

� North American Operations

� Developing Markets

North American Operations includes the United States and
Canada.

� Xerox Europe

Xerox Europe covers 17 countries across Europe.

Developing Markets supports more than 130 countries.

� Fuji Xerox

Fuji Xerox, an unconsolidated entity of which we own 25%,
develops, manufactures and distributes document
management systems, supplies and services.

Our reselling relationship with key partners contributed to our
market coverage expansion and new business penetration.
Through our global reseller alliance with Fujifilm, we distribute our
production products and solutions to graphic communications
customers as well as photo specialty markets spanning Retail,
Professional Lab and Processing Center businesses. In 2008, we
signed additional country-level contracts with Fujifilm Graphics
Systems in Europe and developing markets to extend Xerox digital
production systems reach to new commercial print customers and
prospects. We continue to use our alliances to integrate “best in
class” information technologies and services to deliver improved
workflow and document output management enabling our
customers to accelerate profitable revenue growth in their
businesses. Through the world-class Xerox Business Partner
Program we are able to deliver an extensive portfolio of products

which streamline our customers’ workflows enabling them to
reduce costs, improve operational efficiencies and drive new
business opportunities.

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 which we refer to collectively as Xerox Limited. Xerox
Limited enters into distribution agreements with unaffiliated third
parties to provide distribution of our products in many of the
countries located in these regions, and previously entered into
agreements with unaffiliated third parties providing distribution of
our products in 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

Xerox 2008 Annual Report

Text.indd 21

3/18/09 5:58:42 PM

Our Business

sanctions. We maintain an export and sanctions compliance
program and believe that we have been and are in compliance
with U.S. laws and government regulations for these countries. In
addition, we have no assets, liabilities, or operations in these
countries other than liabilities under the distribution agreements.
After observing required prior notice periods, Xerox Limited
terminated its distribution agreements with distributors servicing
Sudan and Syria in August 2006 and terminated its distribution
agreement with the distributor servicing Iran in December 2006.
Now, Xerox only has legacy obligations to third parties such as
providing spare parts and supplies to these third parties. In 2008,
we had total revenues of $17.6 billion, of which approximately $7.4
million was attributable to Iran and less than $0.2 million in total
was attributable to Sudan and Syria.

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 countrywide
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 conducted according to
the U.S. laws and government regulations that relate to Libya.

Customer Financing

We finance a large portion of customer purchases of Xerox
equipment through our bundled lease arrangements. We believe
that financing facilitates customer acquisition of Xerox technology
and enhances our value proposition to the customer while
providing Xerox a profitable revenue stream and a strong return on
equity.

As a result of our customer financing program, we benefit by
gaining in-depth knowledge of the products being leased and a
deep understanding of the customer base and their use of our
technology. This knowledge allows us to effectively manage the
credit and residual value risk normally associated with financing.
Our financing risk is further mitigated because the majority of our
lease contracts are non-cancelable and include cancellation
penalties approximately equal to the full value of the lease
receivables.

Because our lease contracts permit 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
lease contracts. We fund our customer financing activity through a
combination of cash generated from operations, cash on hand,
borrowings under bank credit facilities and proceeds from capital
market offerings. At December 31, 2008 we had $7.3 billion of

Globally, we have 57,100 direct employees. We have over 7,500 Sales Professionals,
over 13,000 Managed Service Employees at customer sites and over 13,000
Technical Service Employees. In addition, we have over 6,500 Agents and
Concessionaires and over 10,000 resellers.

finance receivables and $0.6 billion of equipment on operating

We are currently in the second year of a master supply agreement

leases, or Total Finance assets of $7.9 billion. We maintain an

with Flextronics, a global electronics manufacturing services

assumed 7:1 leverage ratio of debt to equity as compared to our

company, to outsource portions of manufacturing for our Office

Finance assets and therefore a significant portion of our $8.4

segment. The agreement has a three year term, with two

billion of debt is associated with our financing business.

additional one-year extension periods at our option. Our inventory

In addition to being an excellent customer retention vehicle, our

customer financing program also achieves an attractive gross

margin which provides us a reasonable return on our investment in

this business. This program is also a strong value proposition for

our customers because it provides them a bundled monthly

payment for their document management needs and an attractive

financing alternative.

Service

As of December 31, 2008, we had a worldwide service force of

approximately 13,000 employees and an extensive variable

contract service force. We continue to expand 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

because it is continually trained on our products and its diagnostic

equipment is state-of-the-art. We offer service 24 hours a day,

7 days a week, in major metropolitan areas around the world,

providing a consistent and superior level of service worldwide.

Manufacturing and Supply

Our manufacturing and distribution facilities are located around

the world. The company’s largest manufacturing site is in Webster,

N.Y., where we make fusers, photoreceptors, Xerox iGen and

Nuvera systems, components, consumables and other products.

Additionally this year, updates were made at the EA Toner plant in

Webster, N.Y. that was built in 2007 to give the plant the flexibility

to meet demand for both first and second generations of EA

Toner. This allows the plant to produce the new breakthrough Ultra

Low-Melt EA Toner. Our remaining primary manufacturing

operations are located in: 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. We also have a major facility in Venray,

Netherlands, that handles supplies manufacturing and supply

chain management for the eastern hemisphere.

purchases from Flextronics currently represent approximately 15%

of our overall worldwide inventory procurement and production.

Our pricing for inventory sourced through Flextronics is generally

market based. We have agreed to purchase from Flextronics some

products and consumables within specified product families

although we do have the ability to source product from other

suppliers without penalty to extent needed. Flextronics is required

to acquire inventory based on our forecasted requirements and

must maintain sufficient manufacturing capacity to satisfy these

requirements. Under certain circumstances, we may become

obligated to purchase inventory that remains unused for more

than 180 days, becomes obsolete or remains unused on the

termination of the supply agreement. If Flextronics were unable to

continue to supply product, it would not result in a material

disruption to our business because Flextronics primarily provides

contract assembly labor and we continue to manage the inbound

sourcing and supply chain management of raw materials and

sub-assembly parts. In addition, we own the tooling and

technology that Flextronics currently uses to produce our products;

there are a number of alternative suppliers that could replace the

contract assembly labor Flextronics provides and we have business

resumption plans in place for Flextronics and other similar

suppliers.

We acquire other office products from various third parties in order

to increase the breadth of our product portfolio and meet channel

requirements. We have arrangements with Fuji Xerox under which

we purchase and sell products, some of which are the result of

mutual research and development arrangements. Refer to Note 7 –

Investments in Affiliates, at Equity in the Consolidated Financial

Statements in our 2008 Annual Report for additional information

regarding our relationship with Fuji Xerox.

Fuji Xerox

Fuji Xerox is an unconsolidated entity in which we currently own a

25% interest and FUJIFILM Holdings Corporation (“FujiFilm”) owns

a 75% interest. Fuji Xerox develops, manufactures and distributes

document processing products in Japan, China, Hong Kong, 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.

Xerox 2008 Annual Report

Text.indd 22

3/18/09 5:58:43 PM

Our Business

sanctions. We maintain an export and sanctions compliance

program and believe that we have been and are in compliance

with U.S. laws and government regulations for these countries. In

addition, we have no assets, liabilities, or operations in these

countries other than liabilities under the distribution agreements.

After observing required prior notice periods, Xerox Limited

terminated its distribution agreements with distributors servicing

Sudan and Syria in August 2006 and terminated its distribution

agreement with the distributor servicing Iran in December 2006.

Now, Xerox only has legacy obligations to third parties such as

providing spare parts and supplies to these third parties. In 2008,

we had total revenues of $17.6 billion, of which approximately $7.4

million was attributable to Iran and less than $0.2 million in total

was attributable to Sudan and Syria.

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 countrywide

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 conducted according to

the U.S. laws and government regulations that relate to Libya.

Customer Financing

We finance a large portion of customer purchases of Xerox

equipment through our bundled lease arrangements. We believe

that financing facilitates customer acquisition of Xerox technology

and enhances our value proposition to the customer while

providing Xerox a profitable revenue stream and a strong return on

equity.

As a result of our customer financing program, we benefit by

gaining in-depth knowledge of the products being leased and a

deep understanding of the customer base and their use of our

technology. This knowledge allows us to effectively manage the

credit and residual value risk normally associated with financing.

Our financing risk is further mitigated because the majority of our

lease contracts are non-cancelable and include cancellation

penalties approximately equal to the full value of the lease

receivables.

Because our lease contracts permit 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

lease contracts. We fund our customer financing activity through a

combination of cash generated from operations, cash on hand,

borrowings under bank credit facilities and proceeds from capital

market offerings. At December 31, 2008 we had $7.3 billion of

Globally, we have 57,100 direct employees. We have over 7,500 Sales Professionals,

over 13,000 Managed Service Employees at customer sites and over 13,000

Technical Service Employees. In addition, we have over 6,500 Agents and

Concessionaires and over 10,000 resellers.

finance receivables and $0.6 billion of equipment on operating
leases, or Total Finance assets of $7.9 billion. We maintain an
assumed 7:1 leverage ratio of debt to equity as compared to our
Finance assets and therefore a significant portion of our $8.4
billion of debt is associated with our financing business.

In addition to being an excellent customer retention vehicle, our
customer financing program also achieves an attractive gross
margin which provides us a reasonable return on our investment in
this business. This program is also a strong value proposition for
our customers because it provides them a bundled monthly
payment for their document management needs and an attractive
financing alternative.

Service

As of December 31, 2008, we had a worldwide service force of
approximately 13,000 employees and an extensive variable
contract service force. We continue to expand 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
because it is continually trained on our products and its diagnostic
equipment is state-of-the-art. We offer service 24 hours a day,
7 days a week, in major metropolitan areas around the world,
providing a consistent and superior level of service worldwide.

Manufacturing and Supply

Our manufacturing and distribution facilities are located around
the world. The company’s largest manufacturing site is in Webster,
N.Y., where we make fusers, photoreceptors, Xerox iGen and
Nuvera systems, components, consumables and other products.
Additionally this year, updates were made at the EA Toner plant in
Webster, N.Y. that was built in 2007 to give the plant the flexibility
to meet demand for both first and second generations of EA
Toner. This allows the plant to produce the new breakthrough Ultra
Low-Melt EA Toner. Our remaining primary manufacturing
operations are located in: 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. We also have a major facility in Venray,
Netherlands, that handles supplies manufacturing and supply
chain management for the eastern hemisphere.

We are currently in the second year of a master supply agreement
with Flextronics, a global electronics manufacturing services
company, to outsource portions of manufacturing for our Office
segment. The agreement has a three year term, with two
additional one-year extension periods at our option. Our inventory
purchases from Flextronics currently represent approximately 15%
of our overall worldwide inventory procurement and production.
Our pricing for inventory sourced through Flextronics is generally
market based. We have agreed to purchase from Flextronics some
products and consumables within specified product families
although we do have the ability to source product from other
suppliers without penalty to extent needed. Flextronics is required
to acquire inventory based on our forecasted requirements and
must maintain sufficient manufacturing capacity to satisfy these
requirements. Under certain circumstances, we may become
obligated to purchase inventory that remains unused for more
than 180 days, becomes obsolete or remains unused on the
termination of the supply agreement. If Flextronics were unable to
continue to supply product, it would not result in a material
disruption to our business because Flextronics primarily provides
contract assembly labor and we continue to manage the inbound
sourcing and supply chain management of raw materials and
sub-assembly parts. In addition, we own the tooling and
technology that Flextronics currently uses to produce our products;
there are a number of alternative suppliers that could replace the
contract assembly labor Flextronics provides and we have business
resumption plans in place for Flextronics and other similar
suppliers.

We acquire other office products from various third parties in order
to increase the breadth of our product portfolio and meet channel
requirements. We have arrangements with Fuji Xerox under which
we purchase and sell products, some of which are the result of
mutual research and development arrangements. Refer to Note 7 –
Investments in Affiliates, at Equity in the Consolidated Financial
Statements in our 2008 Annual Report for additional information
regarding our relationship with Fuji Xerox.

Fuji Xerox

Fuji Xerox is an unconsolidated entity in which we currently own a
25% interest and FUJIFILM Holdings Corporation (“FujiFilm”) owns
a 75% interest. Fuji Xerox develops, manufactures and distributes
document processing products in Japan, China, Hong Kong, 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.

Xerox 2008 Annual Report

Text.indd 23

3/18/09 5:58:43 PM

Our Business

Management’s Discussion and

Analysis of Financial Condition

and Results of Operations

International Operations

Other Information

Xerox is a New York corporation, organized in 1906, and our
principal executive offices are located at 45 Glover Avenue, P.O.
Box 4505, Norwalk, Connecticut 06856-4505.

Our telephone number is (203) 968-3000.

On the Investor Information section of our Internet website, you
will find our annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and any amendments to these
reports. We make these documents available as soon as we can
after we have filed them with, or furnished them to, the Securities
and Exchange Commission.

Our Internet address is http://www.xerox.com

We are incorporating by reference the financial measures by
geographical area for 2008, 2007 and 2006 that are included in
Note 2 – Segment Reporting in the Consolidated Financial
Statements in our 2008 Annual Report. See also the risk factors
entitled “Our business, results of operations and financial condition
may be negatively impacted by economic conditions abroad,
including fluctuating foreign currencies and shifting regulatory
schemes.” in Part 1, Item 1A of this Form 10K.

Backlog

We believe that backlog, or the value of unfilled orders, is not a
meaningful indicator of future business prospects because of the
significant proportion of our revenue that follows equipment
installation, the large volume of products we deliver 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.

The following Management’s Discussion and Analysis (“MD&A”) is

our installed base of equipment at customer locations, page

intended to help the reader understand the results of operations

volume growth and higher revenue per page. Key drivers to

and financial condition of Xerox Corporation. MD&A is provided as

increase equipment usage are connected multifunction devices,

a supplement to, and should be read in conjunction with, our

new services and solutions. The transition to color is the primary

consolidated financial statements and the accompanying notes.

driver to improve revenue per page, as color documents typically

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

document equipment, solutions and services. Increasingly,

businesses are digitally creating and storing documents and using

the Internet to exchange electronic documents. More customers

are seeking to gain efficiencies in their document management

processes and are looking to us for document-related services to

achieve those efficiencies. We believe these trends play to the

strengths of our product and service offerings and represent

opportunities for future growth in the $132 billion market we serve.

These transformations also represent opportunities for future

growth since our research and development investments have

been focused on digital, color and services offerings and our

acquisitions have focused on expanding our services, software and

distribution capabilities.

We operate in a global business environment, serving a wide range

of customers with about 50 percent of our revenue generated from

customers outside the U.S. Our markets are competitive. Customers

are demanding document services such as assessment consulting,

managed services, imaging and hosting and document intensive

business process improvements. Additionally, our customers

demand improved technology solutions, such as the ability to print

offset quality color documents on-demand; improved product

require significantly more toner coverage per page than traditional

black-and-white printing. In addition, our growing services business,

including offerings such as managed print services which help

customers reduce their costs, also drives post sale revenue.

In 2008, we completed several acquisitions to further strengthen

our distribution capacity and expand our reach in the small to

mid-size business (“SMB”) market. Global Imaging Systems, Inc.

(“GIS”) acquired Saxon Business Systems (“Saxon”), an office

equipment supplier with offices throughout Florida, as well as three

additional smaller businesses – Better Quality Business Systems,

Precision Copier Service Inc. DBA Sierra Office Solutions and Inland

Business Systems of Chico. We also acquired Veenman B.V.

(“Veenman”), expanding our reach into the SMB market in Europe.

Veenman is Netherlands’ leading independent distributor of office

printers, copiers and multifunction devices serving small and

mid-size businesses.

Financial Overview

2008 was an extremely challenging year due to worldwide

economic weakness, particularly in the second half of the year. The

unfavorable economic conditions, as well as a rapid shift in

currency exchange rates and the related impact on foreign

currency revenue and purchases put significant pressure on the

business in 2008. The downturn in the economy adversely

impacted equipment sales to large enterprises, as well as revenues

from high volume production systems. In the fourth quarter of

2008, the increasingly wide-spread economic concerns found

customers and partners prioritizing cash and delaying decisions on

major contracts. In addition, our distribution partners reduced their

inventories of supplies at year end, which negatively impacted our

functionality, such as the ability to print, copy, fax and scan from a

post sale revenue.

single device; and lower prices for the same functionality.

Our business model is built upon an annuity model that yields

consistent strong cash flow, expanded earnings and enables us to

provide good returns to shareholders. The majority of our revenue

Revenue from our developing markets were also negatively

impacted by the dramatic weakening of the Russian and eastern

European economies.

(supplies, service, paper, outsourcing, rentals and financing) is

Despite the difficult economic conditions in the second half of

recurring, which we collectively refer to as post sale revenue. This

2008, total revenue in 2008 increased 2% over the prior year,

recurring revenue provides a significant degree of stability to our

reflecting 4% growth in post sale revenue offset by a 2% decline

revenue, profits and cash flow. Post sale revenue currently

in equipment sales revenue. Total color revenue of $6.7 billion was

represents more than 70 percent of the Company’s revenue and is

up 5% over the prior year, benefiting from our investments in this

driven by the amount of equipment installed at customer locations

market and post sale revenue for document management services

and the utilization of that equipment. As such, our critical success

(also referred to as “Xerox Global Services”) of $3.5 billion increased

factors include equipment installations, which stabilize and grow

3% over 2007.

Xerox 2008 Annual Report

Text.indd 24

3/18/09 5:58:44 PM

Our Business

Management’s Discussion and
Analysis of Financial Condition
and Results of Operations

International Operations

Other Information

We are incorporating by reference the financial measures by

Xerox is a New York corporation, organized in 1906, and our

geographical area for 2008, 2007 and 2006 that are included in

principal executive offices are located at 45 Glover Avenue, P.O.

Note 2 – Segment Reporting in the Consolidated Financial

Box 4505, Norwalk, Connecticut 06856-4505.

Statements in our 2008 Annual Report. See also the risk factors

entitled “Our business, results of operations and financial condition

may be negatively impacted by economic conditions abroad,

including fluctuating foreign currencies and shifting regulatory

schemes.” in Part 1, Item 1A of this Form 10K.

Backlog

Our telephone number is (203) 968-3000.

On the Investor Information section of our Internet website, you

will find our annual reports on Form 10-K, quarterly reports on Form

10-Q, current reports on Form 8-K and any amendments to these

reports. We make these documents available as soon as we can

after we have filed them with, or furnished them to, the Securities

and Exchange Commission.

We believe that backlog, or the value of unfilled orders, is not a

meaningful indicator of future business prospects because of the

Our Internet address is http://www.xerox.com

significant proportion of our revenue that follows equipment

installation, the large volume of products we deliver 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.

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
document equipment, solutions and services. Increasingly,
businesses are digitally creating and storing documents and using
the Internet to exchange electronic documents. More customers
are seeking to gain efficiencies in their document management
processes and are looking to us for document-related services to
achieve those efficiencies. We believe these trends play to the
strengths of our product and service offerings and represent
opportunities for future growth in the $132 billion market we serve.
These transformations also represent opportunities for future
growth since our research and development investments have
been focused on digital, color and services offerings and our
acquisitions have focused on expanding our services, software and
distribution capabilities.

We operate in a global business environment, serving a wide range
of customers with about 50 percent of our revenue generated from
customers outside the U.S. Our markets are competitive. Customers
are demanding document services such as assessment consulting,
managed services, imaging and hosting and document intensive
business process improvements. Additionally, our customers
demand improved technology 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.

Our business model is built upon an annuity model that yields
consistent strong cash flow, expanded earnings and enables us to
provide good returns to shareholders. The majority of our revenue
(supplies, service, paper, outsourcing, rentals and financing) is
recurring, which we collectively refer to as post sale revenue. This
recurring revenue provides a significant degree of stability to our
revenue, profits and cash flow. Post sale revenue currently
represents more than 70 percent of the Company’s revenue and is
driven by the amount of equipment installed at customer locations
and the utilization of that equipment. As such, our critical success
factors include equipment installations, which stabilize and grow

our installed base of equipment at customer locations, page
volume growth and higher revenue per page. Key drivers to
increase equipment usage are connected multifunction devices,
new services and solutions. The transition to color is the primary
driver to improve revenue per page, as color documents typically
require significantly more toner coverage per page than traditional
black-and-white printing. In addition, our growing services business,
including offerings such as managed print services which help
customers reduce their costs, also drives post sale revenue.

In 2008, we completed several acquisitions to further strengthen
our distribution capacity and expand our reach in the small to
mid-size business (“SMB”) market. Global Imaging Systems, Inc.
(“GIS”) acquired Saxon Business Systems (“Saxon”), an office
equipment supplier with offices throughout Florida, as well as three
additional smaller businesses – Better Quality Business Systems,
Precision Copier Service Inc. DBA Sierra Office Solutions and Inland
Business Systems of Chico. We also acquired Veenman B.V.
(“Veenman”), expanding our reach into the SMB market in Europe.
Veenman is Netherlands’ leading independent distributor of office
printers, copiers and multifunction devices serving small and
mid-size businesses.

Financial Overview

2008 was an extremely challenging year due to worldwide
economic weakness, particularly in the second half of the year. The
unfavorable economic conditions, as well as a rapid shift in
currency exchange rates and the related impact on foreign
currency revenue and purchases put significant pressure on the
business in 2008. The downturn in the economy adversely
impacted equipment sales to large enterprises, as well as revenues
from high volume production systems. In the fourth quarter of
2008, the increasingly wide-spread economic concerns found
customers and partners prioritizing cash and delaying decisions on
major contracts. In addition, our distribution partners reduced their
inventories of supplies at year end, which negatively impacted our
post sale revenue.

Revenue from our developing markets were also negatively
impacted by the dramatic weakening of the Russian and eastern
European economies.

Despite the difficult economic conditions in the second half of
2008, total revenue in 2008 increased 2% over the prior year,
reflecting 4% growth in post sale revenue offset by a 2% decline
in equipment sales revenue. Total color revenue of $6.7 billion was
up 5% over the prior year, benefiting from our investments in this
market and post sale revenue for document management services
(also referred to as “Xerox Global Services”) of $3.5 billion increased
3% over 2007.

Xerox 2008 Annual Report

Text.indd 25

3/18/09 5:58:45 PM

Management’s Discussion

2008 total gross margin of 38.9% was 1.4-percentage points
below the prior year. Pricing, product mix and unfavorable
exchange rates on our Yen based inventory purchases were only
partially offset by cost productivity improvements. Selling,
administrative and general (“SAG”) expenses as a percent of
revenue were 25.7 percent or 0.7-percentage points higher than
the prior year. SAG expenses increased due to the full year inclusion
of GIS, higher bad debt provisions and increased marketing
investments partially offset by restructuring savings. Additionally,
we continued to invest in research and development and to
prioritize our investments in the faster growing areas of the market.
Research, development and engineering (“RD&E”) expenses were
5% of revenue in 2008, which is consistent with the prior year. Our
investments in the growing areas of digital production and office
systems, particularly with respect to color products, contributed to
more than two-thirds of our equipment sales being generated from
products launched in the last two years.

Changes in our revenue mix – both from geographic and product
line perspectives – have reduced our gross profit margins. This,
combined with uncertain economic conditions, required us to take
actions to adjust our cost and expense profile. Accordingly, we
recognized pre-tax restructuring charges of $429 million for 2008
actions in order to reduce our cost base and provide increased
flexibility in our business in this depressed or recessionary
economy. Refer to Note 9 – Restructuring and Asset Impairment
Charges in the Consolidated Financial Statements for further
information.

Our balance sheet strategy focused on optimizing operating cash
flows and returning value to shareholders through acquisitions,
share repurchase and dividends. We continue to maintain debt
levels primarily to support our customer financing operations. Cash
flow from operations was $939 million in 2008 and included $615
million of net securities-related litigation payments as we resolved
two long standing securities litigation cases. Cash used for
investments was $441 million and included capital expenditures of
$335 million and acquisitions of $155 million. Cash used for
financing of $311 million reflected continued net repayments of
secured borrowings of $227 million; $812 million for share
repurchases; and $154 million for dividends, partially offset by net
cash flows from new borrowings of $926 million. New borrowings
included $1.4 billion of Senior Notes in an April 2008 public
offering. We finished the year with cash and cash equivalents of
$1.2 billion.

Our prospective balance sheet strategy includes: optimizing
operating cash flows; maintaining our investment grade credit
ratings; achieving an optimal cost of capital; and effectively
deploying cash to deliver and maximize long-term shareholder
value through acquisitions, share repurchase and dividends.
However, due to the current economic uncertainty, we have no
immediate plans for further share repurchases at this time. Our
strategy also includes appropriately leveraging our financing assets
(finance receivables and equipment on operating leases).

Currency Impacts

To understand the trends in our business, we believe that it is
helpful to analyze the impact of changes in the translation of
foreign currencies into U.S. Dollars on revenues and expenses. We
refer to this analysis as “currency impact” or “the impact from
currency”. Revenues and expenses from our developing markets 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.

Approximately 50% of our consolidated revenues are 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 and Canadian Dollar on a revenue-
weighted basis, the U.S. Dollar was 3% weaker in 2008 and 9%
weaker in 2007, each compared to the prior year. As a result, the
foreign currency translation impact on revenue was a 1% benefit
in 2008 and a 3% benefit in 2007.

Currency exchange rates fluctuated significantly in the fourth
quarter 2008. The U.S. Dollar strengthened significantly in the
fourth quarter 2008 as compared to the currencies of our major
foreign operations – the Euro, Pound Sterling and Canadian Dollar.
The foreign currency translation impact on revenue from this
fluctuation in exchange rates was a 3% point benefit through the
third quarter 2008 as compared to a 5% detriment in the fourth
quarter 2008. If U.S. Dollar exchange rates against these major
currencies remain at their current levels we expect it will have an
estimated 5% to 6% negative impact on total revenue in the first
half of 2009.

Year Ended December 31,

Percent Change

compared to 39% in 2007 reflecting:

Summary Results

Revenue

follows:

Revenues for the three years ended December 31, 2008 were as

(in millions)

2008

2007

2006

2008

2007

Equipment sales

$ 4,679 $ 4,753 $ 4,457 (2)%

Post sale revenue(1)

12,929

12,475

11,438

Total Revenue

$17,608 $17,228 $15,895

8 %

4 %

2 %

Reconciliation to Consolidated Statements of Income

Sales

$ 8,325 $ 8,192 $ 7,464

Less: Supplies, paper

and other sales

(3,646)

(3,439)

(3,007)

Equipment sales

$ 4,679 $ 4,753 $ 4,457

Service, outsourcing

Finance income

Add: Supplies, paper

and rentals

$ 8,485 $ 8,214 $ 7,591

798

822

840

and other sales

3,646

3,439

3,007

Post sale revenue

$12,929 $12,475 $11,438

Memo: Color(3)

$ 6,669 $ 6,356 $ 5,578

14%

in our 2007 results,(2) equipment sales revenue decreased 5%,

with a 1-percentage point benefit from currency. Overall price

declines of between 5%- 10% as well as product mix more than

offset overall growth in install activity.

• 5% growth in color revenue.(3) Color revenue of $6,669 million in

2008 represented 41% of total revenue, excluding GIS,

– 10% growth in color post sale revenue to $4,590 million.

Color post sale revenue represented 37% and 35% of post

sale revenue, in 2008 and 2007, respectively.(4)

– Color equipment sales revenue declined 4% to $2,079

million. Color equipment sales represented 50% of total

equipment sales, in 2008 and 2007,(4) respectively.

– 24%(5) growth in color pages. Color pages represented

18%(5) and 12% of total pages in 2008 and 2007,

respectively.

Total 2007 revenue increased 8% compared to the prior year and

includes the results of GIS since May 9, 2007, the effective date of

our acquisition. When including GIS in our 2006 results,(2) our 2007

total revenue increased 4%. Currency had a 3-percentage point

positive impact on total revenues. Total revenues included the

following:

• 9% increase in post sale revenue, or 6% including GIS in our

2006 results.(2) This included a 3-percentage point benefit from

currency. Growth in GIS, color products, developing markets and

Total 2008 revenue increased 2% compared to the prior year and

document management services more than offset the decline in

was flat when including GIS in our 2007 results.(2) Currency had a

black-and-white digital office revenue and light lens product

1-percentage point positive impact on total revenues. Total

revenue. The components of post sale revenue increased as

revenues included the following:

follows:

• 4% increase in post sale revenue, or 2% including GIS in our

– 8% increase in service, outsourcing and rentals revenue to

2007 results.(2) This included a 1-percentage point benefit from

currency. Growth in GIS, color products and document

management services offset the declines in high-volume

black-and-white printing systems, black-and-white multifunction

devices and light lens product revenue. The components of post

sale revenue increased as follows:

– 3% increase in service, outsourcing, and rentals revenue to

$8,485 million reflected the full year inclusion of GIS, and

growth in document management services.

– Supplies, paper, and other sales of $3,646 million grew 6%

year-over-year due to the full year inclusion of GIS as well as

growth in color supplies and paper sales.

$8,214 million reflected the inclusion of GIS, growth in

document management services and technical service

revenue.

– Supplies, paper and other sales of $3,439 million grew 14%

year-over-year due to the inclusion of GIS as well as growth in

developing markets.

• 7% increase in equipment sales revenue, or a decrease of 1%

when including GIS in our 2006 results.(2) This included a

3-percentage point benefit from currency. Growth in office

multifunction color and production color install activity was

offset by overall price declines of between 5%-10%, declines in

production black-and-white products and color printers, as well

as an increased proportion of equipment installed under

• 2% decrease in equipment sales revenue. There was no impact

operating lease contracts where revenue is recognized over-time

from currency on equipment sales revenue. When including GIS

in post sale.

Xerox 2008 Annual Report

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Management’s Discussion

2008 total gross margin of 38.9% was 1.4-percentage points

Our prospective balance sheet strategy includes: optimizing

below the prior year. Pricing, product mix and unfavorable

operating cash flows; maintaining our investment grade credit

exchange rates on our Yen based inventory purchases were only

ratings; achieving an optimal cost of capital; and effectively

partially offset by cost productivity improvements. Selling,

deploying cash to deliver and maximize long-term shareholder

administrative and general (“SAG”) expenses as a percent of

value through acquisitions, share repurchase and dividends.

revenue were 25.7 percent or 0.7-percentage points higher than

However, due to the current economic uncertainty, we have no

the prior year. SAG expenses increased due to the full year inclusion

immediate plans for further share repurchases at this time. Our

of GIS, higher bad debt provisions and increased marketing

strategy also includes appropriately leveraging our financing assets

investments partially offset by restructuring savings. Additionally,

(finance receivables and equipment on operating leases).

we continued to invest in research and development and to

prioritize our investments in the faster growing areas of the market.

Research, development and engineering (“RD&E”) expenses were

5% of revenue in 2008, which is consistent with the prior year. Our

investments in the growing areas of digital production and office

systems, particularly with respect to color products, contributed to

more than two-thirds of our equipment sales being generated from

products launched in the last two years.

Changes in our revenue mix – both from geographic and product

line perspectives – have reduced our gross profit margins. This,

combined with uncertain economic conditions, required us to take

actions to adjust our cost and expense profile. Accordingly, we

recognized pre-tax restructuring charges of $429 million for 2008

actions in order to reduce our cost base and provide increased

flexibility in our business in this depressed or recessionary

economy. Refer to Note 9 – Restructuring and Asset Impairment

Charges in the Consolidated Financial Statements for further

information.

Our balance sheet strategy focused on optimizing operating cash

flows and returning value to shareholders through acquisitions,

share repurchase and dividends. We continue to maintain debt

levels primarily to support our customer financing operations. Cash

flow from operations was $939 million in 2008 and included $615

million of net securities-related litigation payments as we resolved

two long standing securities litigation cases. Cash used for

investments was $441 million and included capital expenditures of

$335 million and acquisitions of $155 million. Cash used for

financing of $311 million reflected continued net repayments of

secured borrowings of $227 million; $812 million for share

repurchases; and $154 million for dividends, partially offset by net

cash flows from new borrowings of $926 million. New borrowings

included $1.4 billion of Senior Notes in an April 2008 public

offering. We finished the year with cash and cash equivalents of

$1.2 billion.

Currency Impacts

To understand the trends in our business, we believe that it is

helpful to analyze the impact of changes in the translation of

foreign currencies into U.S. Dollars on revenues and expenses. We

refer to this analysis as “currency impact” or “the impact from

currency”. Revenues and expenses from our developing markets 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.

Approximately 50% of our consolidated revenues are 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 and Canadian Dollar on a revenue-

weighted basis, the U.S. Dollar was 3% weaker in 2008 and 9%

weaker in 2007, each compared to the prior year. As a result, the

foreign currency translation impact on revenue was a 1% benefit

in 2008 and a 3% benefit in 2007.

Currency exchange rates fluctuated significantly in the fourth

quarter 2008. The U.S. Dollar strengthened significantly in the

fourth quarter 2008 as compared to the currencies of our major

foreign operations – the Euro, Pound Sterling and Canadian Dollar.

The foreign currency translation impact on revenue from this

fluctuation in exchange rates was a 3% point benefit through the

third quarter 2008 as compared to a 5% detriment in the fourth

quarter 2008. If U.S. Dollar exchange rates against these major

currencies remain at their current levels we expect it will have an

estimated 5% to 6% negative impact on total revenue in the first

half of 2009.

Summary Results

Revenue

Revenues for the three years ended December 31, 2008 were as
follows:

(in millions)

2008

2007

2006

2008

2007

Year Ended December 31,

Percent Change

7%
9%

8 %

Equipment sales
Post sale revenue(1)

$ 4,679 $ 4,753 $ 4,457 (2)%
4 %

12,929

12,475

11,438

Total Revenue

$17,608 $17,228 $15,895

2 %

Reconciliation to Consolidated Statements of Income

Sales
Less: Supplies, paper
and other sales

$ 8,325 $ 8,192 $ 7,464

(3,646)

(3,439)

(3,007)

Equipment sales

$ 4,679 $ 4,753 $ 4,457

Service, outsourcing

and rentals
Finance income
Add: Supplies, paper
and other sales

$ 8,485 $ 8,214 $ 7,591
840

798

822

3,646

3,439

3,007

Post sale revenue

$12,929 $12,475 $11,438

Memo: Color(3)

$ 6,669 $ 6,356 $ 5,578

14%

Total 2008 revenue increased 2% compared to the prior year and
was flat when including GIS in our 2007 results.(2) Currency had a
1-percentage point positive impact on total revenues. Total
revenues included the following:

• 4% increase in post sale revenue, or 2% including GIS in our

2007 results.(2) This included a 1-percentage point benefit from
currency. Growth in GIS, color products and document
management services offset the declines in high-volume
black-and-white printing systems, black-and-white multifunction
devices and light lens product revenue. The components of post
sale revenue increased as follows:

– 3% increase in service, outsourcing, and rentals revenue to
$8,485 million reflected the full year inclusion of GIS, and
growth in document management services.

– Supplies, paper, and other sales of $3,646 million grew 6%

year-over-year due to the full year inclusion of GIS as well as
growth in color supplies and paper sales.

• 2% decrease in equipment sales revenue. There was no impact
from currency on equipment sales revenue. When including GIS

in our 2007 results,(2) equipment sales revenue decreased 5%,
with a 1-percentage point benefit from currency. Overall price
declines of between 5%- 10% as well as product mix more than
offset overall growth in install activity.

• 5% growth in color revenue.(3) Color revenue of $6,669 million in

2008 represented 41% of total revenue, excluding GIS,
compared to 39% in 2007 reflecting:

– 10% growth in color post sale revenue to $4,590 million.

Color post sale revenue represented 37% and 35% of post
sale revenue, in 2008 and 2007, respectively.(4)

– Color equipment sales revenue declined 4% to $2,079

million. Color equipment sales represented 50% of total
equipment sales, in 2008 and 2007,(4) respectively.

– 24%(5) growth in color pages. Color pages represented
18%(5) and 12% of total pages in 2008 and 2007,
respectively.

Total 2007 revenue increased 8% compared to the prior year and
includes the results of GIS since May 9, 2007, the effective date of
our acquisition. When including GIS in our 2006 results,(2) our 2007
total revenue increased 4%. Currency had a 3-percentage point
positive impact on total revenues. Total revenues included the
following:

• 9% increase in post sale revenue, or 6% including GIS in our

2006 results.(2) This included a 3-percentage point benefit from
currency. Growth in GIS, color products, developing markets and
document management services more than offset the decline in
black-and-white digital office revenue and light lens product
revenue. The components of post sale revenue increased as
follows:

– 8% increase in service, outsourcing and rentals revenue to
$8,214 million reflected the inclusion of GIS, growth in
document management services and technical service
revenue.

– Supplies, paper and other sales of $3,439 million grew 14%

year-over-year due to the inclusion of GIS as well as growth in
developing markets.

• 7% increase in equipment sales revenue, or a decrease of 1%

when including GIS in our 2006 results.(2) This included a
3-percentage point benefit from currency. Growth in office
multifunction color and production color install activity was
offset by overall price declines of between 5%-10%, declines in
production black-and-white products and color printers, as well
as an increased proportion of equipment installed under
operating lease contracts where revenue is recognized over-time
in post sale.

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Management’s Discussion

• 14% growth in color revenue.(3) Color revenue of $6,356 million
in 2007 comprised 39% of total revenue, compared to 35% in
2006 reflecting:

2007 Net income of $1,135 million, or $1.19 per diluted share,
included $30 million after-tax charge for our share of Fuji Xerox
(“FX”) restructuring charges.

– 18% growth in color post sale revenue to $4,180 million.

Color post sale revenue represented 35% and 31% of post
sale revenue, in 2007 and 2006, respectively.(4)

2006 Net income of $1,210 million, or $1.22 per diluted share,
included the following:

• $472 million income tax benefit related to the favorable

– 7% growth in color equipment sales revenue to $2,176

resolution of certain tax matters from the 1999-2003 IRS audit.

Revenue Recognition for Leases

million. Color equipment sales represented 49% and 45% of
total equipment sales, in 2007 and 2006, respectively.(4)

– 31% growth in color pages. Color pages represented 12%
and 9% of total pages in 2007 and 2006, respectively.(4)

(1) 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, the mix of color
pages and associated services.

(2) The percentage point impacts from GIS reflect the revenue growth year-over-year after
including GIS’s results for 2007 and 2006 on a proforma basis. See “Non-GAAP Financial
Measures” section for an explanation of this non-GAAP measure.

(3) Color revenues represent a subset of total revenues and excludes the impact of GIS’s

revenues.

(4) As of December 31, 2008, total color, color post sale and color equipment sales revenues

comprised 41%, 37% and 50%, respectively, if calculated on total, total post sale, and
total equipment sales revenues, including GIS. GIS is excluded from the color information
presented, because the breakout of the information required to make this computation for
all periods is not available.

(5) Pages include estimates for developing markets, GIS and printers.

Net Income

Net income and diluted earnings per share for the three years
ended December 31, 2008 were as follows:

(in millions, except per share amounts)

2008

2007

2006

Net income
Diluted earnings per share

$ 230
$0.26

$1,135
$ 1.19

$1,210
$ 1.22

2008 Net income of $230 million, or $0.26 per diluted share,
included the following:

• $491 million after-tax charges ($774 million pre-tax) associated

with securities-related litigation matters as well as other
probable litigation-related losses including $36 million for the
Brazilian labor-related contingencies.

• $292 million after-tax charge ($426 million pre-tax) for second,

third and fourth quarter 2008 restructuring and asset
impairment actions.

• $24 million after-tax charge ($39 million pre-tax) for an Office

product line equipment write-off.

• $41 million income tax benefit from the settlement of certain

previously unrecognized tax benefits.

• $68 million (pre-tax and after-tax) for probable losses on

Brazilian labor-related contingencies.

• $46 million tax benefit resulting from the resolution of certain

tax matters associated with foreign tax audits.

• $9 million after-tax ($13 million pre-tax) charge from the

write-off of the remaining unamortized deferred debt issuance
costs as a result of the termination of our 2003 Credit Facility.

• $257 million after-tax ($385 million pre-tax) restructuring and

asset impairment charges.

Application of Critical Accounting Policies

In preparing our Consolidated Financial Statements and
accounting for the underlying transactions and balances, we apply
various accounting policies. 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. 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. In instances where different estimates
could have reasonably been used, we disclosed the impact of these
different estimates on our operations. In certain instances, like
revenue recognition for leases, the accounting rules are
prescriptive; therefore, it would not have been possible to
reasonably use different estimates. 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.

Specific risks associated with these critical accounting policies are

objective evidence of equipment fair value based on cash selling

discussed throughout the MD&A, where such policies affect our

prices during the applicable period. The cash selling prices are

reported and expected financial results. For a detailed discussion of

compared to the range of values included in our lease accounting

the application of these and other accounting policies, refer to

systems. The range of cash selling prices must be reasonably

Note 1 – Summary of Significant Accounting Policies, in the

consistent with the lease selling prices, taking into account residual

Consolidated Financial Statements.

values, in order for us to determine that such lease prices are

Our accounting for leases involves specific determinations under

applicable lease accounting standards, which often involve

complex and prescriptive provisions. These provisions affect the

timing of revenue recognition for our equipment. If a lease

qualifies as a sales-type capital lease, 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 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 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.

Revenue Recognition Under Bundled Arrangements

We sell the majority 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. Typically these arrangements 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

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. We reassess our pricing interest

rates quarterly based on changes in the local prevailing rates in the

marketplace. These interest rates have been historically adjusted if

the 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. In light of worldwide

economic conditions prevailing at the end of 2008, we expect to

continually review this methodology in 2009 to ensure that our

pricing interest rates are reflective of changes in the local

prevailing rates in the marketplace.

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

$188 million, $134 million and $87 million in SAG expenses in our

Consolidated Statements of Income for the years ended

December 31, 2008, 2007 and 2006, respectively.

upon the estimated relative fair values of each element. Lease

Historically, the majority of the bad debt provision relates to our

deliverables include maintenance and executory costs, equipment

finance receivables portfolio. This provision is inherently more

and financing, while non-lease deliverables generally consist of

difficult to estimate than the provision for trade accounts

supplies and non-maintenance services. Our revenue allocation for

receivable because the underlying lease portfolio has an average

lease deliverables begins by allocating revenues to the

maturity, at any time, of approximately two to three years and

maintenance and executory costs plus profit thereon. The

contains past due billed amounts, as well as unbilled amounts. The

remaining amounts are allocated to the equipment and financing

estimated credit quality of any given customer and class of

elements. We perform extensive analyses of available verifiable

customer or geographic location can significantly change during

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Management’s Discussion

• 14% growth in color revenue.(3) Color revenue of $6,356 million

2007 Net income of $1,135 million, or $1.19 per diluted share,

in 2007 comprised 39% of total revenue, compared to 35% in

included $30 million after-tax charge for our share of Fuji Xerox

2006 reflecting:

(“FX”) restructuring charges.

– 18% growth in color post sale revenue to $4,180 million.

2006 Net income of $1,210 million, or $1.22 per diluted share,

Color post sale revenue represented 35% and 31% of post

included the following:

sale revenue, in 2007 and 2006, respectively.(4)

• $472 million income tax benefit related to the favorable

million. Color equipment sales represented 49% and 45% of

total equipment sales, in 2007 and 2006, respectively.(4)

– 31% growth in color pages. Color pages represented 12%

and 9% of total pages in 2007 and 2006, respectively.(4)

(1) 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, the mix of color

pages and associated services.

(2) The percentage point impacts from GIS reflect the revenue growth year-over-year after

including GIS’s results for 2007 and 2006 on a proforma basis. See “Non-GAAP Financial

Measures” section for an explanation of this non-GAAP measure.

(3) Color revenues represent a subset of total revenues and excludes the impact of GIS’s

revenues.

(4) As of December 31, 2008, total color, color post sale and color equipment sales revenues

comprised 41%, 37% and 50%, respectively, if calculated on total, total post sale, and

total equipment sales revenues, including GIS. GIS is excluded from the color information

presented, because the breakout of the information required to make this computation for

all periods is not available.

(5) Pages include estimates for developing markets, GIS and printers.

Net Income

Net income and diluted earnings per share for the three years

ended December 31, 2008 were as follows:

(in millions, except per share amounts)

2008

2007

2006

Net income

Diluted earnings per share

$ 230

$0.26

$1,135

$ 1.19

$1,210

$ 1.22

2008 Net income of $230 million, or $0.26 per diluted share,

included the following:

• $491 million after-tax charges ($774 million pre-tax) associated

with securities-related litigation matters as well as other

probable litigation-related losses including $36 million for the

Brazilian labor-related contingencies.

• $68 million (pre-tax and after-tax) for probable losses on

Brazilian labor-related contingencies.

• $46 million tax benefit resulting from the resolution of certain

tax matters associated with foreign tax audits.

• $9 million after-tax ($13 million pre-tax) charge from the

write-off of the remaining unamortized deferred debt issuance

costs as a result of the termination of our 2003 Credit Facility.

• $257 million after-tax ($385 million pre-tax) restructuring and

asset impairment charges.

Application of Critical Accounting Policies

In preparing our Consolidated Financial Statements and

accounting for the underlying transactions and balances, we apply

various accounting policies. 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. 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. In instances where different estimates

could have reasonably been used, we disclosed the impact of these

different estimates on our operations. In certain instances, like

revenue recognition for leases, the accounting rules are

prescriptive; therefore, it would not have been possible to

reasonably use different estimates. 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

• $292 million after-tax charge ($426 million pre-tax) for second,

operations and financial condition in any quarterly or annual

third and fourth quarter 2008 restructuring and asset

period.

impairment actions.

• $24 million after-tax charge ($39 million pre-tax) for an Office

product line equipment write-off.

• $41 million income tax benefit from the settlement of certain

previously unrecognized tax benefits.

– 7% growth in color equipment sales revenue to $2,176

resolution of certain tax matters from the 1999-2003 IRS audit.

Revenue Recognition for Leases

Specific risks associated with these critical accounting policies are
discussed throughout the MD&A, where such policies affect our
reported and expected financial results. For a detailed discussion of
the application of these and other accounting policies, refer to
Note 1 – Summary of Significant Accounting Policies, in the
Consolidated Financial Statements.

Our accounting for leases involves specific determinations under
applicable lease accounting standards, which often involve
complex and prescriptive provisions. These provisions affect the
timing of revenue recognition for our equipment. If a lease
qualifies as a sales-type capital lease, 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 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 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.

Revenue Recognition Under Bundled Arrangements

We sell the majority 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. Typically these arrangements 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
deliverables include maintenance and executory costs, equipment
and financing, while non-lease deliverables generally consist of
supplies and non-maintenance services. Our revenue allocation for
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, 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. We reassess our pricing interest
rates quarterly based on changes in the local prevailing rates in the
marketplace. These interest rates have been historically adjusted if
the 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. In light of worldwide
economic conditions prevailing at the end of 2008, we expect to
continually review this methodology in 2009 to ensure that our
pricing interest rates are reflective of changes in the local
prevailing rates in the marketplace.

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
$188 million, $134 million and $87 million in SAG expenses in our
Consolidated Statements of Income for the years ended
December 31, 2008, 2007 and 2006, respectively.

Historically, the majority of the bad debt provision 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

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Management’s Discussion

the life of the portfolio. We consider all available information in our
quarterly assessments of the adequacy of the provision for
doubtful accounts.

The current economic environment has increased the risk of
non-collection of receivables. We have accordingly considered this
increased risk in the evaluation and assessment of our allowance
for doubtful accounts at year-end. Collection risk is somewhat
mitigated by the fact that our receivables are fairly well dispersed
among a diverse customer base both in size and geography. Days
sales outstanding remained fairly flat year-over-year. In addition,
the aging of receivables has not increased significantly. Accounts
receivable balances greater than 60 days outstanding were 17%
of total gross accounts receivables at December 31, 2008 as
compared to 15% at December 31, 2007. However, we continue to
assess our receivable portfolio in light of the current economic
environment and its impact on our estimation of the adequacy of
the allowance for doubtful accounts.

As discussed above, in preparing our Consolidated Financial
Statements for the three year period ended December 31, 2008,
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, 2008,
our reserve for doubtful accounts ranged from 3.0% to 4.2% of
gross receivables. Holding all other assumptions constant, a
1-percentage point increase or decrease in the reserve from the
December 31, 2008 rate of 3.4% would change the 2008 provision
by approximately $98 million.

Pension and Post-Retirement Benefit Plan Assumptions

We sponsor defined benefit 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 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.
Difference between these assumptions and actual experiences are
reported as net actuarial gains and losses and are subject to
amortization to net periodic pension cost over the average
remaining service lives of the employees participating in the
pension plan.

Cumulative actuarial losses for our pension plans as of
December 31, 2008 were $1.8 billion, as compared to $1 billion at
December 31, 2007. The change from December 31, 2007 relates

primarily to actual losses on plan assets in 2008 as compared to
expected returns partially offset by an increase in the discount
rate. The total actuarial loss will be amortized in the future, subject
to offsetting gains or losses that will change the future
amortization amount.

We have utilized a weighted average expected rate of return on
plan assets of 7.6% for 2008, 7.6% for 2007 and 7.8% for 2006,
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.

During 2008, the actual loss on plan assets was $1.5 billion,
primarily as a result of the significant declines in the equity
markets during the fourth quarter of 2008. In estimating the 2009
expected rate of return we considered this significant decline in the
fair value of our plan assets as well as potential changes in our
investment mix, partly in response to the significant volatility
expected in the equity markets for the foreseeable future. The
weighted average expected rate of return on plan assets we will
utilize for 2009 will be 7.4% as compared to 7.6% in 2008.

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 can result 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 net
actuarial gain or loss.

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 indices, adjusted to eliminate the effects of call
provisions and differences in the timing and amounts of cash
outflows related to the bonds. In the U.S. and the U.K., which
comprise approximately 80% of our projected benefit obligations,

we consider the Moody’s Aa Corporate Bond Index and the

the expected timing of the reversals of existing temporary

International Index Company’s iBoxx Sterling Corporate AA Cash

differences and tax planning strategies. If we continue to operate

Bond Index, respectively, in the determination of the appropriate

at a loss in certain jurisdictions or are unable to generate sufficient

discount rate assumptions. Due to the recent, unprecedented

future taxable income, or if there is a material change in the actual

events in the financial markets associated with the current credit

effective tax rates or time period within which the underlying

environment, there is a greater than usual disparity in yields

temporary differences become taxable or deductible, we could be

among the bonds included in the various indices used to determine

required to increase the valuation allowance against all or a

our pension discount rates. Given this disparity, we carefully

significant portion of our deferred tax assets resulting in a

evaluated our existing methodologies for determining our pension

substantial increase in our effective tax rate and a material adverse

discount rates and refined those methodologies to the extent

impact on our operating results. Conversely, if and when our

required to ensure we selected an appropriate discount rate. The

operations in some jurisdictions were to become sufficiently

weighted average discount rate we utilized to measure our pension

profitable to recover previously reserved deferred tax assets, we

obligation as of December 31, 2008 and to calculate our 2009

would reduce all or a portion of the applicable valuation allowance

expense was 6.3%, which is an increase of 0.4% from 5.9% used

in the period when such determination is made. This would result in

in determining our 2008 expense. The increase is primarily driven

an increase to reported earnings in such period. Adjustments to our

by our U.K. and Canadian plans.

valuation allowance, through charges to income tax expense, were

Assuming settlement losses in 2009 are consistent with 2008, our

2009 net periodic defined benefit pension cost is expected to be

approximately $20 million higher than 2008, primarily as a result

of the reduction in the expected return on plan assets due to lower

asset values and increased amortization of actuarial gains and

losses partially offset by an increase in the discount rate.

On a consolidated basis, we recognized net periodic pension cost of

$254 million, $315 million and $425 million for the years ended

December 31, 2008, 2007 and 2006, respectively. The costs

associated with our defined contribution plans, which are included

in net periodic pension cost, were $80 million, $80 million and $70

million for the years ended December 31, 2008, 2007 and 2006,

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 – Employee Benefit Plans in the Consolidated Financial

Statements. Holding all other assumptions constant, a 0.25%

increase or decrease in the discount rate would (decrease)/increase

the 2009 projected net periodic pension cost by $(13) million or

$17 million, $14 million and $12 million for the years ended

December 31, 2008, 2007 and 2006, respectively. There were

other (decreases) increases to our valuation allowance, including

the effects of currency, of $(136) million, $86 million and $45

million for the years ended December 31, 2008, 2007 and 2006,

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 $3.8

billion and $3.6 billion had valuation allowances of $628 million

and $747 million at December 31, 2008 and 2007, 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 more-likely-than-not

outcomes of such matters. In addition, when applicable, we adjust

the previously recorded tax expense to reflect examination results.

Our ongoing assessments of the more-likely-than-not 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.

$18 million, respectively. Likewise, a 0.25% increase or decrease in

We file income tax returns in the U.S. Federal jurisdiction and

the expected return on plan assets would change the 2009

various foreign jurisdictions. In the U.S. we are no longer subject to

projected net periodic pension cost by $11 million.

U.S. Federal income tax examinations by tax authorities for years

before 2007. With respect to our major foreign jurisdictions, we are

no longer subject to tax examinations by tax authorities for years

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

before 2000.

Legal Contingencies

operating loss and tax credit carryforwards. We follow very specific

We are involved in a variety of claims, lawsuits, investigations and

and detailed guidelines in each tax jurisdiction regarding the

proceedings concerning securities law, intellectual property law,

recoverability of any tax assets recorded in our Consolidated

environmental law, employment law and ERISA, as discussed in

Balance Sheets and provide valuation allowances as required. We

Note 16 – Contingencies in the Consolidated Financial Statements.

regularly review our deferred tax assets for recoverability

We determine whether an estimated loss from a contingency

considering historical profitability, projected future taxable income,

should be accrued by assessing whether a loss is deemed probable

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Management’s Discussion

the life of the portfolio. We consider all available information in our

primarily to actual losses on plan assets in 2008 as compared to

quarterly assessments of the adequacy of the provision for

expected returns partially offset by an increase in the discount

doubtful accounts.

rate. The total actuarial loss will be amortized in the future, subject

to offsetting gains or losses that will change the future

The current economic environment has increased the risk of

non-collection of receivables. We have accordingly considered this

amortization amount.

increased risk in the evaluation and assessment of our allowance

We have utilized a weighted average expected rate of return on

for doubtful accounts at year-end. Collection risk is somewhat

plan assets of 7.6% for 2008, 7.6% for 2007 and 7.8% for 2006,

mitigated by the fact that our receivables are fairly well dispersed

on a worldwide basis. In estimating this rate, we considered the

among a diverse customer base both in size and geography. Days

historical returns earned by the plan assets, the rates of return

sales outstanding remained fairly flat year-over-year. In addition,

expected in the future and our investment strategy and asset mix

the aging of receivables has not increased significantly. Accounts

with respect to the plans’ funds.

receivable balances greater than 60 days outstanding were 17%

of total gross accounts receivables at December 31, 2008 as

compared to 15% at December 31, 2007. However, we continue to

assess our receivable portfolio in light of the current economic

environment and its impact on our estimation of the adequacy of

the allowance for doubtful accounts.

During 2008, the actual loss on plan assets was $1.5 billion,

primarily as a result of the significant declines in the equity

markets during the fourth quarter of 2008. In estimating the 2009

expected rate of return we considered this significant decline in the

fair value of our plan assets as well as potential changes in our

investment mix, partly in response to the significant volatility

As discussed above, in preparing our Consolidated Financial

expected in the equity markets for the foreseeable future. The

Statements for the three year period ended December 31, 2008,

weighted average expected rate of return on plan assets we will

we estimated our provision for doubtful accounts based on

utilize for 2009 will be 7.4% as compared to 7.6% in 2008.

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, 2008,

our reserve for doubtful accounts ranged from 3.0% to 4.2% of

gross receivables. Holding all other assumptions constant, a

1-percentage point increase or decrease in the reserve from the

December 31, 2008 rate of 3.4% would change the 2008 provision

by approximately $98 million.

Pension and Post-Retirement Benefit Plan Assumptions

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

We sponsor defined benefit pension plans in various forms in

volatility in net periodic pension cost that can result from using the

several countries covering substantially all employees who meet

fair market value approach. The difference between the actual

eligibility requirements. Post-retirement benefit plans cover

return on plan assets and the expected return on plan assets is

primarily U.S. employees for retirement medical costs. Several

added to, or subtracted from, any cumulative differences that

statistical and other factors that attempt to anticipate future

arose in prior years. This amount is a component of the net

events are used in calculating the expense, liability and asset

actuarial gain or loss.

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.

Difference between these assumptions and actual experiences are

reported as net actuarial gains and losses and are subject to

amortization to net periodic pension cost over the average

remaining service lives of the employees participating in the

pension plan.

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 indices, adjusted to eliminate the effects of call

Cumulative actuarial losses for our pension plans as of

provisions and differences in the timing and amounts of cash

December 31, 2008 were $1.8 billion, as compared to $1 billion at

outflows related to the bonds. In the U.S. and the U.K., which

December 31, 2007. The change from December 31, 2007 relates

comprise approximately 80% of our projected benefit obligations,

we consider the Moody’s Aa Corporate Bond Index and the
International Index Company’s iBoxx Sterling Corporate AA Cash
Bond Index, respectively, in the determination of the appropriate
discount rate assumptions. Due to the recent, unprecedented
events in the financial markets associated with the current credit
environment, there is a greater than usual disparity in yields
among the bonds included in the various indices used to determine
our pension discount rates. Given this disparity, we carefully
evaluated our existing methodologies for determining our pension
discount rates and refined those methodologies to the extent
required to ensure we selected an appropriate discount rate. The
weighted average discount rate we utilized to measure our pension
obligation as of December 31, 2008 and to calculate our 2009
expense was 6.3%, which is an increase of 0.4% from 5.9% used
in determining our 2008 expense. The increase is primarily driven
by our U.K. and Canadian plans.

Assuming settlement losses in 2009 are consistent with 2008, our
2009 net periodic defined benefit pension cost is expected to be
approximately $20 million higher than 2008, primarily as a result
of the reduction in the expected return on plan assets due to lower
asset values and increased amortization of actuarial gains and
losses partially offset by an increase in the discount rate.

On a consolidated basis, we recognized net periodic pension cost of
$254 million, $315 million and $425 million for the years ended
December 31, 2008, 2007 and 2006, respectively. The costs
associated with our defined contribution plans, which are included
in net periodic pension cost, were $80 million, $80 million and $70
million for the years ended December 31, 2008, 2007 and 2006,
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 – Employee Benefit Plans in the Consolidated Financial
Statements. Holding all other assumptions constant, a 0.25%
increase or decrease in the discount rate would (decrease)/increase
the 2009 projected net periodic pension cost by $(13) million or
$18 million, respectively. Likewise, a 0.25% increase or decrease in
the expected return on plan assets would change the 2009
projected net periodic pension cost by $11 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 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 charges to income tax expense, were
$17 million, $14 million and $12 million for the years ended
December 31, 2008, 2007 and 2006, respectively. There were
other (decreases) increases to our valuation allowance, including
the effects of currency, of $(136) million, $86 million and $45
million for the years ended December 31, 2008, 2007 and 2006,
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 $3.8
billion and $3.6 billion had valuation allowances of $628 million
and $747 million at December 31, 2008 and 2007, 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 more-likely-than-not
outcomes of such matters. In addition, when applicable, we adjust
the previously recorded tax expense to reflect examination results.
Our ongoing assessments of the more-likely-than-not 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.

We file income tax returns in the U.S. Federal jurisdiction and
various foreign jurisdictions. In the U.S. we are no longer subject to
U.S. Federal income tax examinations by tax authorities for years
before 2007. With respect to our major foreign jurisdictions, we are
no longer subject to tax examinations by tax authorities for years
before 2000.

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 – Contingencies in the Consolidated Financial Statements.
We determine whether an estimated loss from a contingency
should be accrued by assessing whether a loss is deemed probable

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Management’s Discussion

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.

Business Combinations and Goodwill

The application of the purchase method of accounting for business
combinations requires the use of significant estimates and
assumptions in the determination of the fair value of assets
acquired and liabilities assumed in order to properly allocate
purchase price consideration between assets that are depreciated
and amortized from goodwill. Our estimates of the fair values of
assets and liabilities acquired are based upon assumptions believed
to be reasonable, and when appropriate, include assistance from
independent third-party appraisal firms.

As a result of our acquisition of GIS, as well as other prior year
acquisitions, we have a significant amount of goodwill. Goodwill is
tested for impairment 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 for purposes of establishing a discount rate and relevant
market data.

Our annual impairment test of goodwill is performed in the fourth
quarter. The estimated fair values of the Company’s reporting
units were based on discounted cash flow models derived from
internal earnings forecasts and assumptions. The assumptions and
estimates used in those valuations incorporated the expected
impact of the challenging economic environment that has
persisted over the past year. In performing our 2008 impairment
test, the following were the overall composite long-term
assumptions regarding revenue and expense growth, which were
the basis for estimating future cash flows used in the discounted
cash flow model: 1) revenue growth 3%; 2) gross margin 39-40%;
3) RD&E 4-5%; 4) SAG 24-25%; and 5) return on sales 8-9%. We
believe these estimated assumptions are appropriate for our
circumstances, in-line with historical results and consistent with our
forecasted long-term business model. These assumptions also have
considered the current economic environment.

Based on those valuations, we determined that the fair values of
our reporting units exceeded their carrying values and no goodwill
impairment charge was required during the fourth quarter. In light
of the continued difficult economic conditions and the fact that
the Company’s stock has been generally trading below net book
value per share over the past quarter, we reassessed our
assumptions as of December 31, 2008. We do not believe the
recent general downturn in the U.S. equity markets is
representative of any fundamental change in our business. Based
on current results and expectations, we determined that the fair
values of our reporting units continue to exceed their carrying
values and determined that no goodwill impairment charge was
required as of December 31, 2008.

Refer to Note 1 – Summary of Significant Accounting Policies –
“Goodwill and Intangible Assets” for further information regarding
our goodwill impairment testing, as well as Note 8 – Goodwill and
Intangible Assets, Net in the Consolidated Financial Statements for
further information regarding goodwill by operating segment.

Operations Review

(in millions)

2008

2007

2006

Equipment sales

Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

Equipment sales

Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

Equipment sales

Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

Our reportable segments are consistent with how we manage the business and view the markets we serve. Our reportable segments are

Production, Office and Other. See Note 2 – Segment Reporting in the Consolidated Financial Statements for further discussion on our

segment operating revenues and segment operating profit.

Revenues by segment for the years ended 2008, 2007 and 2006 were as follows:

Production

Office

Other

Total

Year Ended December 31,

$ 1,325

3,912

$ 5,237

$ 394

7.5%

$ 1,471

3,844

$ 5,315

$ 562

10.6%

$ 1,491

3,564

$ 5,055

$ 504

10.0%

$ 3,105

6,723

$ 9,828

$ 1,062

10.8%

$ 3,030

6,443

$ 9,473

$ 1,115

11.8%

$ 2,786

5,926

$ 8,712

$ 1,010

11.6%

$ 249

2,294

$ 2,543

$ (165)

(6.5)%

$ 252

2,188

$ 2,440

(89)

(3.7)%

$ 180

1,948

$ 2,128

$ (124)

(5.8)%

$ 4,679

12,929

$17,608

$ 1,291

7.3%

$ 4,753

12,475

$17,228

$ 1,588

9.2%

$ 4,457

11,438

$15,895

$ 1,390

8.7%

In 2008 we revised our segment reporting to integrate the Developing Markets Operations (“DMO”) into the Production, Office and Other

segments. DMO is a geographic region that has matured to a level where we now manage it on the basis of products sold, consistent with

our North American and European geographic regions. All prior periods presented have been restated accordingly.

Note: Install activity percentages include the Xerox-branded product shipments to GIS.

Xerox 2008 Annual Report

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Management’s Discussion

and can be reasonably estimated. We assess our potential liability

Our annual impairment test of goodwill is performed in the fourth

by analyzing our litigation and regulatory matters using available

quarter. The estimated fair values of the Company’s reporting

information. We develop our views on estimated losses in

units were based on discounted cash flow models derived from

consultation with outside counsel handling our defense in these

internal earnings forecasts and assumptions. The assumptions and

matters, which involves an analysis of potential results, assuming a

estimates used in those valuations incorporated the expected

combination of litigation and settlement strategies. Should

impact of the challenging economic environment that has

developments in any of these matters cause a change in our

persisted over the past year. In performing our 2008 impairment

determination as to an unfavorable outcome and result in the

test, the following were the overall composite long-term

need to recognize a material accrual, or should any of these

assumptions regarding revenue and expense growth, which were

matters result in a final adverse judgment or be settled for

the basis for estimating future cash flows used in the discounted

significant amounts, they could have a material adverse effect on

cash flow model: 1) revenue growth 3%; 2) gross margin 39-40%;

our results of operations, cash flows and financial position in the

3) RD&E 4-5%; 4) SAG 24-25%; and 5) return on sales 8-9%. We

period or periods in which such change in determination, judgment

believe these estimated assumptions are appropriate for our

or settlement occurs.

Business Combinations and Goodwill

circumstances, in-line with historical results and consistent with our

forecasted long-term business model. These assumptions also have

considered the current economic environment.

combinations requires the use of significant estimates and

assumptions in the determination of the fair value of assets

acquired and liabilities assumed in order to properly allocate

purchase price consideration between assets that are depreciated

and amortized from goodwill. Our estimates of the fair values of

our reporting units exceeded their carrying values and no goodwill

impairment charge was required during the fourth quarter. In light

of the continued difficult economic conditions and the fact that

the Company’s stock has been generally trading below net book

value per share over the past quarter, we reassessed our

assets and liabilities acquired are based upon assumptions believed

assumptions as of December 31, 2008. We do not believe the

to be reasonable, and when appropriate, include assistance from

recent general downturn in the U.S. equity markets is

independent third-party appraisal firms.

As a result of our acquisition of GIS, as well as other prior year

acquisitions, we have a significant amount of goodwill. Goodwill is

tested for impairment 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

representative of any fundamental change in our business. Based

on current results and expectations, we determined that the fair

values of our reporting units continue to exceed their carrying

values and determined that no goodwill impairment charge was

required as of December 31, 2008.

Refer to Note 1 – Summary of Significant Accounting Policies –

“Goodwill and Intangible Assets” for further information regarding

our goodwill impairment testing, as well as Note 8 – Goodwill and

Intangible Assets, Net in the Consolidated Financial Statements for

of each reporting unit. We estimate the fair value of each reporting

further information regarding goodwill by operating segment.

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 for purposes of establishing a discount rate and relevant

market data.

Operations Review

Our reportable segments are consistent with how we manage the business and view the markets we serve. Our reportable segments are
Production, Office and Other. See Note 2 – Segment Reporting in the Consolidated Financial Statements for further discussion on our
segment operating revenues and segment operating profit.

Revenues by segment for the years ended 2008, 2007 and 2006 were as follows:

The application of the purchase method of accounting for business

Based on those valuations, we determined that the fair values of

2007

(in millions)

2008

Equipment sales
Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

Equipment sales
Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

2006

Equipment sales
Post sale revenue

Total Revenues

Segment Profit (Loss)

Operating Margin

Production

Office

Other

Total

Year Ended December 31,

$ 1,325
3,912

$ 5,237

$ 394

7.5%

$ 1,471
3,844

$ 5,315

$ 562

10.6%

$ 1,491
3,564

$ 5,055

$ 504

10.0%

$ 3,105
6,723

$ 9,828

$ 1,062

10.8%

$ 3,030
6,443

$ 9,473

$ 1,115

11.8%

$ 2,786
5,926

$ 8,712

$ 1,010

11.6%

$ 249
2,294

$ 2,543

$ (165)

(6.5)%

$ 252
2,188

$ 2,440

(89)

(3.7)%

$ 180
1,948

$ 2,128

$ (124)

(5.8)%

$ 4,679
12,929

$17,608

$ 1,291

7.3%

$ 4,753
12,475

$17,228

$ 1,588

9.2%

$ 4,457
11,438

$15,895

$ 1,390

8.7%

In 2008 we revised our segment reporting to integrate the Developing Markets Operations (“DMO”) into the Production, Office and Other
segments. DMO is a geographic region that has matured to a level where we now manage it on the basis of products sold, consistent with
our North American and European geographic regions. All prior periods presented have been restated accordingly.

Note: Install activity percentages include the Xerox-branded product shipments to GIS.

Xerox 2008 Annual Report

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Management’s Discussion

Segment Revenue and Operating Profit

Production

2007 Operating profit of $562 million increased $58 million from
2006. The increase is primarily the result of higher gross profit and
lower R,D&E, partially offset by an increase in bad debt expense.

Revenue
2008 Production revenue of $5,237 million decreased 1%,
including a 1-percentage point benefit from currency, reflecting:

• 2% increase in post sale revenue as growth from color,

continuous feed and light production products offset declines in
revenue from black-and-white high-volume printing systems and
light lens devices.

• 10% decrease in equipment sales revenue, primarily reflecting
pricing declines in both black-and-white and color production
systems, driven in part by weakness in the U.S.

• 1% increase in installs of production color products driven in

part by Xerox 700 and iGen4TM activity as well as color
continuous feed.

• 6% decline in installs of production black-and-white systems
driven primarily by declines in installs of light production
systems.

Office

offset by the full year inclusion of GIS.

Revenue
2008 Office revenue of $9,828 million increased 4%, including a
1-percentage point benefit from currency, as well as the benefits
from our expansion in the SMB market through GIS and Veenman.
Revenue for 2008 reflects:

• 4% increase in post sale revenue, reflecting the full year

inclusion of GIS as well as growth from color multifunction
devices and color printers partially offset by declines in
black-and-white digital devices. Office post sale revenue was
negatively impacted in the fourth quarter of 2008 by declines in
channel supply purchases, including lower purchases within
developing markets.

• 2% increase in equipment sales revenue, reflecting the full year
inclusion of GIS as well as growth from color digital products
which more than offset declines from black-and-white devices
primarily due to price declines and product mix.

2007 Production revenue of $5,315 million increased 5%,
including a 4-percentage point benefit from currency, reflecting:

• 24% color multifunction device install growth led by strong
demand for Xerox WorkCentre® and Phaser® products.

• 8% increase in post sale and other revenue, including a

• 8% increase in installs of black-and-white copiers and

4-percentage point benefit from currency, as growth from digital
products more than offset declines in revenue from older light
lens technology.

• 1% decrease in equipment sales revenue, including a

3-percentage point benefit from currency, reflecting growth in
production color systems offset by declines in black-and-white
production printing systems and light production and an
increased proportion of equipment installed under operating
lease contracts where revenue is recognized over-time in post
sale.

• 6% growth in installs of production color products driven by

DocuColor® 242/252/260 family, DocuColor 5000 and iGen3®
activity.

• 8% decline in installs of production black-and-white systems
reflecting declines in installs of both high-volume and light
production systems.

Operating Profit
2008 Operating profit of $394 million decreased $168 million from
2007. The decrease is primarily the result of lower revenue and
lower gross margins due to pricing and product mix as well as
increased SAG expenses.

multifunction devices, including 8% growth in Segment 1&2
products (11-30 ppm) and 8% growth in Segment 3-5 products
(31-90 ppm). Segment 3-5 installs include the Xerox 4595, a 95
ppm device with an embedded controller.

• 12% increase in color printer installs.

2007 Office revenue of $9,473 million increased 9%, including a
3-percentage point benefit from currency, reflecting:

• 9% increase in post sale revenue, reflecting the inclusion of GIS

since May 2007 as well as growth from color multifunction
devices and color printers.

• 9% increase in equipment sales revenue, reflecting the inclusion
of GIS since May 2007 as well as color multifunction products
install growth.

• 65% color multifunction device install growth led by strong

demand for Xerox WorkCentre products.

• 5% increase in installs of black-and-white copiers and

multifunction devices, including 4% growth in Segment 1&2
products (11-30 ppm) and 7% growth in Segment 3-5 products
(31-90 ppm) that includes the 95 ppm device with an embedded
controller.

• 10% decline in color printer installs due to lower OEM sales.

Operating Profit

2008 Total gross margin decreased 1.4-percentage points

2008 Operating profit of $1,062 million decreased $53 million

compared to 2007 as price declines and mix of approximately

from 2007. The decrease was primarily due to lower gross profits

2.0-percentage points were only partially offset by cost

reflecting lower margins as well as higher SAG expenses partially

productivity improvements. Cost improvements were limited by an

2007 Operating profit of $1,115 million increased $105 million

from 2006. The increase was primarily due to the inclusion of GIS

since May 2007 and higher gross profits partially offset by higher

SAG expenses.

Other

Revenue

2008 Other revenue of $2,543 million increased 4% primarily

reflecting the full year inclusion of GIS and increased paper

revenue partially offset by lower revenue from wide format

systems. There was no impact from currency. Paper comprised

2007 Other revenue of $2,440 million increased 15%, including a

3-percentage point benefit from currency, primarily reflecting the

inclusion of GIS since May 2007 as well as increased paper and

value-added services revenues. Paper comprised approximately

50% of Other segment revenue.

unfavorable impact on product costs of approximately

0.5-percentage points from the significant strengthening of the

Yen versus the U.S. Dollar and Euro. The negative impact of

0.3-percentage points from an Office product line equipment

write-off was offset by positive adjustments related to the

capitalized costs for equipment on operating leases and European

product disposal costs.

• Sales gross margin decreased 2.2-percentage points primarily

due to the approximately 2.5-percentage point impact of price

declines as well as channel and product mix. Cost improvements,

which historically tend to offset price declines, were limited in

2008 by the adverse impact of the strengthening Yen on our

inventory purchases.

0.8-percentage points primarily due to mix as price declines of

1.3-percentage points were offset by cost improvements. Mix

reflects margin pressure from document management services.

• Financing income margin of approximately 62% remained

comparable to 2007.

Since a large portion of our inventory procurement is from Japan,

the strengthening of the Yen versus the U.S. Dollar and Euro in

approximately 50% of Other segment revenue.

• Service, outsourcing and rentals margin decreased

2008 Operating loss of $165 million increased $76 million from

2008 significantly impacted our product cost. The Yen

2007 reflecting lower wide format revenue, higher foreign

strengthened approximately 14% against the U.S. Dollar and 6%

exchange losses and lower interest income partially offset by gains

against the Euro in 2008 as compared to 2007. A significant

Operating Loss

on sales of assets.

2007 Operating loss of $89 million decreased $35 million from

2006 reflecting higher revenue as well as lower currency exchange

losses and litigation charges, partially offset by higher interest

expense and lower gains on the sales of businesses and assets.

Costs, Expenses and Other Income

Gross Margin

portion of that strengthening occurred in the fourth quarter 2008

when the Yen strengthened 17% against the U.S. Dollar and 29%

against the Euro as compared to prior year. We expect product

costs and gross margins to continue to be negatively impacted in

2009 if Yen exchange rates remain at current levels.

2007 Total Gross margin was down slightly as compared to 2006

as cost improvements were offset by price and product mix.

• Sales gross margin increased 0.2-percentage points primarily as

cost improvements and other variances more than offset the

Gross margins by revenue classification were as follows:

2.0-percentage point impact of price declines.

Year Ended December 31,

• Service, outsourcing and rentals margin decreased

0.3-percentage points as cost improvements and other variances

2008

2007

2006

did not fully offset price declines and unfavorable product mix of

approximately 2.0-percentage points.

Sales

Service, outsourcing and rentals

Finance income

Total Gross margin

33.7% 35.9% 35.7%

41.9% 42.7% 43.0%

61.8% 61.6% 63.7%

38.9%

40.3%

40.6%

• Financing income margin declined 2.1-percentage points

reflecting additional interest expense due to higher interest

rates.

Xerox 2008 Annual Report

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Management’s Discussion

Segment Revenue and Operating Profit

Production

Revenue

2008 Production revenue of $5,237 million decreased 1%,

including a 1-percentage point benefit from currency, reflecting:

Revenue

Office

2007 Operating profit of $562 million increased $58 million from

2006. The increase is primarily the result of higher gross profit and

lower R,D&E, partially offset by an increase in bad debt expense.

• 2% increase in post sale revenue as growth from color,

continuous feed and light production products offset declines in

revenue from black-and-white high-volume printing systems and

light lens devices.

• 10% decrease in equipment sales revenue, primarily reflecting

pricing declines in both black-and-white and color production

systems, driven in part by weakness in the U.S.

• 1% increase in installs of production color products driven in

part by Xerox 700 and iGen4TM activity as well as color

continuous feed.

• 6% decline in installs of production black-and-white systems

driven primarily by declines in installs of light production

systems.

2008 Office revenue of $9,828 million increased 4%, including a

1-percentage point benefit from currency, as well as the benefits

from our expansion in the SMB market through GIS and Veenman.

Revenue for 2008 reflects:

• 4% increase in post sale revenue, reflecting the full year

inclusion of GIS as well as growth from color multifunction

devices and color printers partially offset by declines in

black-and-white digital devices. Office post sale revenue was

negatively impacted in the fourth quarter of 2008 by declines in

channel supply purchases, including lower purchases within

developing markets.

• 2% increase in equipment sales revenue, reflecting the full year

inclusion of GIS as well as growth from color digital products

which more than offset declines from black-and-white devices

primarily due to price declines and product mix.

2007 Production revenue of $5,315 million increased 5%,

including a 4-percentage point benefit from currency, reflecting:

• 24% color multifunction device install growth led by strong

demand for Xerox WorkCentre® and Phaser® products.

• 8% increase in post sale and other revenue, including a

• 8% increase in installs of black-and-white copiers and

4-percentage point benefit from currency, as growth from digital

multifunction devices, including 8% growth in Segment 1&2

products more than offset declines in revenue from older light

products (11-30 ppm) and 8% growth in Segment 3-5 products

lens technology.

• 1% decrease in equipment sales revenue, including a

3-percentage point benefit from currency, reflecting growth in

production color systems offset by declines in black-and-white

production printing systems and light production and an

increased proportion of equipment installed under operating

lease contracts where revenue is recognized over-time in post

sale.

activity.

• 6% growth in installs of production color products driven by

DocuColor® 242/252/260 family, DocuColor 5000 and iGen3®

• 8% decline in installs of production black-and-white systems

reflecting declines in installs of both high-volume and light

production systems.

Operating Profit

(31-90 ppm). Segment 3-5 installs include the Xerox 4595, a 95

ppm device with an embedded controller.

• 12% increase in color printer installs.

2007 Office revenue of $9,473 million increased 9%, including a

3-percentage point benefit from currency, reflecting:

• 9% increase in post sale revenue, reflecting the inclusion of GIS

since May 2007 as well as growth from color multifunction

devices and color printers.

• 9% increase in equipment sales revenue, reflecting the inclusion

of GIS since May 2007 as well as color multifunction products

install growth.

• 65% color multifunction device install growth led by strong

demand for Xerox WorkCentre products.

• 5% increase in installs of black-and-white copiers and

multifunction devices, including 4% growth in Segment 1&2

products (11-30 ppm) and 7% growth in Segment 3-5 products

(31-90 ppm) that includes the 95 ppm device with an embedded

2008 Operating profit of $394 million decreased $168 million from

2007. The decrease is primarily the result of lower revenue and

lower gross margins due to pricing and product mix as well as

controller.

increased SAG expenses.

• 10% decline in color printer installs due to lower OEM sales.

Operating Profit
2008 Operating profit of $1,062 million decreased $53 million
from 2007. The decrease was primarily due to lower gross profits
reflecting lower margins as well as higher SAG expenses partially
offset by the full year inclusion of GIS.

2007 Operating profit of $1,115 million increased $105 million
from 2006. The increase was primarily due to the inclusion of GIS
since May 2007 and higher gross profits partially offset by higher
SAG expenses.

Other

Revenue
2008 Other revenue of $2,543 million increased 4% primarily
reflecting the full year inclusion of GIS and increased paper
revenue partially offset by lower revenue from wide format
systems. There was no impact from currency. Paper comprised
approximately 50% of Other segment revenue.

2007 Other revenue of $2,440 million increased 15%, including a
3-percentage point benefit from currency, primarily reflecting the
inclusion of GIS since May 2007 as well as increased paper and
value-added services revenues. Paper comprised approximately
50% of Other segment revenue.

Operating Loss
2008 Operating loss of $165 million increased $76 million from
2007 reflecting lower wide format revenue, higher foreign
exchange losses and lower interest income partially offset by gains
on sales of assets.

2007 Operating loss of $89 million decreased $35 million from
2006 reflecting higher revenue as well as lower currency exchange
losses and litigation charges, partially offset by higher interest
expense and lower gains on the sales of businesses and assets.

Costs, Expenses and Other Income

Gross Margin
Gross margins by revenue classification were as follows:

Sales
Service, outsourcing and rentals
Finance income
Total Gross margin

Year Ended December 31,

2008

2007

2006

33.7% 35.9% 35.7%
41.9% 42.7% 43.0%
61.8% 61.6% 63.7%
40.6%
40.3%
38.9%

2008 Total gross margin decreased 1.4-percentage points
compared to 2007 as price declines and mix of approximately
2.0-percentage points were only partially offset by cost
productivity improvements. Cost improvements were limited by an
unfavorable impact on product costs of approximately
0.5-percentage points from the significant strengthening of the
Yen versus the U.S. Dollar and Euro. The negative impact of
0.3-percentage points from an Office product line equipment
write-off was offset by positive adjustments related to the
capitalized costs for equipment on operating leases and European
product disposal costs.

• Sales gross margin decreased 2.2-percentage points primarily

due to the approximately 2.5-percentage point impact of price
declines as well as channel and product mix. Cost improvements,
which historically tend to offset price declines, were limited in
2008 by the adverse impact of the strengthening Yen on our
inventory purchases.

• Service, outsourcing and rentals margin decreased

0.8-percentage points primarily due to mix as price declines of
1.3-percentage points were offset by cost improvements. Mix
reflects margin pressure from document management services.

• Financing income margin of approximately 62% remained

comparable to 2007.

Since a large portion of our inventory procurement is from Japan,
the strengthening of the Yen versus the U.S. Dollar and Euro in
2008 significantly impacted our product cost. The Yen
strengthened approximately 14% against the U.S. Dollar and 6%
against the Euro in 2008 as compared to 2007. A significant
portion of that strengthening occurred in the fourth quarter 2008
when the Yen strengthened 17% against the U.S. Dollar and 29%
against the Euro as compared to prior year. We expect product
costs and gross margins to continue to be negatively impacted in
2009 if Yen exchange rates remain at current levels.

2007 Total Gross margin was down slightly as compared to 2006
as cost improvements were offset by price and product mix.

• Sales gross margin increased 0.2-percentage points primarily as
cost improvements and other variances more than offset the
2.0-percentage point impact of price declines.

• Service, outsourcing and rentals margin decreased

0.3-percentage points as cost improvements and other variances
did not fully offset price declines and unfavorable product mix of
approximately 2.0-percentage points.

• Financing income margin declined 2.1-percentage points

reflecting additional interest expense due to higher interest
rates.

Xerox 2008 Annual Report

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Management’s Discussion

Research, Development and Engineering Expenses
(“R,D&E”)

We invest in technological development, particularly in color, and
believe our R,D&E spending is sufficient to remain technologically
competitive.

Year Ended December 31,

Change

(in millions)

2008

2007

2006

2008

2007

Total R,D&E expenses
R,D&E % revenue

$884 $912 $922
5.0% 5.3% 5.8% (0.3)pts

$28

$10
(0.5)pts

2008 R,D&E of $884 million decreased $28 million from 2007. We
expect our 2009 R,D&E spending to approximate 4% to 5% of
total revenue.

• R&D of $750 million decreased $14 million from 2007. Our R&D

is strategically coordinated with that of Fuji Xerox, which
invested $788 million and $672 million in R&D in 2008 and
2007, respectively. Much of the reported Fuji Xerox R&D increase
was caused by changes in foreign exchange rates.

• Sustaining engineering costs of $134 million were $14 million
lower than 2007 due primarily to lower spending related to
environmental compliance activities and maturing product
platforms in the Production segment.

• R,D&E as a percentage of revenue declined 0.3-percentage
points reflecting the capture of efficiencies following a
significant number of new product launches over the past two
years as well as leveraging our current R,D&E investments to
support our GIS operations.

2007 R,D&E of $912 million decreased $10 million from 2006.

• R&D of $764 million increased $3 million from 2006. Our R&D is
strategically coordinated with that of Fuji Xerox, which invested
$672 million and $660 million in R&D in 2007 and 2006,
respectively.

Selling, Administrative and General Expenses (“SAG”)

Bad debt expense included in SAG was $188 million, $134 million

Other Expenses, Net

Year Ended December 31,

Change

2008

2007

2006

2008

2007

(in millions)

Total SAG

expenses
SAG % revenue

$4,534 $4,312 $4,008 $222
25.7% 25.0% 25.2% 0.7pts

$304

(0.2)pts

2008 SAG expenses of $4,534 million were $222 million higher
than 2007, including a $12 million unfavorable impact from
currency. The SAG expense increase was the result of the following:

• $94 million increase in selling expenses primarily reflecting the
full year inclusion of GIS, investments in selling resources and
marketing communications and unfavorable currency partially
offset by lower compensation.

• $75 million increase in general and administrative (“G&A”)
expenses primarily from the full year inclusion of GIS and
unfavorable currency.

• $54 million increase in bad debt expense reflecting increased

write-offs, particularly in the fourth quarter 2008, which included
several high value account bankruptcies in the U.S., U.K. and
Germany.

2007 SAG expenses of $4,312 million were $304 million higher
than 2006, including a $141 million negative impact from
currency. The SAG expense increase was the result of the following:

• $93 million increase in selling expenses primarily reflecting the
negative impact from currency and the inclusion of GIS. This
increase was partially offset by lower costs reflecting the
benefits from the 2006 restructuring programs intended to
realign our sales infrastructure.

• $164 million increase in G&A expenses primarily from the
inclusion of GIS, unfavorable currency and information
technology investments.

• Sustaining engineering costs of $148 million were $13 million
lower than 2006 due primarily to lower spending related to
environmental compliance activities and maturing product
platforms in the Production segment.

• $47 million increase in bad debt expense primarily as a result of
an increase in reserves for several customers in Europe as well as
a 2006 reduction in expense due to adjustments to the reserves
to reflect improvement in write-offs and aging.

• R,D&E as a percentage of revenue declined 0.5-percentage

points as we leveraged our current R,D&E investments to support
GIS operations.

Xerox 2008 Annual Report

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and $87 million in 2008, 2007 and 2006, respectively. Bad debt

expense as a percent of total revenue increased in the fourth

quarter 2008 but was 1.1% in 2008 as compared to 0.8% and

0.5% for 2007 and 2006, respectively. Despite the fourth quarter

2008 increase in the provision and write-offs, days sales

(in millions)

outstanding at December 31, 2008 remained fairly flat year-over-

year and the aging of receivables as compared to historical levels

has not increased significantly. However, due to the current

economic conditions, there is an increased risk for our provision for

bad debts to trend higher in 2009 as compared to 2008. At

December 31, 2008, bad debt reserves, as a percentage of

receivables, were comparable to year end 2007.

Restructuring and Asset Impairment Charges

For the years ended December 31, 2008, 2007 and 2006 we

Other expenses, net for each of the three years ended

December 31, 2008, 2007 and 2006 consisted of the following:

Year Ended December 31,

2008

2007

2006

Non-financing interest expense

$ 262

$263

$239

Interest income

Gain on sales of businesses and assets

Currency losses, net

Amortization of intangible assets

Legal matters

All other expenses, net

(35)

(21)

781

(55)

(7)

(6)

(69)

(44)

Total Other expenses, net

$1,122

$295

$336

recorded net restructuring and asset impairment charges (credits)

Non-financing interest expense: 2008 non-financing interest

of $429 million, $(6) million and $385 million, respectively. The

2008 net charge included $357 million related to headcount

expense was flat compared to 2007, as the benefit of lower

interest rates was offset by higher average non-financing debt

reductions of approximately 4,900 employees primarily in North

balances. In 2007 non-financing interest expense increased

America and Europe and lease termination and asset impairment

primarily due to higher average non-financing debt balances as

charges of $72 million primarily reflecting the exit from certain

well as higher interest rates.

leased and owned facilities resulting from a rationalization of our

worldwide operating locations. These actions applied equally to

both North America and Europe with approximately half focused

on SAG expense reductions, approximately a third on gross margin

improvements and the remainder focused on the optimization of

R,D&E investments. We expect to realize savings in 2009 of

Interest income: Interest income is derived primarily from our

invested cash and cash equivalent balances. The decline in interest

income in 2008 was primarily due to lower average cash balances

and rates of return. The decline in 2007 was primarily due to lower

average cash balances partially offset by higher rates of return.

approximately $250 million as a result of the 2008 restructuring

Gain on sales of businesses and assets: 2008 gain on sales of

actions. Restructuring activity was minimal in 2007 and the related

business and assets primarily consisted of the sale of certain

credit of $6 million primarily reflected changes in estimates for

surplus facilities in Latin America.

prior years’ severance costs. The 2006 net charge included $318

million related to headcount reductions of approximately 3,400

employees in North America and Europe, and lease termination

and asset impairment charges of $67 million primarily reflecting

the relocation of certain manufacturing operations and the exit

from certain leased and owned facilities. The restructuring reserve

balance as of December 31, 2008, for all programs was $352

million of which approximately $325 million is expected to be

The 2006 gain on sales of businesses and assets primarily

consisted of $15 million on the sale of our Corporate headquarters,

$11 million on the sale of a manufacturing facility and $10 million

receipt from escrow of additional proceeds related to our 2005 sale

of Integic.

Currency losses net: Currency losses primarily result from the

re-measurement of foreign currency-denominated assets and

spent over the next twelve months. Refer to Note 9 – Restructuring

liabilities, the cost of hedging foreign currency-denominated assets

and Asset Impairment Charges in the Consolidated Financial

Statements for further information regarding our restructuring

programs.

Worldwide Employment

and liabilities, the mark-to-market of foreign exchange contracts

utilized to hedge those foreign currency-denominated assets and

liabilities and the mark-to-market impact of hedges of anticipated

transactions, primarily future inventory purchases, for those that

we do not apply cash flow hedge accounting treatment.

Worldwide employment of 57,100 as of December 31, 2008

decreased approximately 300 from December 31, 2007, primarily

The 2008 currency losses were primarily due to net

reflecting the reductions from restructuring partially offset by

re-measurement losses associated with our Yen-denominated

additions as a result of 2008 acquisition activity. Worldwide

payables, foreign currency denominated assets and liabilities in our

employment was approximately 57,400 and 53,700 at

December 31, 2007 and 2006, respectively.

developing markets and the cost of hedging. The currency losses

on Yen-denominated payables were largely limited to the first

Management’s Discussion

Research, Development and Engineering Expenses

Selling, Administrative and General Expenses (“SAG”)

(“R,D&E”)

competitive.

Year Ended December 31,

Change

We invest in technological development, particularly in color, and

(in millions)

2008

2007

2006

2008

2007

believe our R,D&E spending is sufficient to remain technologically

Total SAG

expenses

$4,534 $4,312 $4,008 $222

$304

Year Ended December 31,

Change

SAG % revenue

25.7% 25.0% 25.2% 0.7pts

(0.2)pts

(in millions)

2008

2007

2006

2008

Total R,D&E expenses

$884 $912 $922

$28

R,D&E % revenue

5.0% 5.3% 5.8% (0.3)pts

(0.5)pts

2007

$10

2008 SAG expenses of $4,534 million were $222 million higher

than 2007, including a $12 million unfavorable impact from

currency. The SAG expense increase was the result of the following:

2008 R,D&E of $884 million decreased $28 million from 2007. We

• $94 million increase in selling expenses primarily reflecting the

expect our 2009 R,D&E spending to approximate 4% to 5% of

total revenue.

• R&D of $750 million decreased $14 million from 2007. Our R&D

is strategically coordinated with that of Fuji Xerox, which

invested $788 million and $672 million in R&D in 2008 and

full year inclusion of GIS, investments in selling resources and

marketing communications and unfavorable currency partially

offset by lower compensation.

• $75 million increase in general and administrative (“G&A”)

expenses primarily from the full year inclusion of GIS and

2007, respectively. Much of the reported Fuji Xerox R&D increase

unfavorable currency.

was caused by changes in foreign exchange rates.

• Sustaining engineering costs of $134 million were $14 million

lower than 2007 due primarily to lower spending related to

environmental compliance activities and maturing product

platforms in the Production segment.

• R,D&E as a percentage of revenue declined 0.3-percentage

points reflecting the capture of efficiencies following a

significant number of new product launches over the past two

years as well as leveraging our current R,D&E investments to

support our GIS operations.

2007 R,D&E of $912 million decreased $10 million from 2006.

• R&D of $764 million increased $3 million from 2006. Our R&D is

• $54 million increase in bad debt expense reflecting increased

write-offs, particularly in the fourth quarter 2008, which included

several high value account bankruptcies in the U.S., U.K. and

Germany.

2007 SAG expenses of $4,312 million were $304 million higher

than 2006, including a $141 million negative impact from

currency. The SAG expense increase was the result of the following:

• $93 million increase in selling expenses primarily reflecting the

negative impact from currency and the inclusion of GIS. This

increase was partially offset by lower costs reflecting the

benefits from the 2006 restructuring programs intended to

realign our sales infrastructure.

strategically coordinated with that of Fuji Xerox, which invested

• $164 million increase in G&A expenses primarily from the

$672 million and $660 million in R&D in 2007 and 2006,

inclusion of GIS, unfavorable currency and information

respectively.

technology investments.

• Sustaining engineering costs of $148 million were $13 million

• $47 million increase in bad debt expense primarily as a result of

lower than 2006 due primarily to lower spending related to

environmental compliance activities and maturing product

platforms in the Production segment.

an increase in reserves for several customers in Europe as well as

a 2006 reduction in expense due to adjustments to the reserves

to reflect improvement in write-offs and aging.

• R,D&E as a percentage of revenue declined 0.5-percentage

points as we leveraged our current R,D&E investments to support

GIS operations.

Bad debt expense included in SAG was $188 million, $134 million
and $87 million in 2008, 2007 and 2006, respectively. Bad debt
expense as a percent of total revenue increased in the fourth
quarter 2008 but was 1.1% in 2008 as compared to 0.8% and
0.5% for 2007 and 2006, respectively. Despite the fourth quarter
2008 increase in the provision and write-offs, days sales
outstanding at December 31, 2008 remained fairly flat year-over-
year and the aging of receivables as compared to historical levels
has not increased significantly. However, due to the current
economic conditions, there is an increased risk for our provision for
bad debts to trend higher in 2009 as compared to 2008. At
December 31, 2008, bad debt reserves, as a percentage of
receivables, were comparable to year end 2007.

Restructuring and Asset Impairment Charges
For the years ended December 31, 2008, 2007 and 2006 we
recorded net restructuring and asset impairment charges (credits)
of $429 million, $(6) million and $385 million, respectively. The
2008 net charge included $357 million related to headcount
reductions of approximately 4,900 employees primarily in North
America and Europe and lease termination and asset impairment
charges of $72 million primarily reflecting the exit from certain
leased and owned facilities resulting from a rationalization of our
worldwide operating locations. These actions applied equally to
both North America and Europe with approximately half focused
on SAG expense reductions, approximately a third on gross margin
improvements and the remainder focused on the optimization of
R,D&E investments. We expect to realize savings in 2009 of
approximately $250 million as a result of the 2008 restructuring
actions. Restructuring activity was minimal in 2007 and the related
credit of $6 million primarily reflected changes in estimates for
prior years’ severance costs. The 2006 net charge included $318
million related to headcount reductions of approximately 3,400
employees in North America and Europe, and lease termination
and asset impairment charges of $67 million primarily reflecting
the relocation of certain manufacturing operations and the exit
from certain leased and owned facilities. The restructuring reserve
balance as of December 31, 2008, for all programs was $352
million of which approximately $325 million is expected to be
spent over the next twelve months. Refer to Note 9 – Restructuring
and Asset Impairment Charges in the Consolidated Financial
Statements for further information regarding our restructuring
programs.

Worldwide Employment
Worldwide employment of 57,100 as of December 31, 2008
decreased approximately 300 from December 31, 2007, primarily
reflecting the reductions from restructuring partially offset by
additions as a result of 2008 acquisition activity. Worldwide
employment was approximately 57,400 and 53,700 at
December 31, 2007 and 2006, respectively.

Other Expenses, Net

Other expenses, net for each of the three years ended
December 31, 2008, 2007 and 2006 consisted of the following:

(in millions)

Non-financing interest expense
Interest income
Gain on sales of businesses and assets
Currency losses, net
Amortization of intangible assets
Legal matters
All other expenses, net

Year Ended December 31,

2008

2007

2006

$ 262
(35)
(21)
34
54
781
47

$263
(55)
(7)
8
42
(6)
50

$239
(69)
(44)
39
41
89
41

Total Other expenses, net

$1,122

$295

$336

Non-financing interest expense: 2008 non-financing interest
expense was flat compared to 2007, as the benefit of lower
interest rates was offset by higher average non-financing debt
balances. In 2007 non-financing interest expense increased
primarily due to higher average non-financing debt balances as
well as higher interest rates.

Interest income: Interest income is derived primarily from our
invested cash and cash equivalent balances. The decline in interest
income in 2008 was primarily due to lower average cash balances
and rates of return. The decline in 2007 was primarily due to lower
average cash balances partially offset by higher rates of return.

Gain on sales of businesses and assets: 2008 gain on sales of
business and assets primarily consisted of the sale of certain
surplus facilities in Latin America.

The 2006 gain on sales of businesses and assets primarily
consisted of $15 million on the sale of our Corporate headquarters,
$11 million on the sale of a manufacturing facility and $10 million
receipt from escrow of additional proceeds related to our 2005 sale
of Integic.

Currency losses net: Currency losses primarily result from the
re-measurement of foreign currency-denominated assets and
liabilities, the cost of hedging foreign currency-denominated assets
and liabilities, the mark-to-market of foreign exchange contracts
utilized to hedge those foreign currency-denominated assets and
liabilities and the mark-to-market impact of hedges of anticipated
transactions, primarily future inventory purchases, for those that
we do not apply cash flow hedge accounting treatment.

The 2008 currency losses were primarily due to net
re-measurement losses associated with our Yen-denominated
payables, foreign currency denominated assets and liabilities in our
developing markets and the cost of hedging. The currency losses
on Yen-denominated payables were largely limited to the first

Xerox 2008 Annual Report

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Management’s Discussion

quarter 2008 as a result of the significant and rapid weakening of
the U.S. Dollar and Euro versus the Yen.

Income Taxes

The 2006 currency losses primarily reflected the mark-to-market of
derivative contracts which are economically hedging anticipated
foreign currency denominated payments. The mark-to-market
losses were primarily due to the strengthening of the Euro against
other currencies, in particular the Canadian Dollar, U.S. Dollar and
the Yen, as compared to the weakening Euro in 2005.

Amortization of intangible assets: 2008 amortization of
intangible assets expense of $54 million reflects amortization
expense of $33 million for intangible assets acquired as part of our
recent acquisitions.

2007 amortization of intangible assets expense of $42 million
reflects amortization expense of $16 million associated with
intangible assets acquired as part of our acquisition of GIS,
partially offset by reduced amortization from prior years due to the
full amortization of certain intangible assets from previous
acquisitions.

Legal matters: In 2008 legal matters consisted of the following:

• $721 million reflecting provisions for the $670 million court

approved settlement of Carlson v. Xerox Corporation (“Carlson”)
and other pending securities-related cases, net of expected
insurance recoveries. On January 14, 2009, the United States
Court for the District of Connecticut entered a Final Order and
Judgment approving the settlement in the Carlson litigation.

• $36 million for probable losses on Brazilian labor-related

contingencies. Following an assessment of the most recent trend
in the outcomes of these matters, we reassessed the probable
estimated loss and, as a result, recorded an additional reserve of
$36 million in the fourth quarter of 2008.

• $24 million associated with probable losses from various other

legal matters.

In 2006 legal matters consisted of the following:

• $68 million for probable losses on Brazilian labor-related

contingencies.

• $33 million associated with probable losses from various legal
matters partially offset by $12 million of proceeds from the
Palm litigation matter.

Refer to Note 16 – Contingencies in the Consolidated Financial
Statements for additional information regarding litigation against
the Company.

(in millions)

Year Ended December 31,

2008

2007

2006

Pre-tax (loss) income
Income tax (benefits) expenses
Effective tax rate

$(114)
(231)
202.6%

$1,438
400

$ 808
(288)
27.8% (35.6)%

The 2008 effective tax rate of 202.6% reflected the tax benefits
from certain discrete items including the net provision for litigation
matters; the second, third and fourth quarter restructuring and
asset impairment charges; the product line equipment write-off;
and the settlement of certain previously unrecognized tax benefits.
Excluding these items, the adjusted effective tax rate was 21.5%*.
The adjusted 2008 effective tax rate was lower than the U.S.
statutory tax rate primarily reflecting the benefit to taxes from the
geographical mix of income before taxes and the related effective
tax rates in those jurisdictions, the utilization of foreign tax credits
and tax law changes.

The 2007 effective tax rate of 27.8% was lower than the U.S.
statutory rate primarily reflecting tax benefits from the
geographical mix of income before taxes and the related effective
tax rates in those jurisdictions and the utilization of foreign tax
credits as well as the resolution of other tax matters. These
benefits were partially offset by changes in tax law.

The 2006 effective tax rate of (35.6%) was lower than the U.S.
statutory rate primarily due to the tax benefits of $518 million
from the resolution of tax issues associated with the 1999-2003
IRS audits and other domestic and foreign tax audits; tax benefits
of $19 million as a result of tax law changes and tax treaty
changes; and $11 million from the reversal of a valuation
allowance on deferred tax assets associated with foreign net
operating loss carryforwards, as well as the geographical mix of
income before taxes and related effective tax rates in those
jurisdictions. These benefits were partially offset by losses in
certain jurisdictions where we are not providing tax benefits and
continue to maintain deferred tax valuation allowances.

Our effective tax rate will change based on nonrecurring events as
well as recurring factors including the geographical mix of income
before taxes and the related effective tax rates in those
jurisdictions and 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 2009 will
approximate 28%, excluding the effect of any discrete items.

* See the “Non-GAAP Measures” section for additional information.

Equity in Net Income of Unconsolidated Affiliates

Recent Accounting Pronouncements

2008 equity in net income of unconsolidated affiliates of $113

Refer to Note 1 – Summary of Significant Accounting Policies in

million is principally related to our 25% share of Fuji Xerox (“FX”)

the Consolidated Financial Statements for a description of recent

income. The $16 million increase from 2007 is primarily due to a

accounting pronouncements including the respective dates of

$14 million reduction in our share of FX restructuring charges.

adoption and the effects on results of operations and financial

2007 equity in net income of unconsolidated affiliates reflects a

reduction from 2006 of $17 million, primarily due to $30 million

for our after-tax share of FX restructuring charges.

condition.

Capital Resources and Liquidity

Cash Flow Analysis

The following summarizes our cash flows for each of the three years ended December 31, 2008, 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 investing activities

Net cash 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 period

Change

2008

2007

2006

2008

2007

$ 939

$ 1,871

$ 1,617

$ (932)

$ 254

(441)

(311)

(57)

130

1,099

(1,612)

(619)

(300)

1,399

(143)

(1,428)

1,322

1,171

(1,469)

308

(117)

430

(300)

809

(377)

Cash and cash equivalents at end of period

$1,229

$ 1,099

$ 1,399

$ 130

$ (300)

Cash Flows from Operating Activities

Net cash provided by operating activities was $939 million for the

year ended December 31, 2008. The $932 million decrease in cash

was primarily due to the following:

• $330 million decrease in pre-tax income before litigation and

restructuring.

Net cash provided by operating activities was $1,871 million for

the year ended December 31, 2007. The $254 million increase in

cash was primarily due to the following:

• $348 million increase in pre-tax income before restructuring,

depreciation, other provisions and net gains.

• $108 million increase in other liabilities primarily reflecting the

absence of the prior year payment of $106 million related to the

• $615 million decrease due to net payments for the settlement

MPI litigation.

of the securities-related litigation.

• $90 million decrease due to higher net income tax payments,

primarily resulting from the absence of prior year tax refunds.

• $74 million decrease primarily due to lower benefit and

compensation accruals.

• $71 million decrease due to higher inventory levels as a result of

lower equipment and supplies sales in 2008.

• $57 million increase reflecting lower pension contributions to our

U.S. pension plans.

• $30 million increase as a result of lower restructuring payments

due to minimal activity in 2007.

• $114 million decrease due to year-over-year inventory growth of

$54 million primarily related to increased product launches in

2007, as well as a $60 million increase in equipment on

operating leases reflecting higher operating lease install activity.

• $136 million increase from accounts receivable due to strong

• $73 million decrease due to a lower net run-off of finance

collection effectiveness throughout 2008.

receivables.

• $107 million increase from derivatives, primarily due to the

• $49 million decrease primarily due to higher accounts receivable

termination of certain interest rate swaps in fourth quarter

reflecting increased revenue, partially offset by $110 million

2008.

year-over-year benefit from increased receivables sales.

Xerox 2008 Annual Report

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Management’s Discussion

quarter 2008 as a result of the significant and rapid weakening of

Income Taxes

the U.S. Dollar and Euro versus the Yen.

The 2006 currency losses primarily reflected the mark-to-market of

(in millions)

derivative contracts which are economically hedging anticipated

Pre-tax (loss) income

foreign currency denominated payments. The mark-to-market

Income tax (benefits) expenses

losses were primarily due to the strengthening of the Euro against

Effective tax rate

Year Ended December 31,

2008

2007

2006

$(114)

$1,438

(231)

400

$ 808

(288)

202.6%

27.8% (35.6)%

partially offset by reduced amortization from prior years due to the

full amortization of certain intangible assets from previous

and tax law changes.

acquisitions.

other currencies, in particular the Canadian Dollar, U.S. Dollar and

the Yen, as compared to the weakening Euro in 2005.

Amortization of intangible assets: 2008 amortization of

intangible assets expense of $54 million reflects amortization

expense of $33 million for intangible assets acquired as part of our

recent acquisitions.

2007 amortization of intangible assets expense of $42 million

reflects amortization expense of $16 million associated with

intangible assets acquired as part of our acquisition of GIS,

Legal matters: In 2008 legal matters consisted of the following:

• $721 million reflecting provisions for the $670 million court

approved settlement of Carlson v. Xerox Corporation (“Carlson”)

and other pending securities-related cases, net of expected

insurance recoveries. On January 14, 2009, the United States

Court for the District of Connecticut entered a Final Order and

Judgment approving the settlement in the Carlson litigation.

• $36 million for probable losses on Brazilian labor-related

contingencies. Following an assessment of the most recent trend

in the outcomes of these matters, we reassessed the probable

estimated loss and, as a result, recorded an additional reserve of

$36 million in the fourth quarter of 2008.

• $24 million associated with probable losses from various other

legal matters.

In 2006 legal matters consisted of the following:

• $68 million for probable losses on Brazilian labor-related

contingencies.

• $33 million associated with probable losses from various legal

matters partially offset by $12 million of proceeds from the

Palm litigation matter.

Refer to Note 16 – Contingencies in the Consolidated Financial

The 2008 effective tax rate of 202.6% reflected the tax benefits

from certain discrete items including the net provision for litigation

matters; the second, third and fourth quarter restructuring and

asset impairment charges; the product line equipment write-off;

and the settlement of certain previously unrecognized tax benefits.

Excluding these items, the adjusted effective tax rate was 21.5%*.

The adjusted 2008 effective tax rate was lower than the U.S.

statutory tax rate primarily reflecting the benefit to taxes from the

geographical mix of income before taxes and the related effective

tax rates in those jurisdictions, the utilization of foreign tax credits

The 2007 effective tax rate of 27.8% was lower than the U.S.

statutory rate primarily reflecting tax benefits from the

geographical mix of income before taxes and the related effective

tax rates in those jurisdictions and the utilization of foreign tax

credits as well as the resolution of other tax matters. These

benefits were partially offset by changes in tax law.

The 2006 effective tax rate of (35.6%) was lower than the U.S.

statutory rate primarily due to the tax benefits of $518 million

from the resolution of tax issues associated with the 1999-2003

IRS audits and other domestic and foreign tax audits; tax benefits

of $19 million as a result of tax law changes and tax treaty

changes; and $11 million from the reversal of a valuation

allowance on deferred tax assets associated with foreign net

operating loss carryforwards, as well as the geographical mix of

income before taxes and related effective tax rates in those

jurisdictions. These benefits were partially offset by losses in

certain jurisdictions where we are not providing tax benefits and

continue to maintain deferred tax valuation allowances.

Our effective tax rate will change based on nonrecurring events as

well as recurring factors including the geographical mix of income

before taxes and the related effective tax rates in those

jurisdictions and 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 2009 will

Statements for additional information regarding litigation against

approximate 28%, excluding the effect of any discrete items.

the Company.

* See the “Non-GAAP Measures” section for additional information.

Equity in Net Income of Unconsolidated Affiliates

Recent Accounting Pronouncements

2008 equity in net income of unconsolidated affiliates of $113
million is principally related to our 25% share of Fuji Xerox (“FX”)
income. The $16 million increase from 2007 is primarily due to a
$14 million reduction in our share of FX restructuring charges.

2007 equity in net income of unconsolidated affiliates reflects a
reduction from 2006 of $17 million, primarily due to $30 million
for our after-tax share of FX restructuring charges.

Refer to Note 1 – Summary of Significant Accounting Policies in
the Consolidated Financial Statements for a description of recent
accounting pronouncements including the respective dates of
adoption and the 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, 2008, 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 investing activities
Net cash 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 period

Change

2008

2007

2006

2008

2007

$ 939
(441)
(311)
(57)

130
1,099

$ 1,871
(1,612)
(619)
60

(300)
1,399

$ 1,617
(143)
(1,428)
31

77
1,322

$ (932)
1,171
308
(117)

430
(300)

$ 254
(1,469)
809
29

(377)
77

Cash and cash equivalents at end of period

$1,229

$ 1,099

$ 1,399

$ 130

$ (300)

Cash Flows from Operating Activities

Net cash provided by operating activities was $939 million for the
year ended December 31, 2008. The $932 million decrease in cash
was primarily due to the following:

• $330 million decrease in pre-tax income before litigation and

restructuring.

• $615 million decrease due to net payments for the settlement

of the securities-related litigation.

• $90 million decrease due to higher net income tax payments,
primarily resulting from the absence of prior year tax refunds.

• $74 million decrease primarily due to lower benefit and

compensation accruals.

• $71 million decrease due to higher inventory levels as a result of

lower equipment and supplies sales in 2008.

Net cash provided by operating activities was $1,871 million for
the year ended December 31, 2007. The $254 million increase in
cash was primarily due to the following:

• $348 million increase in pre-tax income before restructuring,

depreciation, other provisions and net gains.

• $108 million increase in other liabilities primarily reflecting the

absence of the prior year payment of $106 million related to the
MPI litigation.

• $57 million increase reflecting lower pension contributions to our

U.S. pension plans.

• $30 million increase as a result of lower restructuring payments

due to minimal activity in 2007.

• $114 million decrease due to year-over-year inventory growth of
$54 million primarily related to increased product launches in
2007, as well as a $60 million increase in equipment on
operating leases reflecting higher operating lease install activity.

• $136 million increase from accounts receivable due to strong

• $73 million decrease due to a lower net run-off of finance

collection effectiveness throughout 2008.

receivables.

• $107 million increase from derivatives, primarily due to the
termination of certain interest rate swaps in fourth quarter
2008.

• $49 million decrease primarily due to higher accounts receivable
reflecting increased revenue, partially offset by $110 million
year-over-year benefit from increased receivables sales.

Xerox 2008 Annual Report

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Management’s Discussion

• $45 million decrease due to lower benefit accruals, partially
offset by higher accounts payable due to the timing of
payments to vendors and suppliers.

Cash Flows from Investing Activities

programs with GE in the United Kingdom and Canada of $634
million and Merrill Lynch in France for $469 million as well as the
repayment of secured borrowings to DLL of $153 million. The
remainder reflects lower payments associated with our GE U.S.
secured borrowings.

Net cash used in investing activities was $441 million for the year
ended December 31, 2008. The $1,171 million increase in cash was
primarily due to the following:

• $1,460 million increase due to less cash used for acquisitions.

2008 acquisitions included $138 million for Veenman B.V. and
Saxon Business Systems as compared to $1,568 million for GIS
and its additional acquisitions in the prior year.

• $192 million decrease due to lower funds from escrow and other
restricted investments in 2008. The prior year reflected funds
received from the run-off of our secured borrowing programs.

• $888 million decrease from lower net cash proceeds from

unsecured debt. 2008 reflects the issuance of $1.4 billion in
Senior Notes, $250 million from a private placement borrowing
and net payments of $354 million on the Credit Facility and
$370 million on other debt. 2007 reflects the issuance of $1.1
billion Senior Notes, $400 million from private placement
borrowings and net proceeds of $600 million on the Credit
Facility, offset by net payments of $286 million on other debt.

• $180 million decrease due to additional purchases under our

share repurchase program.

• $134 million decrease in other investing cash flows due to the

• $154 million decrease due to common stock dividend payments.

absence of proceeds from liquidations of short-term
investments.

Net cash used in investing activities was $1,612 million for the year
ended December 31, 2007. The $1,469 million decrease in cash
was primarily due to the following:

• $1,386 million decrease due to $1,615 million in 2007

acquisitions primarily comprised of $1,568 for GIS and its
additional acquisitions and $30 million for Advectis, Inc., as
compared to $229 million in acquisitions in 2006 comprised of
Amici, LLC and XMPie, Inc.

• $123 million decrease in other investing cash flows reflecting the
absence of the 2006 $122 million distribution related to the sale
of investments held by Ridge Re.

• $65 million decrease due to higher capital and internal use

software investments in 2007.

• $57 million decrease due to higher 2006 proceeds from sales of
land, buildings and equipment, which included the sale of our
corporate headquarters and a parcel of vacant land.

• $162 million increase due to a reduction in escrow and other
restricted investments in 2007, as we continue to run-off our
secured borrowing programs.

• $79 million decrease due to lower proceeds from the issuance of
common stock, reflecting a decrease in stock option exercises as
well as lower related tax benefits.

• $33 million decrease due to share repurchases related to

employee withholding taxes on stock-based compensation
vesting.

Net cash used in financing activities was $619 million in year
ended December 31, 2007. The $809 million increase in cash was
primarily due to the following:

• $538 million increase due to higher net cash proceeds from

unsecured debt. This reflects the May 2007 issuance of the $1.1
billion Senior Notes, the issuances of two zero coupon bonds in
2007 resulting in net proceeds of approximately $400 million,
and the net drawdown of $600 million under the 2007 Credit
Facility. These higher net proceeds were partially offset by the
March 2006 issuance of the $700 million Senior Notes and the
August 2006 issuance of an additional $650 million of Senior
Notes, as well as, higher repayments on other unsecured debt in
2007 as compared to 2006.

• $437 million increase due to lower purchases under our share
repurchase program as cash was invested in acquisitions.

Cash Flows from Financing Activities

Net cash used in financing activities was $311 million for the year
ended December 31, 2008. The $308 million increase in cash was
primarily due to the following:

• $1,642 million increase from lower net repayments on secured

debt. 2007 reflects termination of our secured financing

• $100 million increase relating to the 2006 payment of our

liability to Xerox Capital LLC in connection with their redemption
of Canadian deferred preferred shares.

• $278 million decrease due to higher net repayments of secured
financing. Refer to Note 4-Receivables, net in the consolidated
financial statements for further information.

Financing Activities

Customer Financing Activities

We provide equipment financing to the majority of our customers.

Because finance leases allow our customers to pay for equipment

(in millions)

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. We currently fund our customer financing activity

through cash generated from operations, cash on hand,

borrowings under bank credit facilities and proceeds from capital

markets offerings. We also have funding available through a

secured borrowing arrangement with General Electric Capital

Corporation (“GECC”) referred to as the Loan Agreement.

We have arrangements in certain international countries and

domestically through the acquisition of GIS, where third party

financial institutions originate lease contracts directly with our

customers. In these arrangements, we sell and transfer title of the

equipment to these financial institutions. Generally, we have no

continuing ownership rights in the equipment subsequent to its

sale; therefore, the related receivable and debt are not included in

our Consolidated Financial Statements.

The following represents total finance assets associated with our

lease or finance operations as of December 31, 2008 and 2007:

At December 31, 2008, less than 1% of total debt was secured by

finance receivables and other assets compared to 4% at

December 31, 2007.

Principal Debt Balance

Less: Net unamortized discount

Add: FAS 133 fair value adjustments

Total Reported Debt

Less: Current maturities and short-term debt

Total long-term debt

2008

2007

$ 8,201

$7,465

(6)

189

(13)

8,384

(1,610)

7,464

(525)

$ 6,774

$6,939

Principal debt balance at December 31, 2008 and 2007 includes

short-term debt of $61 million and $99 million, respectively. Refer

to Note 11 – Debt in the Consolidated Financial Statements for

additional information regarding the above balances.

Liquidity, Financial Flexibility and Other Financing

Activity

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

2007

we are a party and (3) the policies and cooperation of the financial

institutions we utilize to maintain and provide cash management

(in millions)

Total Finance receivables, net(1)

Equipment on operating leases, net

Total finance assets, net

2008

$7,278

594

$7,872

$ 8,048

587

$8,635

services.

The reduction of $763 million in Total finance assets, net includes

unfavorable currency of $473 million.

(1)

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, 2008 and 2007.

The following tables summarize our debt as of December 31, 2008

Debt secured by finance receivables

and 2007:

(in millions)

Capital leases

Total Secured Debt

Senior Notes

Credit Facility

Other Debt

Total Unsecured Debt

Total Debt

2008

7,574

246

499

8,319

2007

$ 275

294

5,781

600

789

7,170

$8,384

$7,464

almost three years.

Our liquidity is a function of our ability to successfully generate

cash flows from a combination of efficient operations and

improvement therein, access to capital markets, securitizations,

funding from third parties and borrowings secured by our finance

receivables portfolios. Our ability to maintain positive liquidity

going forward depends on our ability to continue to generate cash

from operations and access to financial markets, both of which are

subject to general economic, financial, competitive, legislative,

regulatory and other market factors that are beyond our control.

The following is a discussion of our liquidity position as of

December 31, 2008:

• As of December 31, 2008, total cash and cash equivalents was

$1.2 billion and our borrowing capacity under our Credit Facility

was $1.7 billion, reflecting $246 million outstanding borrowings

and no outstanding letters of credit. In addition we currently

have approximately $1.0 billion available under the Loan

Agreement through 2010, which has not been accessed in

• We have consistently delivered strong cash flow from operations

over the past three years driven by the strength of our annuity

based revenue model. Cash flows from operations were $939

Xerox 2008 Annual Report

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Management’s Discussion

• $45 million decrease due to lower benefit accruals, partially

programs with GE in the United Kingdom and Canada of $634

offset by higher accounts payable due to the timing of

million and Merrill Lynch in France for $469 million as well as the

payments to vendors and suppliers.

repayment of secured borrowings to DLL of $153 million. The

remainder reflects lower payments associated with our GE U.S.

Cash Flows from Investing Activities

secured borrowings.

Net cash used in investing activities was $441 million for the year

ended December 31, 2008. The $1,171 million increase in cash was

primarily due to the following:

• $1,460 million increase due to less cash used for acquisitions.

2008 acquisitions included $138 million for Veenman B.V. and

Saxon Business Systems as compared to $1,568 million for GIS

and its additional acquisitions in the prior year.

• $192 million decrease due to lower funds from escrow and other

restricted investments in 2008. The prior year reflected funds

received from the run-off of our secured borrowing programs.

• $888 million decrease from lower net cash proceeds from

unsecured debt. 2008 reflects the issuance of $1.4 billion in

Senior Notes, $250 million from a private placement borrowing

and net payments of $354 million on the Credit Facility and

$370 million on other debt. 2007 reflects the issuance of $1.1

billion Senior Notes, $400 million from private placement

borrowings and net proceeds of $600 million on the Credit

Facility, offset by net payments of $286 million on other debt.

• $180 million decrease due to additional purchases under our

share repurchase program.

• $134 million decrease in other investing cash flows due to the

• $154 million decrease due to common stock dividend payments.

absence of proceeds from liquidations of short-term

investments.

Net cash used in investing activities was $1,612 million for the year

ended December 31, 2007. The $1,469 million decrease in cash

was primarily due to the following:

• $1,386 million decrease due to $1,615 million in 2007

acquisitions primarily comprised of $1,568 for GIS and its

additional acquisitions and $30 million for Advectis, Inc., as

compared to $229 million in acquisitions in 2006 comprised of

Amici, LLC and XMPie, Inc.

• $123 million decrease in other investing cash flows reflecting the

absence of the 2006 $122 million distribution related to the sale

of investments held by Ridge Re.

• $65 million decrease due to higher capital and internal use

software investments in 2007.

• $57 million decrease due to higher 2006 proceeds from sales of

land, buildings and equipment, which included the sale of our

corporate headquarters and a parcel of vacant land.

• $162 million increase due to a reduction in escrow and other

restricted investments in 2007, as we continue to run-off our

secured borrowing programs.

Cash Flows from Financing Activities

Net cash used in financing activities was $311 million for the year

ended December 31, 2008. The $308 million increase in cash was

primarily due to the following:

• $79 million decrease due to lower proceeds from the issuance of

common stock, reflecting a decrease in stock option exercises as

well as lower related tax benefits.

• $33 million decrease due to share repurchases related to

employee withholding taxes on stock-based compensation

vesting.

Net cash used in financing activities was $619 million in year

ended December 31, 2007. The $809 million increase in cash was

primarily due to the following:

• $538 million increase due to higher net cash proceeds from

unsecured debt. This reflects the May 2007 issuance of the $1.1

billion Senior Notes, the issuances of two zero coupon bonds in

2007 resulting in net proceeds of approximately $400 million,

and the net drawdown of $600 million under the 2007 Credit

Facility. These higher net proceeds were partially offset by the

March 2006 issuance of the $700 million Senior Notes and the

August 2006 issuance of an additional $650 million of Senior

Notes, as well as, higher repayments on other unsecured debt in

2007 as compared to 2006.

• $437 million increase due to lower purchases under our share

repurchase program as cash was invested in acquisitions.

• $100 million increase relating to the 2006 payment of our

liability to Xerox Capital LLC in connection with their redemption

of Canadian deferred preferred shares.

• $278 million decrease due to higher net repayments of secured

• $1,642 million increase from lower net repayments on secured

financing. Refer to Note 4-Receivables, net in the consolidated

debt. 2007 reflects termination of our secured financing

financial statements for further information.

Financing Activities

Customer Financing Activities
We provide equipment financing to the majority of our customers.
Because 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. We currently fund our customer financing activity
through cash generated from operations, cash on hand,
borrowings under bank credit facilities and proceeds from capital
markets offerings. We also have funding available through a
secured borrowing arrangement with General Electric Capital
Corporation (“GECC”) referred to as the Loan Agreement.

We have arrangements in certain international countries and
domestically through the acquisition of GIS, where third party
financial institutions originate lease contracts directly with our
customers. In these arrangements, we sell and transfer title of the
equipment to these financial institutions. Generally, we have no
continuing ownership rights in the equipment subsequent to its
sale; therefore, the related receivable and debt are not included in
our Consolidated Financial Statements.

The following represents total finance assets associated with our
lease or finance operations as of December 31, 2008 and 2007:

(in millions)

Total Finance receivables, net(1)
Equipment on operating leases, net

Total finance assets, net

2008

$7,278
594

$7,872

2007

$ 8,048
587

$8,635

The reduction of $763 million in Total finance assets, net includes
unfavorable currency of $473 million.

(1)

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, 2008 and 2007.

The following tables summarize our debt as of December 31, 2008
and 2007:

(in millions)

Debt secured by finance receivables
Capital leases

Total Secured Debt

Senior Notes
Credit Facility
Other Debt

Total Unsecured Debt

Total Debt

2008

56
9

7,574
246
499

8,319

2007

$ 275
19

294

5,781
600
789

7,170

$8,384

$7,464

At December 31, 2008, less than 1% of total debt was secured by
finance receivables and other assets compared to 4% at
December 31, 2007.

(in millions)

Principal Debt Balance
Less: Net unamortized discount
Add: FAS 133 fair value adjustments

2008

2007

$ 8,201
(6)
189

$7,465
(13)
12

Total Reported Debt
Less: Current maturities and short-term debt

8,384
(1,610)

7,464
(525)

Total long-term debt

$ 6,774

$6,939

Principal debt balance at December 31, 2008 and 2007 includes
short-term debt of $61 million and $99 million, respectively. Refer
to Note 11 – Debt in the Consolidated Financial Statements for
additional information regarding the above balances.

Liquidity, Financial Flexibility and Other Financing
Activity

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.

Our liquidity is a function of our ability to successfully generate
cash flows from a combination of efficient operations and
improvement therein, access to capital markets, securitizations,
funding from third parties and borrowings secured by our finance
receivables portfolios. Our ability to maintain positive liquidity
going forward depends on our ability to continue to generate cash
from operations and access to financial markets, both of which are
subject to general economic, financial, competitive, legislative,
regulatory and other market factors that are beyond our control.

The following is a discussion of our liquidity position as of
December 31, 2008:

• As of December 31, 2008, total cash and cash equivalents was
$1.2 billion and our borrowing capacity under our Credit Facility
was $1.7 billion, reflecting $246 million outstanding borrowings
and no outstanding letters of credit. In addition we currently
have approximately $1.0 billion available under the Loan
Agreement through 2010, which has not been accessed in
almost three years.

• We have consistently delivered strong cash flow from operations
over the past three years driven by the strength of our annuity
based revenue model. Cash flows from operations were $939

Xerox 2008 Annual Report

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Management’s Discussion

million, $1,871 million and $1,617 million for the years ended
December 31, 2008, 2007 and 2006, respectively. Cash flows
from operations in 2008 included $615 million in net payments
for our securities litigation.

• Our debt maturities are in line with historical and projected cash

flows and are spread over the next ten years as follows (in
millions):

Year

2009
2010
2011
2012
2013
2014
2015
2016
2017
2018 and thereafter

Total

Amount

$1,610
962
802
1,169
1,138
69
—
950
501
1,000

$8,201

On January 15, 2009, we repaid in-full at maturity, our outstanding
U.S. Dollar and Euro-denominated 9.75% Senior Notes. The total
repayment of approximately $900 million was made using cash on
hand and the proceeds of a $400 million borrowing under our
Credit Facility.

Debt Activity

Credit facility: In February 2008, we exercised our right under our
$2.0 billion Credit Facility to request a one-year extension of the
maturity date. Lenders representing approximately $1.4 billion (or
approximately 70%) of the commitments under the Credit Facility
agreed to the extension and the portion represented by these
Lenders now has a maturity date of April 30, 2013, with the
remaining portion of the Credit Facility to mature on April 30, 2012.

In October 2008, we amended our Credit Facility to increase the
permitted leverage ratio (debt/consolidated EBITDA) to a fixed
ratio of 3.75x. The amendment also included a re-pricing of the
Credit Facility such that borrowings will bear interest at LIBOR plus
an all-in spread that will vary between 1.25% and 4.00% subject
to our credit rating and percent of Credit Facility utilization at the
time of borrowing. Based upon our current rating and utilization,
the all-in spread is 1.75%.

Capital markets offerings and other: In 2008, we raised net
proceeds of $1.4 billion through the issuance of Senior Notes and
$250 million from a private placement transaction.

Loan covenants and compliance: At December 31, 2008, we
were in full compliance with the covenants and other provisions of
the Credit Facility, our Senior Notes and the Loan Agreement. We

have the right to prepay any outstanding loans or to terminate the
Credit Facility without penalty. Failure to be in compliance with any
material provision or covenant of these agreements could have a
material adverse effect on our liquidity and operations and our
ability to continue to fund our customers’ purchase of Xerox
equipment.

Refer to Note 11 – Debt and Note 4 – Receivables, Net in the
Consolidated Financial Statements for additional information
regarding the above noted transactions and Loan Agreement,
respectively.

Share Repurchase Programs
The Board of Directors has authorized share repurchase programs
totaling $4.5 billion through December 31, 2008, which included
additional authorizations of $1.0 billion in both January and July of
2008. Since launching this program in October 2005, we have
repurchased 194.1 million shares, totaling approximately $2.9
billion. Refer to Note 17 – Shareholders’ Equity – “Treasury Stock”
in the Consolidated Financial Statements for further information
regarding our share repurchase programs.

Although we have $1.6 billion of remaining authorization, at the
current time, we have no immediate plans for further share
repurchases.

Dividends
The Board of Directors declared a 4.25 cent per share dividend on
common stock in each quarter of 2008.

Financial Instruments
Refer to Note 13 – Financial Instruments in the Consolidated
Financial Statements for additional information regarding our
derivative financial instruments.

Credit Ratings

Moody’s

Fitch

Standard & Poors (“S&P”)

We are currently rated investment grade by all major rating agencies. As of January 31, 2009 the ratings were as follows:

Senior Unsecured Debt

Baa2

BBB

Outlook

Positive

Stable

Contractual Cash Obligations and Other Commercial Commitments and Contingencies

At December 31, 2008, 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)

Liability to subsidiary trust issuing preferred securities(3)

Retiree Health Payments

Purchase Commitments

Flextronics(4)

EDS Contracts(5)

Other(6)

2009

2010

2011

2012

2013

Thereafter

$ 1,610

$ 962

$ 802

$ 1,169

$ 1,138

$ 2,520

223

188

151

100

—————

————

137

—

105

700

239

—

123

648

445

—

Total contractual cash obligations

$2,894

$1,398

$1,140

$1,444

$1,396

$3,752

(1) Refer to Note 11– Debt in our Consolidated Financial Statements for additional information and interest payments related to long-term debt (amounts above include principal portion only).

(2) Refer to Note 6 – Land, Buildings and Equipment, Net in our Consolidated Financial Statements for additional information related to minimum operating lease commitments.

(3) Refer to Note 12 – Liability to Subsidiary Trust Issuing Preferred Securities in our Consolidated Financial Statements for additional information and interest payments (amounts above include

principal portion only).

(4) Flextronics: We outsource certain manufacturing activities to Flextronics and are currently in the second year of the Master Supply Agreement. The term of this agreement is three years, with

two additional one year extension periods at our option. The amounts discussed in the table reflect our estimate of purchases over the next year and are not contractual commitments.

(5) EDS Contract: We have an information management contract with Electronic Data Systems Corp. (“EDS”) through June 30, 2009. Services to be provided under this contract include support for

global mainframe system processing, application maintenance, workplace and service desk, voice and data network management and server management. In 2008, the contracts for global

mainframe system processing and workplace and service desk were extended through December 2013 and March 2014, respectively. In January 2009, the contract for voice and data network

management services was revised and extended through March 2014. There are no minimum payments required under this contract. The amounts disclosed in the table reflect our estimate of

probable minimum payments for the periods shown. We can terminate the 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.

Xerox 2008 Annual Report

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Management’s Discussion

million, $1,871 million and $1,617 million for the years ended

have the right to prepay any outstanding loans or to terminate the

December 31, 2008, 2007 and 2006, respectively. Cash flows

Credit Facility without penalty. Failure to be in compliance with any

from operations in 2008 included $615 million in net payments

material provision or covenant of these agreements could have a

for our securities litigation.

• Our debt maturities are in line with historical and projected cash

flows and are spread over the next ten years as follows (in

equipment.

millions):

material adverse effect on our liquidity and operations and our

ability to continue to fund our customers’ purchase of Xerox

Amount

$1,610

962

802

1,169

1,138

—

950

501

1,000

$8,201

Refer to Note 11 – Debt and Note 4 – Receivables, Net in the

Consolidated Financial Statements for additional information

regarding the above noted transactions and Loan Agreement,

respectively.

Share Repurchase Programs

The Board of Directors has authorized share repurchase programs

totaling $4.5 billion through December 31, 2008, which included

additional authorizations of $1.0 billion in both January and July of

2008. Since launching this program in October 2005, we have

repurchased 194.1 million shares, totaling approximately $2.9

billion. Refer to Note 17 – Shareholders’ Equity – “Treasury Stock”

in the Consolidated Financial Statements for further information

regarding our share repurchase programs.

Although we have $1.6 billion of remaining authorization, at the

current time, we have no immediate plans for further share

repurchases.

Dividends

The Board of Directors declared a 4.25 cent per share dividend on

common stock in each quarter of 2008.

Financial Instruments

Refer to Note 13 – Financial Instruments in the Consolidated

Financial Statements for additional information regarding our

derivative financial instruments.

Year

2009

2010

2011

2012

2013

2014

2015

2016

2017

Total

2018 and thereafter

Credit Facility.

Debt Activity

On January 15, 2009, we repaid in-full at maturity, our outstanding

U.S. Dollar and Euro-denominated 9.75% Senior Notes. The total

repayment of approximately $900 million was made using cash on

hand and the proceeds of a $400 million borrowing under our

Credit facility: In February 2008, we exercised our right under our

$2.0 billion Credit Facility to request a one-year extension of the

maturity date. Lenders representing approximately $1.4 billion (or

approximately 70%) of the commitments under the Credit Facility

agreed to the extension and the portion represented by these

Lenders now has a maturity date of April 30, 2013, with the

remaining portion of the Credit Facility to mature on April 30, 2012.

In October 2008, we amended our Credit Facility to increase the

permitted leverage ratio (debt/consolidated EBITDA) to a fixed

ratio of 3.75x. The amendment also included a re-pricing of the

Credit Facility such that borrowings will bear interest at LIBOR plus

an all-in spread that will vary between 1.25% and 4.00% subject

to our credit rating and percent of Credit Facility utilization at the

time of borrowing. Based upon our current rating and utilization,

the all-in spread is 1.75%.

Capital markets offerings and other: In 2008, we raised net

proceeds of $1.4 billion through the issuance of Senior Notes and

$250 million from a private placement transaction.

Loan covenants and compliance: At December 31, 2008, we

were in full compliance with the covenants and other provisions of

the Credit Facility, our Senior Notes and the Loan Agreement. We

Credit Ratings
We are currently rated investment grade by all major rating agencies. As of January 31, 2009 the ratings were as follows:

Moody’s
Standard & Poors (“S&P”)
Fitch

Senior Unsecured Debt

Baa2
BBB
BBB

Outlook

Positive
Stable
Stable

Contractual Cash Obligations and Other Commercial Commitments and Contingencies

At December 31, 2008, we had the following contractual cash obligations and other commercial commitments and contingencies:

(in millions)

2009

2010

2011

2012

2013

Thereafter

Long-term debt, including capital lease obligations(1)
Minimum operating lease commitments(2)
Liability to subsidiary trust issuing preferred securities(3)
Retiree Health Payments
Purchase Commitments
Flextronics(4)
EDS Contracts(5)
Other(6)

$ 1,610
223

$ 962
188
—————
99

105

$ 802
151

$ 1,169
100

$ 1,138
84

700
239
17

————

137
12

77
11

77
—

$ 2,520
123
648
445

—
16
—

Total contractual cash obligations

$2,894

$1,398

$1,140

$1,444

$1,396

$3,752

(1) Refer to Note 11– Debt in our Consolidated Financial Statements for additional information and interest payments related to long-term debt (amounts above include principal portion only).
(2) Refer to Note 6 – Land, Buildings and Equipment, Net in our Consolidated Financial Statements for additional information related to minimum operating lease commitments.
(3) Refer to Note 12 – Liability to Subsidiary Trust Issuing Preferred Securities in our Consolidated Financial Statements for additional information and interest payments (amounts above include

principal portion only).

(4) Flextronics: We outsource certain manufacturing activities to Flextronics and are currently in the second year of the Master Supply Agreement. The term of this agreement is three years, with
two additional one year extension periods at our option. The amounts discussed in the table reflect our estimate of purchases over the next year and are not contractual commitments.

(5) EDS Contract: We have an information management contract with Electronic Data Systems Corp. (“EDS”) through June 30, 2009. Services to be provided under this contract include support for
global mainframe system processing, application maintenance, workplace and service desk, voice and data network management and server management. In 2008, the contracts for global
mainframe system processing and workplace and service desk were extended through December 2013 and March 2014, respectively. In January 2009, the contract for voice and data network
management services was revised and extended through March 2014. There are no minimum payments required under this contract. The amounts disclosed in the table reflect our estimate of
probable minimum payments for the periods shown. We can terminate the 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.

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Management’s Discussion

Pension and Other Post-Retirement Benefit Plans
We sponsor pension and other post-retirement benefit plans that
may require periodic cash contributions. Our 2008 cash fundings
for these plans were $299 million for pensions and $105 million for
our retiree health plans. Our required cash fundings for 2009 are
approximately $108 million for pensions and approximately $105
million for our retiree health 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 2009 pension contributions do not include
contributions to the domestic tax-qualified plans because none are
required due to the availability of a credit balance which resulted
from funding prior to 2008 in excess of minimum requirements.
This credit balance can be utilized in lieu of any 2009 pension
contributions. However, once the January 1, 2009 actuarial
valuations and projected results as of the end of the 2009
measurement year are available, the desirability 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 $165 million and $158
million in 2008 and 2007, respectively, to our domestic tax
qualified plans in order to make them 100% funded on a current
liability basis under the ERISA funding rules.

Our retiree health 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.
The amounts reported in the above table as retiree health
payments represent our estimated future benefit payments.

Fuji Xerox
We purchased products, including parts and supplies, from Fuji
Xerox totaling $2.1 billion, $1.9 billion and $1.7 billion in 2008,
2007 and 2006, respectively. Our purchase commitments with Fuji
Xerox are in the normal course of business and typically have a
lead time of three months. We do not anticipate 2009 purchases
from Fuji Xerox to exceed 2008 levels. Related party transactions
with Fuji Xerox are discussed in Note 7 – Investments in Affiliates,
at Equity in the Consolidated Financial Statements.

Brazil Tax and Labor Contingencies
As of December 31, 2008, our Brazilian operations are involved in
various litigation matters and have been the subject of numerous
governmental assessments related to indirect and other taxes as
well as disputes associated with former employees and contract
labor. 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 matters and
intend to vigorously defend our position. Based on the opinion of
legal counsel and current reserves for those matters deemed
probable of loss, we do not believe that the ultimate resolution of
these matters will materially impact our results of operations,
financial position or cash flows. The labor matters principally relate
to claims made by former employees and contract labor for the
equivalent payment of all social security and other related labor
benefits, as well as consequential tax claims, as if they were regular
employees. Following our assessment of the most recent trends in
the outcomes of these matters, we reassessed the probable
estimated loss and, as a result, recorded an additional reserve of
$36 million in 2008. As of December 31, 2008, the total amounts
related to the unreserved portion of the tax and labor
contingencies, inclusive of any related interest, amounted to
approximately $839 million, with the decrease from the
December 31, 2007 balance of $1.1 billion primarily related to
currency partially offset by the additional reserve. In connection
with the above 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, 2008
we had $167 million of escrow cash deposits for matters we are
disputing and there are liens on certain Brazilian assets with a net
book value of $30 million and additional letters of credit of
approximately $88 million. Generally, any escrowed amounts
would be refundable and any liens would be removed to the extent
the matters are resolved in our favor. We routinely assess all 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.

Other Contingencies and Commitments
As more fully discussed in Note 16 – Contingencies in the
Consolidated Financial Statements, 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. In addition, guarantees, indemnifications and claims may arise
during the ordinary course of business from relationships with
suppliers, customers and nonconsolidated affiliates.
Nonperformance under a contract including a guarantee,
indemnification or claim could trigger an obligation of the
Company. 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. Should
developments in any of these areas 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

utilized to hedge economic exposures as well as reduce earnings

matters result in a final adverse judgment or be settled for

and cash flow volatility resulting from shifts in market rates. Refer

significant amounts, they could have a material adverse effect on

to Note 13 –Financial Instruments in the Consolidated Financial

our results of operations, cash flows and financial position in the

Statements for further discussion on our financial risk

period or periods in which such change in determination, judgment

management.

or settlement occurs.

Assuming a 10% appreciation or depreciation in foreign currency

exchange rates from the quoted foreign currency exchange rates

at December 31, 2008, 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,

2008. A 10% appreciation or depreciation of the U.S. Dollar

against all currencies from the quoted foreign currency exchange

rates at December 31, 2008 would have an $824 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 $8.2 billion at December 31, 2008.

Interest Rate Risk Management

The consolidated weighted-average interest rates related to our

debt and liabilities to subsidiary trust issuing preferred securities for

2008, 2007 and 2006 approximated 6.6%, 7.1%, and 6.8%,

respectively. Interest expense includes the impact of our interest

rate derivatives.

As of December 31, 2008, approximately $1.1 billion of our debt

and liability to subsidiary trust issuing preferred securities 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 high coupon debt.

The fair market values of our fixed-rate financial instruments are

sensitive to changes in interest rates. At December 31, 2008, a

10% change in market interest rates would change the fair values

of such financial instruments by approximately $317 million. The

recent market events have not required us to materially modify or

change our financial risk management strategies with respect to

our exposures to interest rate and foreign currency risk.

Unrecognized Tax Benefits

As of December 31, 2008, we had $170 million of unrecognized

tax benefits. This represents the tax benefits associated with

various tax positions taken, or expected to be taken, on domestic

and international tax returns that have not been recognized in our

financial statements due to uncertainty regarding their resolution.

The resolution or settlement of these tax positions with the taxing

authorities is at various stages and therefore we are unable to

make a reliable estimate of the eventual cash flows by period that

may be required to settle these matters. In addition, certain of

these matters may not require cash settlement due to the

existence of credit and net operating loss carryforwards as well as

other offsets, including the indirect benefit from other taxing

jurisdictions that may be available.

Off-Balance Sheet Arrangements

Although we rarely 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 – Land, Buildings and Equipment, Net in the Consolidated

consolidated in our financial statements. These transactions, which

are discussed further in Note 4 – Receivables, Net in 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 in the Consolidated Financial

Statements 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

Financial Statements. Additionally, we have utilized special purpose

Virtually all customer-financing assets earn fixed rates of interest.

entities (“SPEs”) in conjunction with certain financing transactions.

The interest rates on a significant portion of the Company’s term

The SPEs utilized in conjunction with these transactions are

debt are fixed.

Xerox 2008 Annual Report

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Management’s Discussion

Pension and Other Post-Retirement Benefit Plans

internal transfer of inventory, municipal service taxes on rentals

We sponsor pension and other post-retirement benefit plans that

and gross revenue taxes. We are disputing these tax matters and

may require periodic cash contributions. Our 2008 cash fundings

intend to vigorously defend our position. Based on the opinion of

for these plans were $299 million for pensions and $105 million for

legal counsel and current reserves for those matters deemed

our retiree health plans. Our required cash fundings for 2009 are

probable of loss, we do not believe that the ultimate resolution of

approximately $108 million for pensions and approximately $105

these matters will materially impact our results of operations,

million for our retiree health plans. Cash contribution requirements

financial position or cash flows. The labor matters principally relate

for our domestic tax qualified pension plans are governed by the

to claims made by former employees and contract labor for the

Employment Retirement Income Security Act (“ERISA”) and the

equivalent payment of all social security and other related labor

Internal Revenue Code. Cash contribution requirements for our

benefits, as well as consequential tax claims, as if they were regular

international plans are subject to the applicable regulations in each

employees. Following our assessment of the most recent trends in

country. The expected 2009 pension contributions do not include

the outcomes of these matters, we reassessed the probable

contributions to the domestic tax-qualified plans because none are

estimated loss and, as a result, recorded an additional reserve of

required due to the availability of a credit balance which resulted

$36 million in 2008. As of December 31, 2008, the total amounts

from funding prior to 2008 in excess of minimum requirements.

related to the unreserved portion of the tax and labor

This credit balance can be utilized in lieu of any 2009 pension

contingencies, inclusive of any related interest, amounted to

contributions. However, once the January 1, 2009 actuarial

approximately $839 million, with the decrease from the

valuations and projected results as of the end of the 2009

December 31, 2007 balance of $1.1 billion primarily related to

measurement year are available, the desirability of additional

currency partially offset by the additional reserve. In connection

contributions will be assessed. Based on these results, we may

with the above proceedings, customary local regulations may

voluntarily decide to contribute to these plans, even though no

require us to make escrow cash deposits or post other security of

contribution is required. In prior years, after making this

up to half of the total amount in dispute. As of December 31, 2008

assessment, we decided to contribute $165 million and $158

we had $167 million of escrow cash deposits for matters we are

million in 2008 and 2007, respectively, to our domestic tax

disputing and there are liens on certain Brazilian assets with a net

qualified plans in order to make them 100% funded on a current

book value of $30 million and additional letters of credit of

liability basis under the ERISA funding rules.

Our retiree health 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.

The amounts reported in the above table as retiree health

payments represent our estimated future benefit payments.

Fuji Xerox

We purchased products, including parts and supplies, from Fuji

Xerox totaling $2.1 billion, $1.9 billion and $1.7 billion in 2008,

2007 and 2006, respectively. Our purchase commitments with Fuji

Xerox are in the normal course of business and typically have a

lead time of three months. We do not anticipate 2009 purchases

from Fuji Xerox to exceed 2008 levels. Related party transactions

with Fuji Xerox are discussed in Note 7 – Investments in Affiliates,

at Equity in the Consolidated Financial Statements.

Brazil Tax and Labor Contingencies

As of December 31, 2008, our Brazilian operations are involved in

various litigation matters and have been the subject of numerous

governmental assessments related to indirect and other taxes as

well as disputes associated with former employees and contract

labor. The tax matters, which comprise a significant portion of the

total contingencies, principally relate to claims for taxes on the

approximately $88 million. Generally, any escrowed amounts

would be refundable and any liens would be removed to the extent

the matters are resolved in our favor. We routinely assess all 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.

Other Contingencies and Commitments

As more fully discussed in Note 16 – Contingencies in the

Consolidated Financial Statements, 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. In addition, guarantees, indemnifications and claims may arise

during the ordinary course of business from relationships with

suppliers, customers and nonconsolidated affiliates.

Nonperformance under a contract including a guarantee,

indemnification or claim could trigger an obligation of the

Company. 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. Should

developments in any of these areas 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.

Unrecognized Tax Benefits
As of December 31, 2008, we had $170 million of unrecognized
tax benefits. This represents the tax benefits associated with
various tax positions taken, or expected to be taken, on domestic
and international tax returns that have not been recognized in our
financial statements due to uncertainty regarding their resolution.
The resolution or settlement of these tax positions with the taxing
authorities is at various stages and therefore we are unable to
make a reliable estimate of the eventual cash flows by period that
may be required to settle these matters. In addition, certain of
these matters may not require cash settlement due to the
existence of credit and net operating loss carryforwards as well as
other offsets, including the indirect benefit from other taxing
jurisdictions that may be available.

Off-Balance Sheet Arrangements

Although we rarely 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 – Land, Buildings and Equipment, Net in the Consolidated
Financial Statements. Additionally, we have utilized special purpose
entities (“SPEs”) in conjunction with certain financing transactions.
The SPEs utilized in conjunction with these transactions are
consolidated in our financial statements. These transactions, which
are discussed further in Note 4 – Receivables, Net in 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 in the Consolidated Financial
Statements 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 in the Consolidated Financial
Statements for further discussion on our financial risk
management.

Assuming a 10% appreciation or depreciation in foreign currency
exchange rates from the quoted foreign currency exchange rates
at December 31, 2008, 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,
2008. A 10% appreciation or depreciation of the U.S. Dollar
against all currencies from the quoted foreign currency exchange
rates at December 31, 2008 would have an $824 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 $8.2 billion at December 31, 2008.

Interest Rate Risk Management

The consolidated weighted-average interest rates related to our
debt and liabilities to subsidiary trust issuing preferred securities for
2008, 2007 and 2006 approximated 6.6%, 7.1%, and 6.8%,
respectively. Interest expense includes the impact of our interest
rate derivatives.

Virtually all customer-financing assets earn fixed rates of interest.
The interest rates on a significant portion of the Company’s term
debt are fixed.

As of December 31, 2008, approximately $1.1 billion of our debt
and liability to subsidiary trust issuing preferred securities 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 high coupon debt.

The fair market values of our fixed-rate financial instruments are
sensitive to changes in interest rates. At December 31, 2008, a
10% change in market interest rates would change the fair values
of such financial instruments by approximately $317 million. The
recent market events have not required us to materially modify or
change our financial risk management strategies with respect to
our exposures to interest rate and foreign currency risk.

Xerox 2008 Annual Report

Text.indd 45

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Management’s Discussion

Xerox Corporation

Consolidated Statements of Income

(in millions, except per-share data)

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

Other expenses, net

Total Costs and Expenses

(Loss) Income before Income Taxes and Equity Income

Income tax (benefits) expenses

Equity in net income of unconsolidated affiliates

Net Income

Basic Earnings per Share

Diluted Earnings per Share

Year Ended December 31,

2008

2007

2006

$ 8,325

8,485

798

17,608

5,519

4,929

305

884

4,534

429

1,122

17,722

(114)

(231)

113

230

$ 0.26

$ 8,192

8,214

822

17,228

5,254

4,707

316

912

4,312

(6)

295

15,790

1,438

400

$ 1,135

$ 1.21

$ 1.19

$ 7,464

7,591

840

15,895

4,803

4,328

305

922

4,008

385

336

15,087

808

(288)

114

$ 1,210

$ 1.25

$ 1.22

Non-GAAP Financial Measures

Adjusted Effective Tax Rate

We have reported our financial results in accordance with generally
accepted accounting principles (“GAAP”). A reconciliation of the
following non-GAAP financial measures to the most directly
comparable financial measures calculated and presented in
accordance with GAAP are set forth below:

Adjusted Revenue

We discussed the revenue growth for the year ended December 31,
2008 using non-GAAP financial measures. To understand trends in
the business, we believe that it is helpful to adjust the revenue
growth rates to illustrate the impact of the acquisition of GIS by
including their estimated revenue for the comparable 2007 and
2006 periods. We refer to this adjusted revenue as “As Adjusted” in
the following reconciliation table. Revenue “As Adjusted” adds
GIS’s revenues from January 1, 2006 to May 8, 2007 to our 2006
and 2007 reported revenue. Management believes these measures
give investors an additional perspective on revenue trends, as well
as the impact to the Company of the acquisition of GIS that was
completed in May 2007.

(in millions)

2008

2007

2006

2008

2007

Year Ended December 31

% Change

Equipment Sales
Revenue:
As Reported
As Adjusted
Post Sale
Revenue:
As Reported
As Adjusted
Total Revenues:
As Reported
As Adjusted

$ 4,679
$ 4,679

$ 4,753
$ 4,938

$ 4,457
$ 4,992

(2)% 7%
(5)% (1)%

$12,929
$12,929

$12,475
$12,681

$11,438
$12,000

4% 9%
2% 6%

$17,608
$17,608

$17,228
$17,619

$15,895
$16,992 —

2% 8%
4%

The effective tax rate for the year ended December 31, 2008 is
discussed using non-GAAP financial measures that exclude the
effects of charges associated with an equipment write-off; second,
third and fourth quarter 2008 restructuring and asset impairments;
certain litigation matters and the settlement of certain previously
unrecognized tax benefits. Management believes that it is helpful
to exclude these effects to better understand and analyze the
current period’s effective tax rate given the discrete nature of
these items.

(in millions)

As Reported
Restructuring and asset
impairment charges

Equipment write-off
Litigation
Tax settlements

Year Ended December 31, 2008

Pre-Tax
Income

Income
Taxes

Effective
Tax Rate

$ (114)

$(231)

202.6%

426
39
774
—

134
15
283
41

As Adjusted

$1,125

$ 242

21.5%

Management believes that these non-GAAP financial measures
provide an additional means of analyzing the current period results
against the corresponding prior period results. However, these
non-GAAP financial measures should be viewed in addition to, and
not as a substitute for, the Company’s reported results prepared in
accordance with GAAP.

Forward Looking Statements

This Annual Report contains forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. The
words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,”
“should” and similar expressions, as they relate to us, are intended
to identify forward-looking statements. These statements reflect
management’s current beliefs, assumptions and expectations and
are subject to a number of factors that may cause actual results to
differ materially. Information concerning these factors is included
in our 2008 Annual Report on Form 10-K filed with the Securities
and Exchange Commission (“SEC”). We do not intend to update
these forward-looking statements, except as required by law.

Xerox 2008 Annual Report

The accompanying notes are an integral part of these Consolidated Financial Statements.

Text.indd 46

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Management’s Discussion

Xerox Corporation
Consolidated Statements of Income

(in millions, except per-share data)

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
Other expenses, net

Total Costs and Expenses

(Loss) Income before Income Taxes and Equity Income
Income tax (benefits) expenses
Equity in net income of unconsolidated affiliates

Net Income

Basic Earnings per Share
Diluted Earnings per Share

Year Ended December 31,

2008

2007

2006

$ 8,325
8,485
798

17,608

5,519
4,929
305
884
4,534
429
1,122

17,722
(114)
(231)
113

230

$ 0.26
$ 0.26

$ 8,192
8,214
822

17,228

5,254
4,707
316
912
4,312
(6)
295

15,790
1,438
400
97

$ 1,135

$ 1.21
$ 1.19

$ 7,464
7,591
840

15,895

4,803
4,328
305
922
4,008
385
336

15,087
808
(288)
114

$ 1,210

$ 1.25
$ 1.22

Non-GAAP Financial Measures

Adjusted Effective Tax Rate

We have reported our financial results in accordance with generally

The effective tax rate for the year ended December 31, 2008 is

accepted accounting principles (“GAAP”). A reconciliation of the

discussed using non-GAAP financial measures that exclude the

following non-GAAP financial measures to the most directly

effects of charges associated with an equipment write-off; second,

comparable financial measures calculated and presented in

third and fourth quarter 2008 restructuring and asset impairments;

accordance with GAAP are set forth below:

Adjusted Revenue

certain litigation matters and the settlement of certain previously

unrecognized tax benefits. Management believes that it is helpful

to exclude these effects to better understand and analyze the

current period’s effective tax rate given the discrete nature of

We discussed the revenue growth for the year ended December 31,

2008 using non-GAAP financial measures. To understand trends in

these items.

the business, we believe that it is helpful to adjust the revenue

growth rates to illustrate the impact of the acquisition of GIS by

including their estimated revenue for the comparable 2007 and

(in millions)

2006 periods. We refer to this adjusted revenue as “As Adjusted” in

As Reported

the following reconciliation table. Revenue “As Adjusted” adds

Restructuring and asset

GIS’s revenues from January 1, 2006 to May 8, 2007 to our 2006

impairment charges

and 2007 reported revenue. Management believes these measures

Equipment write-off

give investors an additional perspective on revenue trends, as well

Litigation

as the impact to the Company of the acquisition of GIS that was

Tax settlements

Year Ended December 31, 2008

Pre-Tax

Income

Taxes

Effective

Tax Rate

$ (114)

$(231)

202.6%

426

774

—

134

283

completed in May 2007.

As Adjusted

$1,125

$ 242

21.5%

(in millions)

2008

2007

2006

2008

2007

Year Ended December 31

% Change

Equipment Sales

Revenue:

As Reported

As Adjusted

Post Sale

Revenue:

As Reported

As Adjusted

Total Revenues:

As Reported

As Adjusted

$ 4,679

$ 4,753

$ 4,938

$ 4,457

$ 4,992

(2)% 7%

(5)% (1)%

$12,929

$12,475

$12,681

$11,438

$12,000

4% 9%

2% 6%

$17,608

$17,228

$17,619

$15,895

2% 8%

$16,992 —

Management believes that these non-GAAP financial measures

provide an additional means of analyzing the current period results

against the corresponding prior period results. However, these

non-GAAP financial measures should be viewed in addition to, and

not as a substitute for, the Company’s reported results prepared in

accordance with GAAP.

Forward Looking Statements

This Annual Report contains forward-looking statements as

defined in the Private Securities Litigation Reform Act of 1995. The

words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,”

“should” and similar expressions, as they relate to us, are intended

to identify forward-looking statements. These statements reflect

management’s current beliefs, assumptions and expectations and

are subject to a number of factors that may cause actual results to

differ materially. Information concerning these factors is included

in our 2008 Annual Report on Form 10-K filed with the Securities

and Exchange Commission (“SEC”). We do not intend to update

these forward-looking statements, except as required by law.

Xerox 2008 Annual Report

The accompanying notes are an integral part of these Consolidated Financial Statements.

Text.indd 47

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Xerox Corporation
Consolidated Balance Sheets

Xerox Corporation

Consolidated Statements of Cash Flows

(in millions, except share data in thousands)

Assets
Cash and cash equivalents
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 Shareholders’ Equity
Short-term debt and current portion of long-term debt
Accounts payable
Accrued compensation and benefits costs
Other current liabilities

Total current liabilities

Long-term debt
Liability to subsidiary trust issuing preferred securities
Pension and other benefit liabilities
Post-retirement medical benefits
Other long-term liabilities

Total Liabilities

Common stock, including additional paid-in-capital
Treasury stock, at cost
Retained earnings
Accumulated other comprehensive loss

Total Shareholders’ Equity

Total Liabilities and Shareholders’ Equity

Shares of common stock issued
Treasury stock

Shares of common stock outstanding

December 31,

2008

2007

$ 1,229
2,184
254
2,461
1,232
790

8,150
4,563
594
1,419
1,080
610
3,182
1,692
1,157

1,099
2,457
304
2,693
1,305
682

8,540
5,051
587
1,587
932
621
3,448
1,349
1,428

$ 22,447

$ 23,543

$ 1,610
1,446
625
1,769

5,450
6,774
648
1,747
896
694

16,209

3,313
—
5,341
(2,416)

6,238

525
1,367
673
1,512

4,077
6,939
632
1,115
1,396
796

14,955

4,096
(31)
5,288
(765)

8,588

$ 22,447

$ 23,543

864,777
—

864,777

919,013
(1,836)

917,177

(in millions)

Net income

Cash Flows from Operating Activities:

Adjustments required to reconcile net income to cash flows from operating activities:

Year Ended December 31,

2008

2007

2006

$ 230

$ 1,135

$ 1,210

Decrease (increase) in accounts receivable and billed portion of finance receivables

Undistributed equity in net income of unconsolidated affiliates

Depreciation and amortization

Provisions for receivables and inventory

Deferred tax (benefit) expense

Net gain on sales of businesses and assets

Stock-based compensation

Provision for litigation, net

Payments for securities litigation, net

Restructuring and asset impairment charges

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 other current and long-term assets

Increase in accounts payable and accrued compensation

(Decrease) increase in other current and long-term liabilities

Net change in income tax assets and liabilities

Net change in derivative assets and liabilities

Other, net

Net cash provided by operating activities

Cash Flows from Investing Activities:

Cost of additions to land, buildings and equipment

Proceeds from sales of land, buildings and equipment

Cost of additions to internal use software

Acquisitions, net of cash acquired

Net change in escrow and other restricted investments

Other, net

Net cash used in investing activities

Cash Flows from Financing Activities:

Net debt payments on secured financings

Net proceeds on other debt

Payment of liability to subsidiary trust issuing preferred securities

Common stock dividends

Preferred stock dividends

Proceeds from issuances of common stock

Excess tax benefits from stock-based compensation

Payments to acquire treasury stock, including fees

Repurchases related to stock-based compensation

Other

Net cash 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

Cash and cash equivalents at end of year

669

314

(324)

(21)

(53)

781

(615)

429

(131)

(299)

(114)

(331)

164

(8)

211

(174)

(92)

230

(69)

939

(206)

(129)

(155)

(441)

(227)

926

—

(154)

—

(812)

(33)

(19)

(311)

(57)

1,871

1,617

656

197

224

(7)

(60)

——

(6)

(235)

(298)

(79)

(43)

(331)

119

130

285

(10)

(6)

(236)

(123)

(1,615)

200

137

(1,612)

(1,869)

1,814

—

——

—

(632)

——

(19)

(619)

636

145

(44)

(70)

385

(265)

(355)

(30)

(271)

192

330

(70)

(459)

(215)

(79)

(229)

260

(143)

(1,591)

1,276

(100)

(43)

(1,069)

(8)

(1,428)

130

1,099

$1,229

(300)

1,399

$ 1,099

1,322

$ 1,399

The accompanying notes are an integral part of these Consolidated Financial Statements.

Xerox 2008 Annual Report

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Xerox Corporation

Consolidated Balance Sheets

Xerox Corporation
Consolidated Statements of Cash Flows

(in millions, except share data in thousands)

Billed portion of finance receivables, net

Assets

Cash and cash equivalents

Accounts receivable, 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 Shareholders’ Equity

Short-term debt and current portion of long-term debt

Accounts payable

Accrued compensation and benefits costs

Liability to subsidiary trust issuing preferred securities

Other current liabilities

Total current liabilities

Long-term debt

Pension and other benefit liabilities

Post-retirement medical benefits

Other long-term liabilities

Total Liabilities

Common stock, including additional paid-in-capital

Treasury stock, at cost

Retained earnings

Accumulated other comprehensive loss

Total Shareholders’ Equity

Shares of common stock issued

Treasury stock

Shares of common stock outstanding

December 31,

2008

2007

$ 1,229

$ 22,447

$ 23,543

$ 1,610

2,184

254

2,461

1,232

790

8,150

4,563

594

1,419

1,080

610

3,182

1,692

1,157

1,446

625

1,769

5,450

6,774

648

1,747

896

694

16,209

3,313

—

5,341

(2,416)

6,238

864,777

—

864,777

1,099

2,457

304

2,693

1,305

682

8,540

5,051

587

1,587

932

621

3,448

1,349

1,428

525

1,367

673

1,512

4,077

6,939

632

1,115

1,396

796

14,955

4,096

(31)

5,288

(765)

8,588

919,013

(1,836)

917,177

(in millions)

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
Stock-based compensation
Provision for litigation, net
Payments for securities litigation, net
Restructuring and asset impairment charges
Payments for restructurings
Contributions to pension benefit plans
Decrease (increase) in accounts receivable and billed portion of finance receivables
(Increase) decrease in inventories
Increase in equipment on operating leases
Decrease in finance receivables
(Increase) decrease in other current and long-term assets
Increase in accounts payable and accrued compensation
(Decrease) increase in other current and long-term liabilities
Net change in income tax assets and liabilities
Net change in derivative assets and liabilities
Other, net

Net cash provided by operating activities

Cash Flows from Investing Activities:

Cost of additions to land, buildings and equipment
Proceeds from sales of land, buildings and equipment
Cost of additions to internal use software
Acquisitions, net of cash acquired
Net change in escrow and other restricted investments
Other, net

Net cash used in investing activities

Cash Flows from Financing Activities:

Net debt payments on secured financings
Net proceeds on other debt
Payment of liability to subsidiary trust issuing preferred securities
Common stock dividends
Preferred stock dividends
Proceeds from issuances of common stock
Excess tax benefits from stock-based compensation
Payments to acquire treasury stock, including fees
Repurchases related to stock-based compensation
Other

Net cash 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
Cash and cash equivalents at end of year

Year Ended December 31,

2008

2007

2006

$ 230

$ 1,135

$ 1,210

669
314
(324)
(21)
(53)
85
781
(615)
429
(131)
(299)
57
(114)
(331)
164
(8)
211
(174)
(92)
230
(69)

939

(206)
38
(129)
(155)
8
3

(441)

(227)
926
—
(154)
—
6
2
(812)
(33)
(19)

(311)

(57)

656
197
224
(7)
(60)
89
——
——
(6)
(235)
(298)
(79)
(43)
(331)
119
130
285
38
73
(10)
(6)

636
145
99
(44)
(70)
64

385
(265)
(355)
(30)
11
(271)
192
64
330
(70)
(459)
9
36

1,871

1,617

(236)
25
(123)
(1,615)
200
137

(1,612)

(1,869)
1,814
—
——
—
65
22
(632)

——
(19)

(619)

(215)
82
(79)
(229)
38
260

(143)

(1,591)
1,276
(100)

(43)
82
25
(1,069)

(8)

(1,428)

130
1,099
$1,229

(300)
1,399
$ 1,099

77
1,322
$ 1,399

Total Liabilities and Shareholders’ Equity

$ 22,447

$ 23,543

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Xerox Corporation
Consolidated Statements of Shareholders’ Equity

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

(in millions, except share data in thousands)

Balance at December 31, 2005
Net income
Translation adjustments
Minimum pension liability
Other unrealized gains

Comprehensive income

Adjustment to initially apply FAS 158, net
Stock option and incentive plans, net
Series C mandatory convertible preferred stock

dividends ($6.25 per share)

Series C mandatory convertible preferred stock

conversion

Payments to acquire treasury stock
Cancellation of treasury stock
Other
Balance at December 31, 2006
Net income
Translation adjustments
Cumulative Effect of Change in Accounting

Principles

Changes in defined benefit plans(2)
Other unrealized losses

Comprehensive income

Cash dividends declared on common stock

($0.0425 per share)

Stock option and incentive plans, net
Payments to acquire treasury stock
Cancellation of treasury stock
Other
Balance at December 31, 2007
Net income
Translation adjustments
Cumulative Effect of Change in Accounting

Principles

Changes in defined benefit plans(2)
Other unrealized losses

Comprehensive loss

Cash dividends declared on common stock

($0.17 per share)

Stock option and incentive plans, net
Payments to acquire treasury stock
Cancellation of treasury stock
Balance at December 31, 2008

Common
Stock
Shares

945,106
—
—
—
—

—
10,256

—

74,797
—
(75,665)
74
954,568
—
—

—
—
—

—
7,588
—
(43,165)
22
919,013
—
—

—
—
—

$945
—
—
—
—

—
11

—

75
—
(75)
—
$956
—
—

—
—
—

—
7
—
(43)
—
$920
—
—

—
—
—

Common
Stock
Amount

Additional
Paid-In-
Capital

Treasury
Stock
Shares

Treasury
Stock
Amount

Retained
Earnings

$ 3,796
—
—
—
—

(13,917) $ (203) $3,021
— 1,210
—
—
—
—
—
—

—
—
—
—

AOCL(1)

Total

$(1,240) $ 6,319
1,210
485
131
1

—
485
131
1

$ 1,827

—
156

—

—
—

—

—
—

—

— (1,024)
—
—

(1,024)
167

(29)

—

(29)

814

—
— (70,111)
75,665
—

—
(1,069)
1,131
—

—
—
—
—
(8,363) $ (141) $4,202
— 1,135
—
—

—
—

(1,056)
—
$ 3,710
—
—

—
—
—

(9)
—
—

889
—
— (1,069)
—
—
—
—
$(1,647) $ 7,080
1,135
501

—
501

—
382
(1)

(9)
382
(1)

$ 2,008

—
165

—
—
— (36,638)
43,165
—
(1,836) $
—
—

(699)
—
$ 3,176
—
—

(40)
—
—
—
—
(632)
—
742
—
—
(31) $5,288
230
—
—

—
—
—
—
—

(40)
172
(632)
—
—
$ (765) $ 8,588
230
(1,364)

—
— (1,364)

—
—
—

(25)
—
—

—
(286)
(1)

(25)
(286)
(1)

$(1,446)

—
4,442
—
(58,678)
864,777

—
5
—
(59)
$866

—
—
—
55
— (56,842)
58,678
—

(784)
$ 2,447

—
—
(812)
843

(152)
—
—
—
— 5,341

—
—
—
—

(152)
60
(812)
—
$(2,416) $ 6,238

(1) Refer to Note 1 “Accumulated Other Comprehensive Loss (AOCL)” section for additional information.
(2) Refer to Note 1 “Benefit Plans Accounting” section for additional information.

The accompanying notes are an integral part of these Consolidated Financial Statements.

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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. We develop, manufacture, market,

service and finance a complete range of document equipment,

software, solutions and services.

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

(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:

Year Ended December 31,

2008

2007

2006

Restructuring provisions and asset

impairments

$429 $ (6) $385

Amortization of intangible assets ($4 for

patents included in cost of sales)

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 internal use and product

Pension benefits – net periodic benefit cost

Other post-retirement benefits – net

199

115

131

781

(6)

298

257

174

269

262

235

230

277

355

beneficiary are included in the Consolidated Statements of Income

software

from the date such determination is made.

For convenience and ease of reference, we refer to the financial

statement caption “(Loss) Income before Income Taxes and Equity

Income” as “pre-tax loss” or “pre-tax income,” throughout the notes

to the Consolidated Financial Statements.

periodic benefit cost

102

117

Deferred tax asset valuation allowance

provisions

Use of Estimates

Changes in 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;

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.

Xerox Corporation

Consolidated Statements of Shareholders’ Equity

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

(in millions, except share data in thousands)

Common

Additional

Treasury

Stock

Amount

Paid-In-

Capital

Stock

Amount

Retained

Earnings

AOCL(1)

Total

Balance at December 31, 2005

945,106

$945

$ 3,796

(13,917) $ (203) $3,021

$(1,240) $ 6,319

— 1,210

Balance at December 31, 2006

954,568

$956

$ 3,710

(8,363) $ (141) $4,202

$(1,647) $ 7,080

— (70,111)

(1,056)

75,665

(1,069)

1,131

—

— 1,135

Net income

Translation adjustments

Minimum pension liability

Other unrealized gains

Comprehensive income

Adjustment to initially apply FAS 158, net

Stock option and incentive plans, net

Series C mandatory convertible preferred stock

dividends ($6.25 per share)

Series C mandatory convertible preferred stock

conversion

Payments to acquire treasury stock

Cancellation of treasury stock

Other

10,256

74,797

(75,665)

Net income

Translation adjustments

Cumulative Effect of Change in Accounting

Principles

Changes in defined benefit plans(2)

Other unrealized losses

Comprehensive income

Cash dividends declared on common stock

($0.0425 per share)

Stock option and incentive plans, net

Payments to acquire treasury stock

Cancellation of treasury stock

Other

Net income

Translation adjustments

Cumulative Effect of Change in Accounting

Principles

Changes in defined benefit plans(2)

Other unrealized losses

Comprehensive loss

Cash dividends declared on common stock

($0.17 per share)

Stock option and incentive plans, net

Payments to acquire treasury stock

Cancellation of treasury stock

—

(75)

—

(43)

—

156

—

814

—

165

—

(632)

742

—

(29)

—

(9)

—

(40)

—

230

(25)

—

— (1,024)

(1,024)

—

485

131

1,210

485

131

$ 1,827

167

(29)

889

—

— (1,069)

—

501

—

382

(1)

1,135

501

(9)

382

(1)

$ 2,008

— (1,364)

(1,364)

—

(286)

(1)

$(1,446)

(40)

172

(632)

—

230

(25)

(286)

(1)

(152)

(812)

—

7,588

(43,165)

— (36,638)

(699)

43,165

4,442

—

(58,678)

(59)

— (56,842)

(784)

58,678

—

(812)

843

(152)

—

Balance at December 31, 2008

864,777

$866

$ 2,447

— 5,341

$(2,416) $ 6,238

(1) Refer to Note 1 “Accumulated Other Comprehensive Loss (AOCL)” section for additional information.

(2) Refer to Note 1 “Benefit Plans Accounting” section for additional information.

The accompanying notes are an integral part of these Consolidated Financial Statements.

Balance at December 31, 2007

919,013

$920

$ 3,176

(1,836) $

(31) $5,288

$ (765) $ 8,588

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. We develop, manufacture, market,
service and finance a complete range of document equipment,
software, solutions and services.

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 “(Loss) Income before Income Taxes and Equity
Income” as “pre-tax loss” or “pre-tax income,” throughout the notes
to the Consolidated Financial Statements.

(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:

Year Ended December 31,

2008

2007

2006

Restructuring provisions and asset

impairments

$429 $ (6) $385

Amortization of intangible assets ($4 for

patents included in cost of sales)

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 internal use and product

software

Pension benefits – net periodic benefit cost
Other post-retirement benefits – net

58
199
115

46
131
66

781

(6)

298
257

56
174

269
262

79
235

45
76
69

230
277

84
355

periodic benefit cost

102

117

Deferred tax asset valuation allowance

provisions

Use of Estimates

Changes in 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;

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.

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

New Accounting Standards and Accounting Changes

Derivative Instruments and Hedging Activities

In March 2008, the FASB issued SFAS No. 161 “Disclosures about
Derivative Instruments and Hedging Activities an amendment of
FASB Statement No. 133”. The new standard requires additional
disclosures regarding a company’s derivative instruments and
hedging activities by requiring disclosure of the fair values of
derivative instruments and their gains and losses in a tabular
format. It also requires disclosure of derivative features that are
credit risk – related as well as cross-referencing within the notes to
the financial statements to enable financial statement users to
locate important information about derivative instruments,
financial performance and cash flows. We adopted this standard
effective as of December 31, 2008. The only impact from this
standard was to require us to expand our disclosures regarding our
derivative instruments. Refer to Note 13 – Financial Instruments
for additional information.

Fair Value Accounting

In 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“FAS 157”). We adopted the provisions of FAS 157 on January 1,
2008. FAS 157 defines fair value, establishes a market-based
framework or hierarchy for measuring fair value and expands
disclosures about fair value measurements. FAS 157 is applicable
whenever another accounting pronouncement requires or permits
assets and liabilities to be measured at fair value. FAS 157 does not
expand or require any new fair value measures; however, the
application of this statement may change current practice. FAS
157 does not apply to fair value measurements for purposes of
lease classification or measurement under SFAS No. 13,
“Accounting for Leases”. In February 2008, the FASB decided that
an entity need not apply this standard to nonfinancial assets and
liabilities that are recognized or disclosed at fair value in the
financial statements on a nonrecurring basis until 2009.
Accordingly, our adoption of this standard in 2008 was limited to
financial assets and liabilities, which primarily affects the valuation
of our derivative contracts. The adoption of FAS 157 did not have a
material effect on our financial condition or results of operations.
We do not believe the full adoption of FAS 157 with respect to our
nonfinancial assets and liabilities will have a material effect on our
financial condition or results of operations. Nonfinancial assets and
liabilities for which we have not applied the provisions of FAS 157
primarily include those measured at fair value in impairment
testing and those initially measured at fair value in a business
combination.

In 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an
Amendment of FASB Statement No. 115” (“FAS 159”). FAS 159
became effective for us on January 1, 2008. FAS 159 permits
entities to choose to measure many financial instruments and
certain other items at fair value. Entities that elect the fair value
option will report unrealized gains and losses in earnings at each
subsequent reporting date. The fair value option may be elected
on an instrument-by-instrument basis, with few exceptions. FAS
159 also establishes presentation and disclosure requirements to
facilitate comparisons between companies that choose different
measurement attributes for similar assets and liabilities. FAS 159
did not have an effect on our financial condition or results of
operations as we did not elect this fair value option, nor is it
expected to have a material impact on future periods as the
election of this option for our financial instruments is expected to
be at most, limited.

Business Combinations and Noncontrolling Interests

In 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“FAS 141(R)”). FAS 141(R) requires the acquiring
entity in a business combination to recognize the full fair value of
assets acquired and liabilities assumed in the transaction (whether
a full or partial acquisition); establishes the acquisition-date fair
value as the measurement objective for all assets acquired and
liabilities assumed; requires expensing of most transaction and
restructuring costs; and requires the acquirer to disclose the
information needed to evaluate and understand the nature and
financial effect of the business combination. FAS 141(R) applies
prospectively to business combinations for which the acquisition
date is on or after January 1, 2009. The impact of FAS No. 141(R)
on our consolidated financial statements will depend upon the
nature, terms and size of the acquisitions we consummate after
the effective date.

In 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
in Consolidated Financial Statements – an amendment of
Accounting Research Bulletin No. 51” (“FAS 160”). FAS 160 requires
reporting entities to present noncontrolling (minority) interests as
equity (as opposed to as a liability) and provides guidance on the
accounting for transactions between an entity and noncontrolling
interests. As of December 31, 2008, we had approximately $120 in
noncontrolling interests classified in other long-term liabilities. FAS
160 applies prospectively as of January 1, 2009, except for the
presentation and disclosure requirements which will be applied
retrospectively for all periods presented.

Benefit Plans Accounting

158 for a total equity charge in 2007 related to the funded status

In 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for

Defined Benefit Pension and Other Postretirement Plans, an

amendment of FASB Statements No. 87, 88, 106 and 132(R)”

of FX’s benefit plans of $49.

Other Accounting Changes

(“FAS 158”) which requires the recognition of an asset or liability

In December 2008, the FASB issued Staff Position No. FAS 140-4

for the funded status of defined pension and other postretirement

and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about

benefit plans in the statement of financial position of the

Transfers of Financial Assets and Interests in Variable Interest

sponsoring entity. The funded status of a benefit plan is measured

Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). This FSP required

as the difference between plan assets at fair value and the benefit

additional disclosures about transfers of financial assets and about

obligation. The initial incremental recognition of the funded status

an entity’s involvement with variable interest entities. The FSP is

under FAS 158 of our defined pension and other post retirement

effective for our fiscal year ended December 31, 2008. Adoption of

benefit plans, as well as subsequent changes in our funded status

this FSP affects disclosures only and therefore has no impact on

that are not included in net periodic benefit cost will be reflected in

the Company’s financial condition, results of operations or cash

shareholders’ equity and other comprehensive loss, respectively. As

flows. Since our transfers of financial assets and involvement with

of December 31, 2006, the net unfunded status of our benefit

variable interest entities are not material, we do not expect a

plans was $2,842 and recognition of this net unfunded status upon

material disclosure requirement from this standard.

The funded status recognition and certain disclosure provisions of

a material effect on our financial condition or results of operations.

the adoption of FAS 158 resulted in an after-tax charge to equity

of $1,024. Prior to the adoption of FAS 158, we recorded an

after-tax credit to our minimum pension liability of $131, for a

total equity charge in 2006 related to the funded status of our

benefit plans of $893. Amounts recognized in accumulated other

comprehensive loss are adjusted as they are subsequently

recognized as a component of net periodic benefit cost. The

method of calculating net periodic benefit cost did not change

from existing guidance. Refer to Note 14 – Employee Benefit Plans

for additional information.

FAS 158 were effective as of our fiscal year ending December 31,

2006. FAS 158 also requires the consistent measurement of plan

assets and benefit obligations as of the date of our fiscal year-end

statement of financial position effective for the year ending

December 31, 2008. Since several of our international plans had a

September 30th measurement date, this standard required us to

change that measurement date to December 31st in 2008. The

adoption of this requirement by our international plans did not

have a material effect on our financial condition or results of

operations. The effect of adoption by our international plans

resulted in a January 1, 2008 opening retained earnings charge of

$16, deferred tax asset increase of $4, pension asset reduction of

$9, a pension liability increase of $6 and a credit to accumulated

other comprehensive loss of $5.

FAS 158 was not effective for our equity investment in Fuji Xerox

(“FX”) until their annual year-end of March 31, 2007. Upon FX’s

adoption of FAS 158, we recorded a $5 charge to equity

representing our share of their after-tax charge to equity for the

unfunded status of their benefit plans. We also recorded a $44

after-tax charge to equity for our portion of a minimum pension

liability adjustment recorded by FX prior to their adoption of FAS

In April 2008, the FASB issued Staff Position No. FAS 142-3,

“Determination of Useful Life of Intangible Assets” (“FSP FAS

142-3”). FSP FAS 142-3 amends the factors that should be

considered in developing renewal or extension assumptions used to

determine the useful life of a recognized intangible asset under FAS

142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also

requires expanded disclosures related to the determination of

intangible asset useful lives. This standard applies prospectively to

intangible assets acquired and/or recognized on or after January 1,

2009. We do not believe that the adoption of this standard will have

In 2007, the FASB’s Emerging Issues Task Force issued EITF Issue

No. 06-10, “Accounting for Deferred Compensation and

Postretirement Benefit Aspects of Collateral Assignment Split-

Dollar Life Insurance Arrangements” (“EITF 06-10”). EITF 06-10

provides that an employer should recognize a liability for the

postretirement benefit related to collateral assignment split-dollar

life insurance arrangements in accordance with either SFAS

No. 106, “Employers’ Accounting for Postretirement Benefits Other

Than Pensions,” or Accounting Principles Board Opinion No. 12,

“Omnibus Opinion.” We recorded a $11 after-tax charge to

retained earnings in 2008 reflecting the cumulative effect upon

adoption of EITF 06-10. The standard is not expected to have a

material impact on results of operations in the future.

In 2006, the FASB ratified the consensus reached on EITF Issue

No. 06-2, “Accounting for Sabbatical Leave and Other Similar

Benefits Pursuant to FASB Statement No. 43” (“EITF 06-2”). EITF

06-2 clarifies recognition guidance on the accrual of employees’

rights to compensated absences under a sabbatical or other similar

benefit arrangement. We recorded a $7 after-tax charge to

Retained earnings in 2007 reflecting our share of the cumulative

effect recorded by Fuji Xerox upon adoption of EITF 06-2. This was

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

New Accounting Standards and Accounting Changes

In 2007, the FASB issued SFAS No. 159, “The Fair Value Option for

Benefit Plans Accounting

Derivative Instruments and Hedging Activities

In March 2008, the FASB issued SFAS No. 161 “Disclosures about

Derivative Instruments and Hedging Activities an amendment of

FASB Statement No. 133”. The new standard requires additional

disclosures regarding a company’s derivative instruments and

hedging activities by requiring disclosure of the fair values of

derivative instruments and their gains and losses in a tabular

format. It also requires disclosure of derivative features that are

credit risk – related as well as cross-referencing within the notes to

the financial statements to enable financial statement users to

locate important information about derivative instruments,

financial performance and cash flows. We adopted this standard

effective as of December 31, 2008. The only impact from this

standard was to require us to expand our disclosures regarding our

derivative instruments. Refer to Note 13 – Financial Instruments

for additional information.

Fair Value Accounting

In 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”

(“FAS 157”). We adopted the provisions of FAS 157 on January 1,

2008. FAS 157 defines fair value, establishes a market-based

framework or hierarchy for measuring fair value and expands

disclosures about fair value measurements. FAS 157 is applicable

whenever another accounting pronouncement requires or permits

assets and liabilities to be measured at fair value. FAS 157 does not

expand or require any new fair value measures; however, the

application of this statement may change current practice. FAS

157 does not apply to fair value measurements for purposes of

lease classification or measurement under SFAS No. 13,

“Accounting for Leases”. In February 2008, the FASB decided that

an entity need not apply this standard to nonfinancial assets and

liabilities that are recognized or disclosed at fair value in the

financial statements on a nonrecurring basis until 2009.

Accordingly, our adoption of this standard in 2008 was limited to

financial assets and liabilities, which primarily affects the valuation

of our derivative contracts. The adoption of FAS 157 did not have a

material effect on our financial condition or results of operations.

We do not believe the full adoption of FAS 157 with respect to our

nonfinancial assets and liabilities will have a material effect on our

financial condition or results of operations. Nonfinancial assets and

liabilities for which we have not applied the provisions of FAS 157

primarily include those measured at fair value in impairment

testing and those initially measured at fair value in a business

combination.

Financial Assets and Financial Liabilities – Including an

Amendment of FASB Statement No. 115” (“FAS 159”). FAS 159

became effective for us on January 1, 2008. FAS 159 permits

entities to choose to measure many financial instruments and

certain other items at fair value. Entities that elect the fair value

option will report unrealized gains and losses in earnings at each

subsequent reporting date. The fair value option may be elected

on an instrument-by-instrument basis, with few exceptions. FAS

159 also establishes presentation and disclosure requirements to

facilitate comparisons between companies that choose different

measurement attributes for similar assets and liabilities. FAS 159

did not have an effect on our financial condition or results of

operations as we did not elect this fair value option, nor is it

expected to have a material impact on future periods as the

election of this option for our financial instruments is expected to

be at most, limited.

Business Combinations and Noncontrolling Interests

In 2007, the FASB issued SFAS No. 141 (revised 2007), “Business

Combinations” (“FAS 141(R)”). FAS 141(R) requires the acquiring

entity in a business combination to recognize the full fair value of

assets acquired and liabilities assumed in the transaction (whether

a full or partial acquisition); establishes the acquisition-date fair

value as the measurement objective for all assets acquired and

liabilities assumed; requires expensing of most transaction and

restructuring costs; and requires the acquirer to disclose the

information needed to evaluate and understand the nature and

financial effect of the business combination. FAS 141(R) applies

prospectively to business combinations for which the acquisition

date is on or after January 1, 2009. The impact of FAS No. 141(R)

on our consolidated financial statements will depend upon the

nature, terms and size of the acquisitions we consummate after

the effective date.

In 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests

in Consolidated Financial Statements – an amendment of

Accounting Research Bulletin No. 51” (“FAS 160”). FAS 160 requires

reporting entities to present noncontrolling (minority) interests as

equity (as opposed to as a liability) and provides guidance on the

accounting for transactions between an entity and noncontrolling

interests. As of December 31, 2008, we had approximately $120 in

noncontrolling interests classified in other long-term liabilities. FAS

160 applies prospectively as of January 1, 2009, except for the

presentation and disclosure requirements which will be applied

retrospectively for all periods presented.

In 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB Statements No. 87, 88, 106 and 132(R)”
(“FAS 158”) which requires the recognition of an asset or liability
for the funded status of defined pension and other postretirement
benefit plans in the statement of financial position of the
sponsoring entity. The funded status of a benefit plan is measured
as the difference between plan assets at fair value and the benefit
obligation. The initial incremental recognition of the funded status
under FAS 158 of our defined pension and other post retirement
benefit plans, as well as subsequent changes in our funded status
that are not included in net periodic benefit cost will be reflected in
shareholders’ equity and other comprehensive loss, respectively. As
of December 31, 2006, the net unfunded status of our benefit
plans was $2,842 and recognition of this net unfunded status upon
the adoption of FAS 158 resulted in an after-tax charge to equity
of $1,024. Prior to the adoption of FAS 158, we recorded an
after-tax credit to our minimum pension liability of $131, for a
total equity charge in 2006 related to the funded status of our
benefit plans of $893. Amounts recognized in accumulated other
comprehensive loss are adjusted as they are subsequently
recognized as a component of net periodic benefit cost. The
method of calculating net periodic benefit cost did not change
from existing guidance. Refer to Note 14 – Employee Benefit Plans
for additional information.

The funded status recognition and certain disclosure provisions of
FAS 158 were effective as of our fiscal year ending December 31,
2006. FAS 158 also requires the consistent measurement of plan
assets and benefit obligations as of the date of our fiscal year-end
statement of financial position effective for the year ending
December 31, 2008. Since several of our international plans had a
September 30th measurement date, this standard required us to
change that measurement date to December 31st in 2008. The
adoption of this requirement by our international plans did not
have a material effect on our financial condition or results of
operations. The effect of adoption by our international plans
resulted in a January 1, 2008 opening retained earnings charge of
$16, deferred tax asset increase of $4, pension asset reduction of
$9, a pension liability increase of $6 and a credit to accumulated
other comprehensive loss of $5.

FAS 158 was not effective for our equity investment in Fuji Xerox
(“FX”) until their annual year-end of March 31, 2007. Upon FX’s
adoption of FAS 158, we recorded a $5 charge to equity
representing our share of their after-tax charge to equity for the
unfunded status of their benefit plans. We also recorded a $44
after-tax charge to equity for our portion of a minimum pension
liability adjustment recorded by FX prior to their adoption of FAS

158 for a total equity charge in 2007 related to the funded status
of FX’s benefit plans of $49.

Other Accounting Changes

In December 2008, the FASB issued Staff Position No. FAS 140-4
and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about
Transfers of Financial Assets and Interests in Variable Interest
Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). This FSP required
additional disclosures about transfers of financial assets and about
an entity’s involvement with variable interest entities. The FSP is
effective for our fiscal year ended December 31, 2008. Adoption of
this FSP affects disclosures only and therefore has no impact on
the Company’s financial condition, results of operations or cash
flows. Since our transfers of financial assets and involvement with
variable interest entities are not material, we do not expect a
material disclosure requirement from this standard.

In April 2008, the FASB issued Staff Position No. FAS 142-3,
“Determination of Useful Life of Intangible Assets” (“FSP FAS
142-3”). FSP FAS 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FAS
142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also
requires expanded disclosures related to the determination of
intangible asset useful lives. This standard applies prospectively to
intangible assets acquired and/or recognized on or after January 1,
2009. We do not believe that the adoption of this standard will have
a material effect on our financial condition or results of operations.

In 2007, the FASB’s Emerging Issues Task Force issued EITF Issue
No. 06-10, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Collateral Assignment Split-
Dollar Life Insurance Arrangements” (“EITF 06-10”). EITF 06-10
provides that an employer should recognize a liability for the
postretirement benefit related to collateral assignment split-dollar
life insurance arrangements in accordance with either SFAS
No. 106, “Employers’ Accounting for Postretirement Benefits Other
Than Pensions,” or Accounting Principles Board Opinion No. 12,
“Omnibus Opinion.” We recorded a $11 after-tax charge to
retained earnings in 2008 reflecting the cumulative effect upon
adoption of EITF 06-10. The standard is not expected to have a
material impact on results of operations in the future.

In 2006, the FASB ratified the consensus reached on EITF Issue
No. 06-2, “Accounting for Sabbatical Leave and Other Similar
Benefits Pursuant to FASB Statement No. 43” (“EITF 06-2”). EITF
06-2 clarifies recognition guidance on the accrual of employees’
rights to compensated absences under a sabbatical or other similar
benefit arrangement. We recorded a $7 after-tax charge to
Retained earnings in 2007 reflecting our share of the cumulative
effect recorded by Fuji Xerox upon adoption of EITF 06-2. This was

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

adjusted by a $2 credit in 2008. With the exception of this charge,
the adoption of EITF 06-2 did not impact the Company as we do
not have a similar benefit arrangement.

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 recognized
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 arrangement 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 generally recognized as
revenue when products are sold to such distributors and resellers.
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 customers in accordance with the sales terms.

Software: Software included within our equipment and services is
generally considered incidental and is therefore accounted for as
part of the equipment sales or services revenues. Software
accessories sold in connection with our equipment sales as well as
free-standing software revenues are accounted for in accordance
with AICPA Statement of Position No. 97-2, “Software Revenue
Recognition” (“SOP 97-2”). In most cases, these software products
are sold as part of multiple element arrangements and include
software maintenance agreements for the delivery of technical
service as well as unspecified upgrades or enhancements on a
when-and-if-available basis. In those software accessory and free-
standing software arrangements that include more than one
element, we allocate the revenue among the elements based on
vendor-specific objective evidence (“VSOE”) of fair value. VSOE of
fair value is based on the price charged when the deliverable is sold
separately by us on a regular basis and not as part of the multiple-
element arrangement. Revenue allocated to software is normally
recognized upon delivery while revenue allocated to the software
maintenance element is recognized ratably over the term of the
arrangement.

Revenue Recognition for Leases: Our accounting for leases
involves specific determinations under FAS 13, which often involve
complex provisions and significant judgments. The two primary
criteria of FAS 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 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

payments are multiplied by the number of months in the contract

accounting are the determination of the economic life and the fair

term to arrive at the total fixed minimum payments that the

value of equipment, including the residual value. For purposes of

customer is obligated to make (“fixed payments”) over the lease

determining the economic life, we consider the most objective

term. The payments associated with page volumes in excess of the

measure to be the original contract term, since most equipment is

minimums are contingent on whether or not such minimums are

returned by lessees at or near the end of the contracted term. The

exceeded (“contingent payments”). The minimum contractual

economic life of most of our products is five years since this

committed page volumes are typically negotiated to equal the

represents the most frequent contractual lease term for our

customer’s estimated page volume at lease inception. In applying

principal products and only a small percentage of our leases have

our lease accounting methodology, we only consider the fixed

original terms longer than five years. We continually evaluate the

payments for purposes of allocating to the relative fair value

economic life of both existing and newly introduced products for

elements of the contract. Contingent payments, if any, are

purposes of this determination. Residual values, if any, are

inherently uncertain and therefore are recognized as revenue in

established at lease inception using estimates of fair value at the

the period when the customer exceeds the minimum copy volumes

end of the lease term.

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. 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. The evaluation of a lease

agreement with a renewal option includes an assessment as to

whether the renewal is reasonably assured based on the apparent

intent and our experience of such governmental unit. 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 the lease as an operating lease.

After the initial lease of equipment to our customers, we may enter

subsequent transactions with the same customer whereby we

extend the term. Revenue from such lease extensions is typically

recognized over the extension period.

Revenue Recognition Under Bundled Arrangements: We sell the

majority 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 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. The fixed minimum monthly

specified in the contract. 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.

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 other

contracts, require us to post cash collateral or maintain minimum

cash balances in escrow. In addition, as more fully discussed in

Note 16 – Contingencies, various litigation matters in Brazil require

us to make cash deposits as a condition of continuing the

litigation. These cash amounts are reported in our Consolidated

Balance Sheets, depending on when the cash will be contractually

released. At December 31, 2008 and 2007, such restricted cash

amounts were as follows:

Escrow and cash collections related to secured

borrowing arrangements

Tax and other litigation deposits in Brazil

Other restricted cash

Total

December 31,

2008

2007

$ 16

$ 41

167

200

$203

$264

Xerox 2008 Annual Report

Text.indd 54

3/18/09 5:59:10 PM

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

adjusted by a $2 credit in 2008. With the exception of this charge,

Sales to distributors and resellers: We utilize distributors and

the adoption of EITF 06-2 did not impact the Company as we do

resellers to sell certain of our products to end-users. We refer to our

not have a similar benefit arrangement.

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 recognized

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 arrangement 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.

distributor and reseller network as our two-tier distribution model.

Sales to distributors and resellers are generally recognized as

revenue when products are sold to such distributors and resellers.

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 customers in accordance with the sales terms.

Software: Software included within our equipment and services is

generally considered incidental and is therefore accounted for as

part of the equipment sales or services revenues. Software

accessories sold in connection with our equipment sales as well as

free-standing software revenues are accounted for in accordance

with AICPA Statement of Position No. 97-2, “Software Revenue

Recognition” (“SOP 97-2”). In most cases, these software products

are sold as part of multiple element arrangements and include

software maintenance agreements for the delivery of technical

service as well as unspecified upgrades or enhancements on a

when-and-if-available basis. In those software accessory and free-

standing software arrangements that include more than one

element, we allocate the revenue among the elements based on

vendor-specific objective evidence (“VSOE”) of fair value. VSOE of

fair value is based on the price charged when the deliverable is sold

separately by us on a regular basis and not as part of the multiple-

element arrangement. Revenue allocated to software is normally

recognized upon delivery while revenue allocated to the software

maintenance element is recognized ratably over the term of the

arrangement.

Revenue Recognition for Leases: Our accounting for leases

involves specific determinations under FAS 13, which often involve

complex provisions and significant judgments. The two primary

criteria of FAS 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 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. We continually evaluate the
economic life of both existing and newly introduced products for
purposes of this determination. Residual values, if any, are
established at lease inception using estimates of fair value at the
end of the lease term.

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. 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. The evaluation of a lease
agreement with a renewal option includes an assessment as to
whether the renewal is reasonably assured based on the apparent
intent and our experience of such governmental unit. 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 the lease as an operating lease.

After the initial lease of equipment to our customers, we may enter
subsequent transactions with the same customer whereby we
extend the term. Revenue from such lease extensions is typically
recognized over the extension period.

Revenue Recognition Under Bundled Arrangements: We sell the
majority 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 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. 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 customer exceeds the minimum copy volumes
specified in the contract. 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.

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 other
contracts, require us to post cash collateral or maintain minimum
cash balances in escrow. In addition, as more fully discussed in
Note 16 – Contingencies, various litigation matters in Brazil require
us to make cash deposits as a condition of continuing the
litigation. These cash amounts are reported in our Consolidated
Balance Sheets, depending on when the cash will be contractually
released. At December 31, 2008 and 2007, such restricted cash
amounts were as follows:

Escrow and cash collections related to secured

borrowing arrangements

Tax and other litigation deposits in Brazil
Other restricted cash

Total

December 31,

2008

2007

$ 16
167
20

$203

$ 41
200
23

$264

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Of these amounts, $20 and $45 were included in Other current
assets and $183 and $219 were included in Other long-term assets,
as of December 31, 2008 and 2007, respectively.

Provisions for Losses on Uncollectible Receivables

The provisions 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 receivable were $131 and $128,
as of December 31, 2008 and 2007, respectively. Allowances for
doubtful accounts on finance receivables were $198 and $203 at
December 31, 2008 and 2007, 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 servicing
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.

Cost of sales in 2008 included a charge of $39 associated with an
Office segment product line equipment and residual value write-
off. The write-off was the result of a late 2008 change in strategy
reflecting our decision to discontinue the remanufacture of
end-of-lease returned inventory from a certain Office segment
product line following an assessment of the current and expected
market for these products.

Land, Buildings and Equipment and Equipment on
Operating Leases

lease term or the estimated useful life. Equipment on operating
leases is depreciated to estimated salvage 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 Note 5 – Inventories and Equipment
on Operating Leases, Net and Note 6 – Land, Buildings and
Equipment, Net for further discussion.

Internal Use Software

We capitalize direct costs associated with developing, purchasing
or otherwise acquiring software for internal use and amortize these
costs 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 was $50, $76, and $73 for the years ended December 31,
2008, 2007 and 2006, respectively. Capitalized costs were $288
and $270 as of December 31, 2008 and 2007, respectively.

Goodwill and Other Intangible Assets

Goodwill is tested for impairment 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
connection 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 carrying value of our intangible assets may not be
recoverable. Other intangible assets are amortized on a straight-
line basis over their estimated economic lives. We believe that 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. Refer to Note 8 – Goodwill and Intangible Assets,
Net for further information.

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

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

those obligations to be recognized not as they occur, but

indicate that the carrying value of the asset may not be

systematically and gradually over subsequent periods. All changes

recoverable. The assessment of possible impairment is based on

are ultimately recognized as components of net periodic benefit

our ability to recover the carrying value of the asset from the

cost, except to the extent they may be offset by subsequent

expected future pre-tax cash flows (undiscounted and without

changes. At any point, changes that have been identified and

interest charges) of the related operations. If these cash flows are

quantified but not recognized as components of net periodic

less than the carrying value of such asset, an impairment loss is

benefit cost, are recognized in Accumulated other comprehensive

recognized for the difference between estimated fair value and

loss, net of tax.

carrying value. Our primary measure of fair value is based on

discounted cash flows.

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 at the

time such retirement is approved by our Board of Directors.

Research, Development and Engineering (“R,D&E”)

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

Research, development and engineering costs are expensed as

specifically allocated to Transitional Retirement Accounts (which

incurred. R,D&E was $884, $912 and $922, for the three years

are accounted for based on specific plan terms).

ended December 31, 2008, respectively. Research and

development (“R&D”) costs were $750 in 2008, $764 in 2007 and

$761 in 2006. Sustaining engineering costs are incurred with

respect to on-going product improvements or environmental

compliance after initial product launch. Our sustaining engineering

costs were $134, $148, and $161, for the three years ended

December 31, 2008, respectively.

Restructuring Charges

Costs associated with exit or disposal 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 U.S. and

Canadian employees for retirement medical costs. We employ a

delayed recognition feature in measuring the costs of pension and

post-retirement benefit plans. This requires changes in the benefit

obligations and changes in the value of assets set aside to meet

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 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 80% of our

projected benefit obligation, we consider the Moody’s Aa

Corporate Bond Index and the International Index Company’s

iBoxx Sterling Corporate AA Cash Bond Index, respectively, in the

determination of the appropriate discount rate assumptions. Refer

to Note 14 – Employee Benefit Plans for further information.

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Of these amounts, $20 and $45 were included in Other current

lease term or the estimated useful life. Equipment on operating

assets and $183 and $219 were included in Other long-term assets,

leases is depreciated to estimated salvage value over the lease

as of December 31, 2008 and 2007, respectively.

Provisions for Losses on Uncollectible Receivables

The provisions 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 receivable were $131 and $128,

as of December 31, 2008 and 2007, respectively. Allowances for

doubtful accounts on finance receivables were $198 and $203 at

December 31, 2008 and 2007, 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

term. Depreciation is computed using the straight-line method.

Significant improvements are capitalized and maintenance and

repairs are expensed. Refer to Note 5 – Inventories and Equipment

on Operating Leases, Net and Note 6 – Land, Buildings and

Equipment, Net for further discussion.

Internal Use Software

We capitalize direct costs associated with developing, purchasing

or otherwise acquiring software for internal use and amortize these

costs 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 was $50, $76, and $73 for the years ended December 31,

2008, 2007 and 2006, respectively. Capitalized costs were $288

and $270 as of December 31, 2008 and 2007, respectively.

Goodwill and Other Intangible Assets

remaining net book value or salvage value. Salvage value consists

Goodwill is tested for impairment annually or more frequently if an

of the estimated market value (generally determined based on

event or circumstance indicates that an impairment loss may have

replacement cost) of the salvageable component parts, which are

been incurred. Application of the goodwill impairment test requires

expected to be used in the remanufacturing process. We regularly

judgment, including the identification of reporting units,

review inventory quantities and record a provision for excess and/

assignment of assets and liabilities to reporting units, assignment

or obsolete inventory based primarily on our estimated forecast of

of goodwill to reporting units, and determination of the fair value

product demand, production requirements and servicing

of each reporting unit. We estimate the fair value of each reporting

commitments. Several factors may influence the realizability of our

unit using a discounted cash flow methodology. This requires us to

inventories, including our decision to exit a product line,

use significant judgment including estimation of future cash flows,

technological changes and new product development. The

which is dependent on internal forecasts, estimation of the long-

provision for excess and/or obsolete raw materials and equipment

term rate of growth for our business, the useful life over which cash

inventories is based primarily on near term forecasts of product

flows will occur, determination of our weighted average cost of

demand and include consideration of new product introductions as

capital, and relevant market data.

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.

Cost of sales in 2008 included a charge of $39 associated with an

Office segment product line equipment and residual value write-

off. The write-off was the result of a late 2008 change in strategy

reflecting our decision to discontinue the remanufacture of

end-of-lease returned inventory from a certain Office segment

product line following an assessment of the current and expected

market for these products.

Other intangible assets primarily consist of assets obtained in

connection 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 carrying value of our intangible assets may not be

recoverable. Other intangible assets are amortized on a straight-

line basis over their estimated economic lives. We believe that 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. Refer to Note 8 – Goodwill and Intangible Assets,

Land, Buildings and Equipment and Equipment on

Operating Leases

Land, buildings and equipment are recorded at cost. Buildings and

Net for further information.

Impairment of Long-Lived Assets

equipment are depreciated over their estimated useful lives.

We review the recoverability of our long-lived assets, including

Leasehold improvements are depreciated over the shorter of the

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 impairment 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.

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 at the
time such retirement is approved by our Board of Directors.

Research, Development and Engineering (“R,D&E”)

Research, development and engineering costs are expensed as
incurred. R,D&E was $884, $912 and $922, for the three years
ended December 31, 2008, respectively. Research and
development (“R&D”) costs were $750 in 2008, $764 in 2007 and
$761 in 2006. Sustaining engineering costs are incurred with
respect to on-going product improvements or environmental
compliance after initial product launch. Our sustaining engineering
costs were $134, $148, and $161, for the three years ended
December 31, 2008, respectively.

Restructuring Charges

Costs associated with exit or disposal 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 U.S. and
Canadian employees for retirement medical costs. We employ a
delayed recognition feature in measuring the costs of pension and
post-retirement benefit plans. This requires changes in the benefit
obligations and 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 as components of net periodic benefit
cost, except to the extent they may be offset by subsequent
changes. At any point, changes that have been identified and
quantified but not recognized as components of net periodic
benefit cost, are recognized in Accumulated other comprehensive
loss, net of tax.

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 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 80% of our
projected benefit obligation, we consider the Moody’s Aa
Corporate Bond Index and the International Index Company’s
iBoxx Sterling Corporate AA Cash Bond Index, respectively, in the
determination of the appropriate discount rate assumptions. Refer
to Note 14 – Employee Benefit Plans for further information.

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Each year, the difference between the actual return on plan assets
and the expected return on plan assets as well as increases or
decreases in the benefit obligation as a result of changes in the
discount rate are added to, or subtracted from, any cumulative
actuarial gain or loss that arose in prior years. This resultant
amount is the net actuarial gain or loss recognized in Accumulated
other comprehensive loss and is subject to subsequent
amortization to net periodic pension cost in future periods over the
remaining service lives of the employees participating in the
pension plan.

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 $34, $8 and $39 in 2008, 2007 and 2006, respectively,
and are included in Other expenses, net in the accompanying
Consolidated Statements of Income.

Accumulated Other Comprehensive Loss (“AOCL”)

AOCL is composed of the following for the three years ending
December 31, 2008:

Income (loss):
Cumulative translation

adjustments

Benefit plans net actuarial losses

and prior service credits
(includes our share of Fuji Xerox)

Minimum pension liabilities
Other unrealized gains

Total Accumulated Other
Comprehensive Loss

December 31,

2008

2007

2006

$(1,395) $ (31) $ (532)

(1,021)
—
—

(735)
—
12

(1,097)
(20)

$(2,416) $(765) $(1,647)

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 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.

The Production segment includes black-and-white products which
operate at speeds over 90 pages per minute (“ppm”) excluding 95
ppm with an embedded controller and color products which operate
at speeds over 40 ppm excluding 50, 60 and 70 ppm products with
an embedded controller. Products include the Xerox iGen3 and
iGen4 digital color production press, Xerox Nuvera®, DocuTech®,
DocuPrint® and DocuColor families, as well as older technology
light-lens products. These products are sold predominantly through
direct sales channels 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 as well as 95 ppm with an
embedded controller and color products up to 40 ppm as well as
50, 60 and 70 ppm products with an embedded controller.
Products include the suite of CopyCentre®, WorkCentre®,
WorkCentre Pro and Phaser® 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 and
non-Xerox branded products with similar specifications. These
products are sold through direct and indirect sales channels to
global, national and mid-size commercial customers as well as
government, education and other public sector customers.
Approximately 75% of Global Imaging Systems’ (“GIS”) revenue is
included in our Office segment representing those sales and
services that align to our Office segment.

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 sales), value-added services, Wide Format
Systems, Xerox Technology Enterprises, royalty and licensing
revenues, GIS network integration solutions and electronic
presentation systems, equity net income and non-allocated
Corporate items. 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 and Office segments, including
non-financing interest as well as other items included in Other
expenses, net.

Selected financial information for our Operating segments for each of the years ended December 31, 2008, 2007 and 2006, respectively,

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

was as follows:

2008(1)

Revenues

Finance income

Total Segment Revenues

Interest expense

Segment profit (loss)(2)

2007(1)

Revenues

Finance income

Total Segment Revenues

Interest expense

Segment profit (loss)(2)

2006(1)

Revenues

Finance income

Total Segment Revenues

Interest expense

Segment profit (loss)(2)

Equity in net income of unconsolidated affiliates

Production

Office

Other

Total

$4,937

300

$5,237

$ 117

394

$ —

$5,001

314

$5,315

$ 123

562

$ —

$4,735

320

$5,055

$ 119

504

$ —

$9,347

481

$9,828

$ 181

1,062

$ —

$ 8,980

493

$9,473

$ 186

1,115

$ —

$ 8,207

505

$8,712

$ 181

1,010

$ —

$2,526

$2,543

$ 269

(165)

$ 113

$ 2,425

$2,440

$ 270

(89)

$ 2,113

$2,128

$ 244

(124)

$ 114

$16,810

798

$17,608

567

1,291

113

$ 16,406

822

$17,228

579

1,588

$ 15,055

840

$15,895

544

1,390

114

Equity in net income of unconsolidated affiliates

(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) 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 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.

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Each year, the difference between the actual return on plan assets

Note 2 – Segment Reporting

Selected financial information for our Operating segments for each of the years ended December 31, 2008, 2007 and 2006, respectively,
was as follows:

Production

Office

Other

Total

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

2008(1)
Revenues
Finance income

Total Segment Revenues

Interest expense
Segment profit (loss)(2)
Equity in net income of unconsolidated affiliates

2007(1)
Revenues
Finance income

Total Segment Revenues

Interest expense
Segment profit (loss)(2)
Equity in net income of unconsolidated affiliates

2006(1)
Revenues
Finance income

Total Segment Revenues

Interest expense
Segment profit (loss)(2)
Equity in net income of unconsolidated affiliates

$4,937
300

$5,237

$ 117
394
$ —

$5,001
314

$5,315

$ 123
562
$ —

$4,735
320

$5,055

$ 119
504
$ —

$9,347
481

$9,828

$ 181
1,062
$ —

$ 8,980
493

$9,473

$ 186
1,115
$ —

$ 8,207
505

$8,712

$ 181
1,010
$ —

$2,526
17

$2,543

$ 269
(165)
$ 113

$ 2,425
15

$2,440

$ 270
(89)
97

$ 2,113
15

$2,128

$ 244
(124)
$ 114

$16,810
798

$17,608

567
1,291
113

$ 16,406
822

$17,228

579
1,588
97

$ 15,055
840

$15,895

544
1,390
114

AOCL is composed of the following for the three years ending

products are sold through direct and indirect sales channels to

(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) 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 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.

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

and the expected return on plan assets as well as increases or

decreases in the benefit obligation as a result of changes in the

discount rate are added to, or subtracted from, any cumulative

actuarial gain or loss that arose in prior years. This resultant

amount is the net actuarial gain or loss recognized in Accumulated

other comprehensive loss and is subject to subsequent

amortization to net periodic pension cost in future periods over the

remaining service lives of the employees participating in the

pension plan.

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 $34, $8 and $39 in 2008, 2007 and 2006, respectively,

and are included in Other expenses, net in the accompanying

Consolidated Statements of Income.

Accumulated Other Comprehensive Loss (“AOCL”)

December 31, 2008:

Income (loss):

Cumulative translation

adjustments

Benefit plans net actuarial losses

and prior service credits

Minimum pension liabilities

Other unrealized gains

Total Accumulated Other

Comprehensive Loss

December 31,

2008

2007

2006

$(1,395) $ (31) $ (532)

—

$(2,416) $(765) $(1,647)

Our reportable segments are consistent with how we manage the

business and view the markets we serve. Our reportable segments

are Production, Office 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.

The Production segment includes black-and-white products which

operate at speeds over 90 pages per minute (“ppm”) excluding 95

ppm with an embedded controller and color products which operate

at speeds over 40 ppm excluding 50, 60 and 70 ppm products with

an embedded controller. Products include the Xerox iGen3 and

iGen4 digital color production press, Xerox Nuvera®, DocuTech®,

DocuPrint® and DocuColor families, as well as older technology

light-lens products. These products are sold predominantly through

direct sales channels 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 as well as 95 ppm with an

embedded controller and color products up to 40 ppm as well as

50, 60 and 70 ppm products with an embedded controller.

Products include the suite of CopyCentre®, WorkCentre®,

WorkCentre Pro and Phaser® 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 and

non-Xerox branded products with similar specifications. These

global, national and mid-size commercial customers as well as

government, education and other public sector customers.

Approximately 75% of Global Imaging Systems’ (“GIS”) revenue is

included in our Office segment representing those sales and

services that align to our Office segment.

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

revenues, GIS network integration solutions and electronic

presentation systems, equity net income and non-allocated

Corporate items. 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 and Office segments, including

non-financing interest as well as other items included in Other

expenses, net.

(includes our share of Fuji Xerox)

(1,021)

(735)

(1,097)

(predominantly paper sales), value-added services, Wide Format

(20)

Systems, Xerox Technology Enterprises, royalty and licensing

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

The following is a reconciliation of segment profit to pre-tax income:

Total Segment profit
Reconciling items:

Restructuring and asset impairment charges
Restructuring charges of Fuji Xerox
Litigation matters(1)
Equipment write-off
Equity in net income of unconsolidated affiliates
Other

Year Ended December 31,

2008

$1,291

2007

$ 1,588

2006

$1,390

(429)
(16)
(774)
(39)
(113)
(34)

6
(30)
—
—
(97)
(29)

(385)
—
(68)
—
(114)
(15)

Pre-tax (loss) income

$ (114)

$1,438

$ 808

(1) The 2008 provision for litigation represents $670 for the Carlson v. Xerox Corporation court approved settlement, as well as provisions for other litigation matters including $36 for the probable
loss related to the Brazil labor related contingencies. The 2006 provision for litigation represents $68 related to probable losses on Brazilian labor-related contingencies. Refer to Note 16 –
Contingencies for further discussion.

Geographic area data is based upon the location of the subsidiary reporting the revenue or long-lived assets and is as follows:

United States
Europe
Other Areas

Total

2008

$ 9,122
6,011
2,475

$17,608

Revenues

2007

$ 9,078
5,888
2,262

$17,228

2006

$ 8,406
5,378
2,111

$15,895

2008

$1,386
680
248

$2,314

Long-Lived Assets(1)

2007

$ 1,375
746
341

$2,462

2006

$ 1,309
572
356

$2,237

(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 – Acquisitions

Veenman B.V.

In June 2008, we acquired Veenman B.V. (“Veenman”), expanding
our reach into the small and mid-sized business market in Europe,
for approximately $69 (€44 million) in cash, including transaction
costs. Veenman is the Netherlands’ leading independent distributor
of office printers, copiers and multifunction devices serving small
and mid-size businesses. The operating results of Veenman are not
material to our financial statements, and are included within our
Office segment from the date of acquisition. The purchase price
was primarily allocated to intangible assets and goodwill based on
third-party valuations and management’s estimates.

Global Imaging Systems, Inc.

Income as of May 9, 2007. Refer to Note 2 – Segment Reporting
for a discussion of the segment classification of GIS.

The total cost of the acquisition has been allocated to the assets
acquired and the liabilities assumed based on their respective
estimated fair values. Goodwill of $1,335 and intangible assets of
$363 were recorded in connection with the acquisition based on
third-party valuations and management’s estimates for those
acquired intangible assets. The majority of the goodwill is not
deductible for tax purposes and the primary elements that
generated goodwill are the value of the acquired assembled
workforce, specialized processes and procedures and operating
synergies, none of which qualify as a separate intangible asset.
Intangible assets included customer relationships of $189 with a
12 year weighted average useful life and tradenames of $174 with
a 20 year weighted average useful life.

In 2007, we acquired GIS, a provider of office technology for small
and mid-size businesses in the United States. The acquisition of
GIS expanded our access to the U.S. small and mid-size business
market. The aggregate purchase price was approximately $1.5
billion. In addition, in connection with the closing, we also repaid
$200 of GIS’s then outstanding bank debt. The results of
operations for GIS are included in our Consolidated Statements of

The unaudited pro forma results presented below include the
effects of the GIS acquisition as if it had been consummated as of
January 1, 2006. The pro forma results include the amortization
associated with the estimated value of acquired intangible assets
and interest expense associated with debt used to fund the
acquisition. However, pro forma results do not include any
anticipated synergies or other expected benefits of the acquisition.

Accordingly, the unaudited pro forma financial information below

the date of acquisition. The purchase price was primarily allocated

is not necessarily indicative of either future results of operations or

to intangible assets and goodwill based on third-party valuations

results that might have been achieved had the acquisition been

and management’s estimates.

consummated as of January 1, 2006.

Year Ended December 31,

Amici LLC

2007

$17,619

1,139

1.22

1.20

2006

1,222

1.26

1.23

In 2006, we acquired all of the net assets of Amici LLC (“Amici”), a

$16,992

provider of electronic-discovery (e-discovery) services, for $175 in

Revenue

Net income

Basic earnings per share

Diluted earnings per share

GIS Acquisitions

In May 2008, GIS acquired Saxon Business Systems, an office

equipment supplier in Florida, for approximately $69 in cash,

including transaction costs. GIS acquired three other similar

businesses in 2008 for a total of $17 in cash. In 2007, GIS acquired

four businesses that provide office-imaging solutions and related

services for $39 in cash. These acquisitions continue GIS’s

development of a national network of office technology suppliers

to serve its expanding base of small and mid-size businesses. The

operating results of these acquired entities are not material to our

financial statements and are included within our Office segment

from the date of acquisition. The purchase prices were primarily

allocated to intangible assets and goodwill based on third-party

valuations and management’s estimates.

Advectis, Inc.

In 2007, we acquired Advectis, Inc. (“Advectis”), a privately-owned

provider of a web-based solution to electronically manage the

process needed to underwrite, audit, collaborate, deliver and

archive mortgage loan documents, for $30 in cash. The operating

results of Advectis are not material to our financial statements, and

are included within our Other segment from the date of

acquisition. The purchase price was primarily allocated to

intangible assets and goodwill based on management’s estimates.

XMPie, Inc.

cash, including transaction costs. Amici provides comprehensive

litigation discovery management services, including the conversion,

hosting and production of electronic and hardcopy documents.

Amici also provides consulting and professional services to assist

attorneys in the discovery process. The operating results of Amici

were not material to our financial statements and are included

within our Other segment from the date of acquisition.

The purchase price was allocated to Net assets $2, Intangible

assets $37 (consisting of customer relationships of $29 and

software of $8), and Goodwill of $136. The primary elements that

generated the Goodwill are the value of synergies and the acquired

assembled workforce, neither of which qualify as a separate

intangible asset. The allocations were based on third-party

valuations and management’s estimates.

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,

2008 and 2007 were as follows:

Gross receivables

Unearned income

Residual values

Allowance for doubtful accounts

Finance receivables, net

Less: Billed portion of finance receivables,

Current portion of finance receivables not

2008

2007

$ 8,718

$ 9,643

(1,273)

(1,461)

(198)

(203)

7,278

8,048

(254)

(304)

(2,461)

(2,693)

$ 4,563

$ 5,051

In 2006, we acquired the stock of XMPie, Inc. (“XMPie”), a provider

net

of variable information software, for $54 in cash, including

transaction costs. XMPie’s software enables printers and marketers

billed, net

to create and print personalized and customized marketing

materials to help improve response rates. We had an existing

Amounts due after one year, net

relationship with XMPie, as its largest reseller, and its software is

Contractual maturities of our gross finance receivables as of

primarily sold together with our Production systems including the

December 31, 2008 were as follows (including those already billed

iGen3.

of $254:

The operating results of XMPie are not material to our financial

2009

2010

2011

2012

2013

Thereafter

Total

statements, and are included within our Production segment from

$3,288

$2,414

$1,690

$953

$335

$38

$8,718

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

The following is a reconciliation of segment profit to pre-tax income:

Total Segment profit

Reconciling items:

Litigation matters(1)

Equipment write-off

Other

Pre-tax (loss) income

Restructuring and asset impairment charges

Restructuring charges of Fuji Xerox

Equity in net income of unconsolidated affiliates

Year Ended December 31,

2008

$1,291

2007

$ 1,588

2006

$1,390

(429)

(16)

(774)

(39)

(113)

(34)

(30)

—

(97)

(29)

(385)

—

(68)

—

(114)

(15)

$ (114)

$1,438

$ 808

(1) The 2008 provision for litigation represents $670 for the Carlson v. Xerox Corporation court approved settlement, as well as provisions for other litigation matters including $36 for the probable

loss related to the Brazil labor related contingencies. The 2006 provision for litigation represents $68 related to probable losses on Brazilian labor-related contingencies. Refer to Note 16 –

Contingencies for further discussion.

Geographic area data is based upon the location of the subsidiary reporting the revenue or long-lived assets and is as follows:

United States

Europe

Other Areas

Total

2008

$ 9,122

6,011

2,475

$17,608

Revenues

2007

$ 9,078

5,888

2,262

$17,228

2006

$ 8,406

5,378

2,111

$15,895

2008

$1,386

680

248

$2,314

Long-Lived Assets(1)

2007

$ 1,375

746

341

$2,462

2006

$ 1,309

572

356

$2,237

(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 – Acquisitions

Veenman B.V.

In June 2008, we acquired Veenman B.V. (“Veenman”), expanding

our reach into the small and mid-sized business market in Europe,

for approximately $69 (€44 million) in cash, including transaction

costs. Veenman is the Netherlands’ leading independent distributor

of office printers, copiers and multifunction devices serving small

and mid-size businesses. The operating results of Veenman are not

material to our financial statements, and are included within our

Office segment from the date of acquisition. The purchase price

was primarily allocated to intangible assets and goodwill based on

third-party valuations and management’s estimates.

Global Imaging Systems, Inc.

Income as of May 9, 2007. Refer to Note 2 – Segment Reporting

for a discussion of the segment classification of GIS.

The total cost of the acquisition has been allocated to the assets

acquired and the liabilities assumed based on their respective

estimated fair values. Goodwill of $1,335 and intangible assets of

$363 were recorded in connection with the acquisition based on

third-party valuations and management’s estimates for those

acquired intangible assets. The majority of the goodwill is not

deductible for tax purposes and the primary elements that

generated goodwill are the value of the acquired assembled

workforce, specialized processes and procedures and operating

synergies, none of which qualify as a separate intangible asset.

Intangible assets included customer relationships of $189 with a

12 year weighted average useful life and tradenames of $174 with

a 20 year weighted average useful life.

In 2007, we acquired GIS, a provider of office technology for small

The unaudited pro forma results presented below include the

and mid-size businesses in the United States. The acquisition of

effects of the GIS acquisition as if it had been consummated as of

GIS expanded our access to the U.S. small and mid-size business

January 1, 2006. The pro forma results include the amortization

market. The aggregate purchase price was approximately $1.5

associated with the estimated value of acquired intangible assets

billion. In addition, in connection with the closing, we also repaid

and interest expense associated with debt used to fund the

$200 of GIS’s then outstanding bank debt. The results of

acquisition. However, pro forma results do not include any

operations for GIS are included in our Consolidated Statements of

anticipated synergies or other expected benefits of the acquisition.

Accordingly, the unaudited pro forma financial information below
is not necessarily indicative of either future results of operations or
results that might have been achieved had the acquisition been
consummated as of January 1, 2006.

the date of acquisition. The purchase price was primarily allocated
to intangible assets and goodwill based on third-party valuations
and management’s estimates.

Year Ended December 31,

Amici LLC

Revenue
Net income
Basic earnings per share
Diluted earnings per share

GIS Acquisitions

2007

$17,619
1,139
1.22
1.20

2006

$16,992
1,222
1.26
1.23

In May 2008, GIS acquired Saxon Business Systems, an office
equipment supplier in Florida, for approximately $69 in cash,
including transaction costs. GIS acquired three other similar
businesses in 2008 for a total of $17 in cash. In 2007, GIS acquired
four businesses that provide office-imaging solutions and related
services for $39 in cash. These acquisitions continue GIS’s
development of a national network of office technology suppliers
to serve its expanding base of small and mid-size businesses. The
operating results of these acquired entities are not material to our
financial statements and are included within our Office segment
from the date of acquisition. The purchase prices were primarily
allocated to intangible assets and goodwill based on third-party
valuations and management’s estimates.

Advectis, Inc.

In 2007, we acquired Advectis, Inc. (“Advectis”), a privately-owned
provider of a web-based solution to electronically manage the
process needed to underwrite, audit, collaborate, deliver and
archive mortgage loan documents, for $30 in cash. The operating
results of Advectis are not material to our financial statements, and
are included within our Other segment from the date of
acquisition. The purchase price was primarily allocated to
intangible assets and goodwill based on management’s estimates.

XMPie, Inc.

In 2006, we acquired the stock of XMPie, Inc. (“XMPie”), a provider
of variable information software, for $54 in cash, including
transaction costs. XMPie’s software enables printers and marketers
to create and print personalized and customized marketing
materials to help improve response rates. We had an existing
relationship with XMPie, as its largest reseller, and its software is
primarily sold together with our Production systems including the
iGen3.

In 2006, we acquired all of the net assets of Amici LLC (“Amici”), a
provider of electronic-discovery (e-discovery) services, for $175 in
cash, including transaction costs. Amici provides comprehensive
litigation discovery management services, including the conversion,
hosting and production of electronic and hardcopy documents.
Amici also provides consulting and professional services to assist
attorneys in the discovery process. The operating results of Amici
were not material to our financial statements and are included
within our Other segment from the date of acquisition.

The purchase price was allocated to Net assets $2, Intangible
assets $37 (consisting of customer relationships of $29 and
software of $8), and Goodwill of $136. The primary elements that
generated the Goodwill are the value of synergies and the acquired
assembled workforce, neither of which qualify as a separate
intangible asset. The allocations were based on third-party
valuations and management’s estimates.

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,
2008 and 2007 were as follows:

Gross receivables
Unearned income
Residual values
Allowance for doubtful accounts

Finance receivables, net
Less: Billed portion of finance receivables,

net

Current portion of finance receivables not

billed, net

Amounts due after one year, net

2008

2007

$ 8,718
(1,273)
31
(198)

$ 9,643
(1,461)
69
(203)

7,278

8,048

(254)

(304)

(2,461)

(2,693)

$ 4,563

$ 5,051

Contractual maturities of our gross finance receivables as of
December 31, 2008 were as follows (including those already billed
of $254:

The operating results of XMPie are not material to our financial
statements, and are included within our Production segment from

2009

2010

2011

2012

2013

Thereafter

Total

$3,288

$2,414

$1,690

$953

$335

$38

$8,718

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Secured Borrowings

We have an agreement in the U.S. (the “Loan Agreement”) under
which General Electric Capital Corporation, a subsidiary of GE,
provides secured funding for our customer leasing activities in the
U.S. The maximum potential level of borrowing under this
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.

Under this agreement, lease originations to be funded by GE are
transferred to a wholly-owned consolidated subsidiary. 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 intended for 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. The final funding date for the
U.S. facility is December 2010. There have been no new borrowings
under the Loan Agreement since December 2005.

As of December 31, 2008 and 2007, net encumbered finance
receivables were $104 and $377, respectively, and secured debt
associated with those receivables was $56 and $275, respectively.

Accounts Receivable Sales Arrangements

We have a facility in Europe that enables us to sell, on an on-going
basis, certain accounts receivables without recourse to a third-
party. During 2008 and 2007, we sold approximately $717 and
$326, respectively, of accounts receivables under this facility. Fees
associated with these sales were $4 and $2, respectively. Of the
amounts sold, $178 and $170 remained uncollected by the third-
party as of December 31, 2008 and 2007, respectively. In the
fourth quarter of 2008, we also sold an additional $43 of accounts
receivable in Europe without recourse under a separate one-time
factoring arrangement.

Note 5 – Inventories and Equipment on Operating
Leases, Net

Inventories at December 31, 2008 and 2007 were as follows:

Finished goods
Work-in-process
Raw materials

Total Inventories

2008

$1,044
80
108

$1,232

2007

$ 1,099
70
136

$1,305

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. 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.
We recorded $115, $66 and $69 in inventory write-down charges for
the years ended December 31, 2008, 2007 and 2006, respectively.

Equipment on operating leases and the related accumulated
depreciation at December 31, 2008 and 2007 were as follows:

Equipment on operating leases
Less: Accumulated depreciation

Equipment on operating leases, net

2008

2007

$1,507
(913)

$ 594

$1,435
(848)

$ 587

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 for
equipment on operating leases was $298, $269 and $230 for the
years ended December 31, 2008, 2007 and 2006, 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:

2009

$380

2010

$282

2011

$183

2012

$86

2013

$38

Thereafter

$21

Total contingent rentals on operating leases, consisting principally
of usage charges in excess of minimum contracted amounts, for
the years ended December 31, 2008, 2007 and 2006 amounted to
$117, $117 and $112, respectively.

Note 6 – Land, Buildings and Equipment, Net

Land, buildings and equipment, net at December 31, 2008 and
2007 were as follows:

Land
Buildings and building equipment
Leasehold improvements
Plant machinery
Office furniture and equipment
Other
Construction in progress

Subtotal
Less: Accumulated depreciation

Land, buildings and equipment,

net

Estimated
Useful Lives
(Years)

25 to 50
Varies
5 to 12
3 to 15
4 to 20
—

2008

2007

45 $

1,156
372
1,597
973
100
95

48
1,208
371
1,710
998
86
88

4,338
(2,919)

4,509
(2,922)

$ 1,419 $ 1,587

Depreciation expense and operating lease rent expense for the

Note 7 – Investments in Affiliates, at Equity

three years ended December 31, 2008 were as follows:

Depreciation expense

Operating lease rent expense(1)

2008

$257

$252

2007

$262

$286

2006

$277

$269

Investments in corporate joint ventures and other companies in

which we generally have a 20% to 50% ownership interest at

December 31, 2008 and 2007 were as follows:

2008

$1,028

$1,080

2007

$887

$932

(1) We lease certain land, buildings and equipment, substantially all

Fuji Xerox

of which are accounted for as operating leases.

All other equity investments

Future minimum operating lease commitments that have initial or

remaining non-cancelable lease terms in excess of one year at

December 31, 2008 were as follows:

2009

$223

2010

$188

2011

$151

2012

$100

2013

$84

Thereafter

$123

EDS Contract: We have an information management contract with

Electronic Data Systems Corp. (“EDS”) through June 30, 2009.

Services to be provided under this contract include support for

global mainframe system processing, application maintenance,

Investments in affiliates, at equity

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 $1,028 at December 31, 2008, differs

from our implied 25% interest in the underlying net assets, or

$1,139, 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.

workplace and service desk, voice and data network management

Our equity in net income of our unconsolidated affiliates for the

and server management. In 2008, the contracts for global

three years ended December 31, 2008 was as follows:

mainframe system processing and workplace and service desk were

extended through December 2013 and March 2014, respectively.

In January 2009, the contract for voice and data network

management services was revised and extended through March

Fuji Xerox

Other investments

2014. There are no minimum payments required under this

Total

2008

$101

$113

2007

$89

$97

2006

$107

$114

contract. The amounts disclosed in the table reflect our estimate of

probable minimum payments for the periods shown. We can

terminate the 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.

Payments to EDS, which are primarily recorded in selling,

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 than that implied by our 25%

ownership interest. Equity income for 2008 and 2007 includes

after-tax restructuring charges of $16 and $30, respectively,

primarily reflecting employee related costs as part of Fuji Xerox’s

administrative and general expenses, were $279, $294 and $288

continued cost-reduction actions to improve its competitive

for the years ended December 31, 2008, 2007 and 2006,

position.

respectively.

In January 2009, we entered into a three year contract with

Verizon Business to provide data network transport services. There

are annual volume commitments included in the contract of $5, $7

and $8 for the three years ended December 31, 2009, 2010 and

2011. We expect to meet the minimum volume commitments

throughout the course of the contract.

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Secured Borrowings

We have an agreement in the U.S. (the “Loan Agreement”) under

which General Electric Capital Corporation, a subsidiary of GE,

provides secured funding for our customer leasing activities in the

U.S. The maximum potential level of borrowing under this

agreement is a function of the size of the portfolio of finance

Statements of Cash Flows in the operating activities section as a

non-cash adjustment. 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.

We recorded $115, $66 and $69 in inventory write-down charges for

the years ended December 31, 2008, 2007 and 2006, respectively.

Depreciation expense and operating lease rent expense for the
three years ended December 31, 2008 were as follows:

Depreciation expense
Operating lease rent expense(1)

2008

$257
$252

2007

$262
$286

2006

$277
$269

receivables generated by us that meet GE’s funding requirements

Equipment on operating leases and the related accumulated

and cannot exceed $5 billion.

depreciation at December 31, 2008 and 2007 were as follows:

(1) We lease certain land, buildings and equipment, substantially all

of which are accounted for as operating leases.

Fuji Xerox
All other equity investments

Under this agreement, lease originations to be funded by GE are

transferred to a wholly-owned consolidated subsidiary. 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 intended for 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. The final funding date for the

U.S. facility is December 2010. There have been no new borrowings

under the Loan Agreement since December 2005.

As of December 31, 2008 and 2007, net encumbered finance

receivables were $104 and $377, respectively, and secured debt

associated with those receivables was $56 and $275, respectively.

Accounts Receivable Sales Arrangements

We have a facility in Europe that enables us to sell, on an on-going

basis, certain accounts receivables without recourse to a third-

party. During 2008 and 2007, we sold approximately $717 and

$326, respectively, of accounts receivables under this facility. Fees

associated with these sales were $4 and $2, respectively. Of the

amounts sold, $178 and $170 remained uncollected by the third-

party as of December 31, 2008 and 2007, respectively. In the

fourth quarter of 2008, we also sold an additional $43 of accounts

receivable in Europe without recourse under a separate one-time

factoring arrangement.

Equipment on operating leases

Less: Accumulated depreciation

Equipment on operating leases, net

2008

2007

$1,507

(913)

$ 594

$1,435

(848)

$ 587

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 for

equipment on operating leases was $298, $269 and $230 for the

years ended December 31, 2008, 2007 and 2006, 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:

2009

$380

2010

$282

2011

$183

2012

$86

2013

$38

Thereafter

$21

Total contingent rentals on operating leases, consisting principally

of usage charges in excess of minimum contracted amounts, for

the years ended December 31, 2008, 2007 and 2006 amounted to

$117, $117 and $112, respectively.

Note 6 – Land, Buildings and Equipment, Net

Land, buildings and equipment, net at December 31, 2008 and

2007 were as follows:

Estimated

Useful Lives

(Years)

2008

2007

Note 5 – Inventories and Equipment on Operating

Land

Inventories at December 31, 2008 and 2007 were as follows:

Buildings and building equipment

25 to 50

Leasehold improvements

Plant machinery

Office furniture and equipment

Construction in progress

Varies

5 to 12

3 to 15

4 to 20

—

2008

$1,044

108

2007

$ 1,099

136

Other

Subtotal

net

$1,232

$1,305

Land, buildings and equipment,

Less: Accumulated depreciation

45 $

1,156

372

1,597

973

100

1,208

371

1,710

998

4,338

4,509

(2,919)

(2,922)

$ 1,419 $ 1,587

Leases, Net

Finished goods

Work-in-process

Raw materials

Total Inventories

The transfer of equipment from our inventories to equipment

subject to an operating lease is presented in our Consolidated

Future minimum operating lease commitments that have initial or
remaining non-cancelable lease terms in excess of one year at
December 31, 2008 were as follows:

2009

$223

2010

$188

2011

$151

2012

$100

2013

$84

Thereafter

$123

EDS Contract: We have an information management contract with
Electronic Data Systems Corp. (“EDS”) through June 30, 2009.
Services to be provided under this contract include support for
global mainframe system processing, application maintenance,
workplace and service desk, voice and data network management
and server management. In 2008, the contracts for global
mainframe system processing and workplace and service desk were
extended through December 2013 and March 2014, respectively.
In January 2009, the contract for voice and data network
management services was revised and extended through March
2014. There are no minimum payments required under this
contract. The amounts disclosed in the table reflect our estimate of
probable minimum payments for the periods shown. We can
terminate the 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.
Payments to EDS, which are primarily recorded in selling,
administrative and general expenses, were $279, $294 and $288
for the years ended December 31, 2008, 2007 and 2006,
respectively.

In January 2009, we entered into a three year contract with
Verizon Business to provide data network transport services. There
are annual volume commitments included in the contract of $5, $7
and $8 for the three years ended December 31, 2009, 2010 and
2011. We expect to meet the minimum volume commitments
throughout the course of the contract.

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, 2008 and 2007 were as follows:

2008

$1,028
52

$1,080

2007

$887
45

$932

Investments in affiliates, at equity

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 $1,028 at December 31, 2008, differs
from our implied 25% interest in the underlying net assets, or
$1,139, 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.

Our equity in net income of our unconsolidated affiliates for the
three years ended December 31, 2008 was as follows:

Fuji Xerox
Other investments

Total

2008

$101
12

$113

2007

$89

$97

2006

$107

$114

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 than that implied by our 25%
ownership interest. Equity income for 2008 and 2007 includes
after-tax restructuring charges of $16 and $30, respectively,
primarily reflecting employee related costs as part of Fuji Xerox’s
continued cost-reduction actions to improve its competitive
position.

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Condensed financial data of Fuji Xerox for the three calendar years
ended December 31, 2008 was as follows:

Yen/U.S. Dollar exchange rates used to translate above are as
follows:

Note 8 – Goodwill and Intangible Assets, Net

Summary of Operations
Revenues
Costs and expenses

Income before income taxes
Income taxes
Minorities’ interests

Net income

Balance Sheet
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 Shareholders’

2008

2007

2006

$11,190 $10,218 $ 9,859
9,119

10,451

9,565

739
287
7

740
281

653
252

445 $

395 $ 454

$ 4,734 $ 4,242 $ 3,731
4,184

5,470

4,639

$10,204 $ 8,881 $7,915

$ 3,534 $ 3,322 $ 2,954
685
590

996
1,095

900
746

23
4,556

25
3,888

21
3,665

Equity

$10,204 $ 8,881 $7,915

Summary of Operations

Balance Sheet

Exchange Basis
Weighted

2008

2007

2006

Average Rate 103.31 117.53 116.36
90.28 112.55 118.89
Year-End Rate

In 2008, 2007 and 2006, we received dividends of $56, $37 and
$41, 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 2008, 2007 and 2006, we earned royalty revenues under our
Technology Agreement of $112, $108 and $117, 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. 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, 2008 were as follows:

Sales
Purchases

2008

2007

2006

$ 162
$2,150

$ 186
$1,946

$ 168
$1,677

In addition to the amounts described above, in 2008, 2007 and
2006, we paid Fuji Xerox $34, $30 and $28, respectively, and Fuji
Xerox paid us $5, $3 and $3, in 2008, 2007 and 2006, respectively,
for unique research and development. As of December 31, 2008
and 2007, amounts due to Fuji Xerox were $194 and $205,
respectively.

The following table presents the changes in the carrying amount of goodwill, by reportable segment, for the three years ended

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Goodwill

December 31, 2008:

Balance at December 31, 2005

Foreign currency translation adjustment

Acquisition of Amici LLC

Acquisition of XMPie, Inc.

Balance at December 31, 2006

Foreign currency translation adjustment

Acquisition of GIS

Acquisition of Advectis, Inc.

GIS Acquisitions

Other

Balance at December 31, 2007

Foreign currency translation adjustment

Acquisition of Veenman B.V.

GIS acquisitions

Purchase Price allocation adjustment – GIS

Balance at December 31, 2008

Intangible Assets, Net

2008 and 2007:

Customer base

Distribution network

Trademarks

Total

Technology, patents and non-compete

$ 892

$ 876

$ 256

$2,024

1,218

1,323

Production

$ 745

Office

$ 807

Other

$ 119

—

$ 913

(233)

—

—4

$2,141

(161)

120

136

—

105

$ 394

(1)

—

(108)

$ 285

Total

$1,671

169

136

$3,448

(395)

$ 680

$2,217

$3,182

In 2008, we finalized the GIS purchase price allocation. As a result, the $108 of Goodwill reflected in our Other segment in 2007 was

reallocated to our Office segment. This adjustment aligned goodwill to the reporting unit benefiting from the synergies of the purchase.

Intangible assets primarily relate to the Office operating segment. Intangible assets were comprised of the following as of December 31,

Weighted

Average

Amortization

Period

14 years

25 years

20 years

6 years

Gross

Carrying

Amount

$492

123

191

$846

December 31, 2008

December 31, 2007

Accumulated

Net

Amortization

Amount

Accumulated

Net

Amortization

Amount

Gross

Carrying

Amount

$155

$337

$462

$118

$344

176

123

175

169

$236

$610

$799

$178

$621

Amortization expense related to intangible assets was $58, $46, and $45 for the years ended December 31, 2008, 2007 and 2006,

respectively, and, excluding the impact of additional acquisitions, is expected to approximate $58 annually from 2009 through 2013.

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.

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

ended December 31, 2008 was as follows:

follows:

Summary of Operations

Revenues

Costs and expenses

Income before income taxes

Income taxes

Minorities’ interests

Net income

Balance Sheet

Assets:

Current assets

Long-term assets

Total Assets

Current liabilities

Long-term debt

Liabilities and Shareholders’ Equity:

Other long-term liabilities

Minorities’ interests in equity of

subsidiaries

Shareholders’ equity

Total Liabilities and Shareholders’

$ 4,734 $ 4,242 $ 3,731

5,470

4,639

4,184

$10,204 $ 8,881 $7,915

$ 3,534 $ 3,322 $ 2,954

996

1,095

900

746

685

590

4,556

3,888

3,665

Equity

$10,204 $ 8,881 $7,915

2008

2007

2006

Exchange Basis

2008

2007

2006

$11,190 $10,218 $ 9,859

10,451

9,565

9,119

Balance Sheet

Average Rate 103.31 117.53 116.36

Year-End Rate

90.28 112.55 118.89

Summary of Operations

Weighted

739

287

740

281

653

252

In 2008, 2007 and 2006, we received dividends of $56, $37 and

$41, respectively, which were reflected as a reduction in our

investment. Additionally, we have a technology agreement with

445 $

395 $ 454

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 2008, 2007 and 2006, we earned royalty revenues under our

Technology Agreement of $112, $108 and $117, 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. 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, 2008 were as follows:

Sales

Purchases

2008

2007

2006

$ 162

$2,150

$ 186

$1,946

$ 168

$1,677

In addition to the amounts described above, in 2008, 2007 and

2006, we paid Fuji Xerox $34, $30 and $28, respectively, and Fuji

Xerox paid us $5, $3 and $3, in 2008, 2007 and 2006, respectively,

for unique research and development. As of December 31, 2008

and 2007, amounts due to Fuji Xerox were $194 and $205,

respectively.

Condensed financial data of Fuji Xerox for the three calendar years

Yen/U.S. Dollar exchange rates used to translate above are as

Note 8 – Goodwill and Intangible Assets, Net

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Goodwill

The following table presents the changes in the carrying amount of goodwill, by reportable segment, for the three years ended
December 31, 2008:

Balance at December 31, 2005
Foreign currency translation adjustment
Acquisition of Amici LLC
Acquisition of XMPie, Inc.

Balance at December 31, 2006
Foreign currency translation adjustment
Acquisition of GIS
Acquisition of Advectis, Inc.
GIS Acquisitions
Other

Balance at December 31, 2007
Foreign currency translation adjustment
Acquisition of Veenman B.V.
GIS acquisitions
Purchase Price allocation adjustment – GIS

Balance at December 31, 2008

Production

$ 745
99
—
48

$ 892
21
—
—
—
—

$ 913
(233)
—
—
—

$ 680

Office

$ 807
69
—
—

$ 876
17
1,218
—
30
—4

$2,141
(161)
44
73
120

$2,217

Other

$ 119
1
136
—

$ 256
—
105
26
3

$ 394
(1)
—
—
(108)

$ 285

Total

$1,671
169
136
48

$2,024
38
1,323
26
33
4

$3,448
(395)
44
73
12

$3,182

In 2008, we finalized the GIS purchase price allocation. As a result, the $108 of Goodwill reflected in our Other segment in 2007 was
reallocated to our Office segment. This adjustment aligned goodwill to the reporting unit benefiting from the synergies of the purchase.

Intangible Assets, Net

Intangible assets primarily relate to the Office operating segment. Intangible assets were comprised of the following as of December 31,
2008 and 2007:

Customer base
Distribution network
Trademarks
Technology, patents and non-compete

Total

Weighted
Average
Amortization
Period

14 years
25 years
20 years
6 years

December 31, 2008

December 31, 2007

Gross
Carrying
Amount

$492
123
191
40

$846

Accumulated
Amortization

Net
Amount

$155
44
15
22

$236

$337
79
176
18

$610

Gross
Carrying
Amount

$462
123
175
39

$799

Accumulated
Amortization

Net
Amount

$118
39
6
15

$178

$344
84
169
24

$621

Amortization expense related to intangible assets was $58, $46, and $45 for the years ended December 31, 2008, 2007 and 2006,
respectively, and, excluding the impact of additional acquisitions, is expected to approximate $58 annually from 2009 through 2013.
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.

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Note 9 – Restructuring and Asset Impairment Charges

Reconciliation to Consolidated Statements of Cash Flows

primarily related to: (i) the relocation of certain manufacturing

The net restructuring and asset impairment charges in the Consolidated Statements of Income totaled $429, $(6) and $385 in 2008,
2007 and 2006, respectively. Detailed information related to restructuring program activity during the three years ended December 31,
2008 is outlined below:

Restructuring Activity

Balance December 31, 2005
Restructuring provision
Reversals of prior accruals

Net current year charges(2)
Charges against reserve and currency

Balance December 31, 2006
Restructuring provision
Reversals of prior accruals

Net current year charges(2)
Charges against reserve and currency

Balance December 31, 2007
Restructuring provision
Reversals of prior accruals

Net current year charges(2)
Charges against reserve and currency

Balance December 31, 2008(3)

Severance and
Related Costs

Lease Cancellation
and Other Costs

Asset
Impairments(1)

$ 217
351
(33)

318
(242)

$ 293
27
(38)

(11)
(211)

$ 71
363
(6)

357
(108)

$ 320

$ 19
39
(2)

37
(12)

$ 44
7
(3)

4
(10)

$ 38
20
(1)

19
(25)

$ 32

$ —
30
—

30
(30)

$ —
1
—

1
(1)

$ —
53
—

53
(53)

$ —

Total

$ 236
420
(35)

385
(284)

$ 337
35
(41)

(6)
(222)

$ 109
436
(7)

429
(186)

$ 352

(1)

(2)

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.
Represents amount recognized within the Consolidated Statements of Income for the years shown.

(3) We expect to utilize the majority of the December 31, 2008 restructuring balance in 2009.

Charges to reserve

Asset impairments

Effects of foreign currency and other

non-cash items

(14)

(11)

Cash payments for restructurings

$(131) $(235) $(265)

Year Ended December 31,

2008

2007

2006

$(186) $(222) $(284)

operations including the closing of our toner plant in Oklahoma

City and the consolidation of our manufacturing operations in

Ireland; and (ii) the exit from certain leased and owned facilities as

a result of the actions noted above.

2007 Activity

Restructuring activity was minimal in 2007 and the related charges

primarily reflected changes in estimates in severance costs from

previously recorded actions.

The following table summarizes the total amount of costs incurred

in connection with these restructuring programs by segment for

the three years ended December 31, 2008:

2006 Activity

Production

Office

Other

Total net charges

2008

2007

2006

$190

200

$429

$(6)

(3)

$(6)

$147

138

100

The 2006 charges primarily relate to the elimination of

approximately 3,400 positions primarily in North America and

Europe. The actions associated with these charges primarily include

the following: technical and professional services infrastructure and

global back-office optimization; continued R&D efficiencies and

$385

productivity improvements; supply chain optimization to ensure,

Over the past several years 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. These initiatives primarily include

severance actions and impact all major geographies and segments.

Management continues to evaluate our business and, therefore,

there may be additional 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.

2008 Activity

During 2008, we recorded $357 of net restructuring charges

predominantly consisting of severance and costs related to the

elimination of approximately 4,900 positions primarily in both

North America and Europe. Focus areas for the actions include the

following:

• Improving efficiency and effectiveness of infrastructure

including: marketing, finance, human resources & training.

• Capturing efficiencies in technical services, managed services

and supply chain & manufacturing infrastructure.

• Optimizing product development and engineering resources.

In addition, related to these activities, we also recorded lease

cancellation and other costs of $19 and asset impairment charges

of $53. The lease termination and asset impairment charges

for example, alignment to our global two-tier model

implementation; and selected off-shoring opportunities. The lease

termination and asset impairment charges primarily related to the

relocation of certain manufacturing operations as well as an exit

from certain leased and owned facilities. These charges were offset

by reversals of $35 primarily related to changes in estimates in

severance costs from previously recorded actions.

Note 10 – Supplementary Financial Information

The components of other current assets and other current liabilities

at December 31, 2008 and 2007 were as follows:

Total Other current assets

$ 790

$ 682

Other current assets

Deferred taxes

Restricted cash

Prepaid expenses

Financial derivative instruments

Other

Other current liabilities

Income taxes payable

Other taxes payable

Interest payable

Restructuring reserves

Unearned income

Financial derivative instruments

Product warranties

Dividends payable

Other

2008

2007

$ 305

$ 200

119

307

173

141

325

203

134

683

120

290

179

137

242

694

Total Other current liabilities

$1,769

$1,512

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

2008 is outlined below:

Restructuring Activity

Balance December 31, 2005

Restructuring provision

Reversals of prior accruals

Net current year charges(2)

Charges against reserve and currency

Balance December 31, 2006

Restructuring provision

Reversals of prior accruals

Net current year charges(2)

Charges against reserve and currency

Balance December 31, 2007

Restructuring provision

Reversals of prior accruals

Net current year charges(2)

Charges against reserve and currency

Balance December 31, 2008(3)

Severance and

Related Costs

Lease Cancellation

and Other Costs

Impairments(1)

Total

$ 217

351

(33)

318

(242)

$ 293

(38)

(11)

(211)

$ 71

363

(6)

357

(108)

$ 320

$ 19

(2)

(12)

$ 44

(3)

(10)

$ 38

(1)

(25)

$ 32

Asset

$ —

—

(30)

$ —

—

(1)

$ —

—

(53)

$ —

$ 236

420

(35)

385

(284)

$ 337

(41)

(6)

(222)

$ 109

436

(7)

429

(186)

$ 352

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.

(1)

(2)

Represents amount recognized within the Consolidated Statements of Income for the years shown.

(3) We expect to utilize the majority of the December 31, 2008 restructuring balance in 2009.

Note 9 – Restructuring and Asset Impairment Charges

Reconciliation to Consolidated Statements of Cash Flows

The net restructuring and asset impairment charges in the Consolidated Statements of Income totaled $429, $(6) and $385 in 2008,

2007 and 2006, respectively. Detailed information related to restructuring program activity during the three years ended December 31,

Year Ended December 31,

2008

2007

2006

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Charges to reserve
Asset impairments
Effects of foreign currency and other

$(186) $(222) $(284)
30

non-cash items

(14)

(11)

Cash payments for restructurings

$(131) $(235) $(265)

The following table summarizes the total amount of costs incurred
in connection with these restructuring programs by segment for
the three years ended December 31, 2008:

Production
Office
Other

Total net charges

2008

2007

2006

$190
200
39

$429

$(6)
3
(3)

$(6)

$147
138
100

$385

Over the past several years 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. These initiatives primarily include
severance actions and impact all major geographies and segments.
Management continues to evaluate our business and, therefore,
there may be additional 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.

2008 Activity

During 2008, we recorded $357 of net restructuring charges
predominantly consisting of severance and costs related to the
elimination of approximately 4,900 positions primarily in both
North America and Europe. Focus areas for the actions include the
following:

• Improving efficiency and effectiveness of infrastructure

including: marketing, finance, human resources & training.

• Capturing efficiencies in technical services, managed services

and supply chain & manufacturing infrastructure.

• Optimizing product development and engineering resources.

In addition, related to these activities, we also recorded lease
cancellation and other costs of $19 and asset impairment charges
of $53. The lease termination and asset impairment charges

primarily related to: (i) the relocation of certain manufacturing
operations including the closing of our toner plant in Oklahoma
City and the consolidation of our manufacturing operations in
Ireland; and (ii) the exit from certain leased and owned facilities as
a result of the actions noted above.

2007 Activity

Restructuring activity was minimal in 2007 and the related charges
primarily reflected changes in estimates in severance costs from
previously recorded actions.

2006 Activity

The 2006 charges primarily relate to the elimination of
approximately 3,400 positions primarily in North America and
Europe. The actions associated with these charges primarily include
the following: technical and professional services infrastructure and
global back-office optimization; continued R&D efficiencies and
productivity improvements; supply chain optimization to ensure,
for example, alignment to our global two-tier model
implementation; and selected off-shoring opportunities. The lease
termination and asset impairment charges primarily related to the
relocation of certain manufacturing operations as well as an exit
from certain leased and owned facilities. These charges were offset
by reversals of $35 primarily related to changes in estimates in
severance costs from previously recorded actions.

Note 10 – Supplementary Financial Information

The components of other current assets and other current liabilities
at December 31, 2008 and 2007 were as follows:

2008

2007

Other current assets
Deferred taxes
Restricted cash
Prepaid expenses
Financial derivative instruments
Other

Total Other current assets

Other current liabilities
Income taxes payable
Other taxes payable
Interest payable
Restructuring reserves
Unearned income
Financial derivative instruments
Product warranties
Dividends payable
Other

$ 305
20
119
39
307

$ 790

47
173
141
325
203
134
25
38
683

$ 200
45
120
27
290

$ 682

84
179
137
81
242
30
25
40
694

Total Other current liabilities

$1,769

$1,512

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

The components of other long-term assets and other long-term
liabilities at December 31, 2008 and 2007 were as follows:

Other long-term assets
Prepaid pension costs
Net investment in discontinued operations(1)
Internal use software, net
Restricted cash
Debt issuance costs, net
Other

2008

2007

61
259
288
183
48
318

$ 322
277
270
219
47
293

Total Other long-term assets

$1,157

$1,428

Other long-term liabilities
Deferred and other tax liabilities
Minorities’ interests in equity of subsidiaries
Financial derivative instruments
Other

$ 182
120
—
392

$ 250
103
14
429

Total Other long-term liabilities

$ 694

$ 796

(1)

At December 31, 2008, our net investment in discontinued operations primarily consists of
a $285 performance-based instrument relating to the 1997 sale of The Resolution Group
(“TRG”) net of remaining net liabilities associated with our discontinued operations of $26.
The recovery of the performance-based instrument is dependent on the sufficiency of
TRG’s available cash flows, as guaranteed by TRG’s ultimate parent, which are expected
to be recovered in annual cash distributions through 2017.

Note 11 – Debt

Long-term debt at December 31, 2008 and 2007 was as follows:

Short-term borrowings at December 31, 2008 and 2007 were as
follows:

Current maturities of long-term debt
Notes payable
France Bridge Facility due 2008
Italy Credit Facility due 2009

Total

2008

2007

$1,549
7
—
54

$426
18
81
—

$1,610

$525

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 Statements of
Income.

Xerox 2008 Annual Report

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Refer to Note 4 – Receivables, Net for further discussion of borrowings secured by finance receivables, net.

(1)

(2)

SFAS No. 133 fair value adjustments represent changes in the fair value of hedged debt obligations attributable to movements in benchmark interest rates. SFAS No. 133 requires hedged debt

instruments to be reported at an amount equal to the sum of their carrying value (principal value plus/minus premiums/discounts) and any fair value adjustment.

$ 6,774

$6,939

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

U.S. Operations

Xerox Corporation

Notes due 2008

Notes due 2011

Senior Notes due 2009

Euro Senior Notes due 2009

Floating Senior Notes due 2009

Senior Notes due 2010

Notes due 2011

Senior Notes due 2011

Credit Facility due 2012

Senior Notes due 2012

Senior Notes due 2013

Convertible Notes due 2014

Notes due 2016

Senior Notes due 2016

Senior Notes due 2017

Senior Notes due 2018

Zero Coupon Notes due 2022

Zero Coupon Notes due 2023

Subtotal

Xerox Credit Corporation

Notes due 2012

Notes due 2013

Notes due 2014

Notes due 2018

Subtotal

Other U.S. Operations

Borrowings secured by finance receivables(1)

Borrowings secured by other assets

Subtotal

Total U.S. Operations

International Operations

Euro Bank Facility due 2008

Other debt due 2009-2010

Total International Operations

Principal debt balance

Less: Unamortized discount

Add: SFAS No. 133 fair value adjustments(2)

Total Debt

Less current maturities

Total Long-term debt

Weighted Average

Interest Rates at

December 31, 2008

2008

2007

$—

—

2.83%

10.75%

10.62%

2.60%

7.13%

7.01%

6.59%

2.21%

5.59%

5.65%

7.63%

9.00%

7.20%

6.48%

6.83%

6.37%

5.77%

5.41%

—

6.42%

6.06%

—

5.59%

10.34%

—

4.12%

1,100

$ 8,002

$ 6,710

583

317

150

700

750

246

400

550

250

700

500

433

253

1,000

—

$ 8,124

8,140

(6)

189

8,323

(1,549)

—

600

330

150

700

750

600

—

550

250

700

500

—

409

—

$ 160

275

$ 283

$ 7,153

177

$ 213

7,366

(13)

7,365

(426)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

The components of other long-term assets and other long-term

liabilities at December 31, 2008 and 2007 were as follows:

Note 11 – Debt

Short-term borrowings at December 31, 2008 and 2007 were as

2008

2007

follows:

$ 322

Net investment in discontinued operations(1)

Other long-term assets

Prepaid pension costs

Internal use software, net

Restricted cash

Debt issuance costs, net

Other

Other long-term liabilities

Deferred and other tax liabilities

Minorities’ interests in equity of subsidiaries

Financial derivative instruments

Other

259

288

183

318

120

—

392

277

270

219

293

103

429

$ 182

$ 250

Total Other long-term assets

$1,157

$1,428

Current maturities of long-term debt

Notes payable

France Bridge Facility due 2008

Italy Credit Facility due 2009

Total

2008

2007

$1,549

$426

—

$1,610

$525

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 Statements of

Total Other long-term liabilities

$ 694

$ 796

Income.

(1)

At December 31, 2008, our net investment in discontinued operations primarily consists of

a $285 performance-based instrument relating to the 1997 sale of The Resolution Group

(“TRG”) net of remaining net liabilities associated with our discontinued operations of $26.

The recovery of the performance-based instrument is dependent on the sufficiency of

TRG’s available cash flows, as guaranteed by TRG’s ultimate parent, which are expected

to be recovered in annual cash distributions through 2017.

Long-term debt at December 31, 2008 and 2007 was as follows:

Weighted Average
Interest Rates at
December 31, 2008

2008

2007

U.S. Operations
Xerox Corporation

Notes due 2008
Notes due 2011
Senior Notes due 2009
Euro Senior Notes due 2009
Floating Senior Notes due 2009
Senior Notes due 2010
Notes due 2011
Senior Notes due 2011
Credit Facility due 2012
Senior Notes due 2012
Senior Notes due 2013
Senior Notes due 2013
Convertible Notes due 2014
Notes due 2016
Senior Notes due 2016
Senior Notes due 2017
Senior Notes due 2018
Zero Coupon Notes due 2022
Zero Coupon Notes due 2023

Subtotal

Xerox Credit Corporation
Notes due 2012
Notes due 2013
Notes due 2014
Notes due 2018

Subtotal

Other U.S. Operations
Borrowings secured by finance receivables(1)
Borrowings secured by other assets

Subtotal

Total U.S. Operations

International Operations

Euro Bank Facility due 2008
Other debt due 2009-2010

Total International Operations

Principal debt balance
Less: Unamortized discount
Add: SFAS No. 133 fair value adjustments(2)

Total Debt
Less current maturities

Total Long-term debt

—
2.83%
10.75%
10.62%
2.60%
7.13%
7.01%
6.59%
2.21%
5.59%
5.65%
7.63%
9.00%
7.20%
6.48%
6.83%
6.37%
5.77%
5.41%

—
6.42%
6.06%
—

5.59%
10.34%

—
4.12%

$—

1
583
317
150
700
50
750
246
1,100
400
550
19
250
700
500
1,000
433
253

—
600
330
150
700
50
750
600
1,100
—
550
19
250
700
500
—
409
—

$ 8,002

$ 6,710

—
10
50
—

56
6

$ 8,124

—
16

8,140
(6)
189

8,323
(1,549)

25
60
50
25

$ 160

275
8

$ 283

$ 7,153

177
36

$ 213

7,366
(13)
12

7,365
(426)

$ 6,774

$6,939

Xerox 2008 Annual Report

(1)

(2)

Refer to Note 4 – Receivables, Net for further discussion of borrowings secured by finance receivables, net.
SFAS No. 133 fair value adjustments represent changes in the fair value of hedged debt obligations attributable to movements in benchmark interest rates. SFAS No. 133 requires hedged debt
instruments to be reported at an amount equal to the sum of their carrying value (principal value plus/minus premiums/discounts) and any fair value adjustment.

Text.indd 69

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Scheduled payments due on long-term debt for the next five years
and thereafter are as follows:

2009

2010

2011

2012

2013

Thereafter

Total

The Credit Facility contains various conditions to borrowing, and
affirmative, negative and financial maintenance covenants.
Certain of the more significant covenants are summarized below:

indebtedness and rank equally with our other existing senior

unsecured indebtedness. Proceeds from the offering were used to

repay borrowings under the Credit Facility and for general

Note 12 – Liability to Subsidiary Trust Issuing

Preferred Securities

$1,549(1) $962 $802 $1,169 $1,138

$2,520 $8,140

(1) Quarterly total debt maturities for 2009 are $937, $12, $442 and $158 for the first,

second, third and fourth quarters, respectively.

The zero coupon notes of $433 due 2022 and $253 due 2023 are
included in the above maturity schedule based on the year of their
first potential put date of 2009 and 2010, respectively.

Credit Facility

The borrowing capacity under our $2 billion Credit Facility was $1.7
billion at December 31, 2008, reflecting $246 outstanding
borrowings and no outstanding letters of credit.

In February 2008, we exercised our right to request a one-year
extension of the maturity date of the Credit Facility. Lenders
representing approximately $1.4 billion (or approximately 70%)
agreed to the extension and the portion represented by these
Lenders now has a maturity date of April 30, 2013, with the
remaining portion of the Credit Facility to mature on April 30, 2012.

The Credit Facility is available, without sublimit, to certain of our
qualifying subsidiaries and includes provisions that would allow us
to increase the overall size of the Credit Facility up to an aggregate
amount of $2.5 billion. Our obligations under the Credit Facility are
unsecured and are not currently guaranteed by any of our
subsidiaries. In the event that any of our subsidiaries borrows
under the Credit Facility, its borrowings thereunder would be
guaranteed by us.

In October 2008, we amended our Credit Facility to increase the
permitted leverage ratio (debt/consolidated EBITDA) and modify
the pricing on borrowings. The following description of the key
terms and conditions of the Credit Facility reflect the changes from
the amendment.

Borrowings under the Credit Facility bear interest at LIBOR plus an
all-in spread that will vary between 1.25% and 4.00% subject to
our credit rating and our percentage utilization of the facility, in
each case, at the time of borrowing. Based upon our current credit
rating and utilization, the all-in spread was 1.75% as of
December 31, 2008.

(a) Maximum leverage ratio (debt divided by consolidated
EBITDA) calculated quarterly and at the date of each borrowing of
3.75.

(b) Minimum interest coverage ratio (a quarterly test that is
calculated as consolidated EBITDA divided by consolidated interest
expense) may not be less than 3.00:1.

(c) Limitations on (i) liens securing debt of Xerox and certain of our
subsidiaries, (ii) certain fundamental changes to corporate
structure, (iii) changes in nature of business and (iv) limitations on
debt incurred by certain subsidiaries.

The Credit Facility also contains various events of default, the
occurrence of which could result in a termination by the lenders
and the acceleration of all our obligations under the Credit Facility.
These events of default include, without limitation: (i) payment
defaults, (ii) breaches of covenants under the Credit Facility
(certain of which breaches do not have any grace period),
(iii) cross-defaults and acceleration to certain of our other
obligations and (iv) a change of control of Xerox.

Private Placement Transaction

In September 2008, we issued $250 of zero coupon notes in a
private placement transaction. The bonds mature in 2023 and the
final amount due at maturity is $709. The bonds are putable
annually at the option of the bond holder beginning in September
2010.

Senior Notes Offerings

In April 2008, we issued $400 of 5.65% senior notes due 2013 (the
“2013 Senior Notes”) at 99.996 percent of par and $1.0 billion of
6.35% senior notes due 2018 (the “2018 Senior Notes”) at 99.856
percent of par, resulting in net proceeds of approximately $1,390.
The 2013 Senior Notes accrue interest at the rate of 5.65% per
annum, payable semiannually, and as a result of the discount, have
a weighted average effective interest rate of 5.65%. The 2018
Senior Notes accrue interest at the rate of 6.35% per annum,
payable semiannually, and as a result of the discount, have a
weighted average effective interest rate of 6.37%. Debt issuance
costs of approximately $10 were deferred. The 2013 Senior Notes
and 2018 Senior Notes are subordinated to our secured

corporate purposes.

Guarantees

At December 31, 2008, we have issued guarantees of $139 to our

foreign subsidiaries. Of this amount, $67 is related to indebtedness

of our foreign subsidiaries and is included in our Consolidated

Balance Sheet as of December 31, 2008 with the remainder

primarily representing letters of credit. In addition, as of December

31, 2008, $55 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 $527,

$552 and $512 for the years ended December 31, 2008, 2007 and

2006, respectively.

Interest expense and interest income for the three years ended

December 31, 2008 was as follows:

Interest expense(1)

Interest income(2)

2008

$567

$833

2007

$579

$877

2006

$544

$909

(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 the estimated level of debt required

to support our net finance receivables. The estimated cost of funds

is based on a blended rate for term and duration comparable to

available borrowing rates for a BBB rated company, which are

The Liability to Subsidiary Trust Issuing Preferred Securities included

in our Consolidated Balance Sheets of $648 and $632 as of

December 31, 2008 and 2007, respectively, reflects our obligations

to Xerox Capital Trust I (“Trust I”) as a result of their loans to us from

proceeds related to their issuance of preferred securities. This

subsidiary is not consolidated in our financial statements because

we are not the primary beneficiary of the trust.

In 1997, 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, was $54 in 2008, 2007 and 2006. We

have guaranteed, on a subordinated basis, distributions and other

payments due on the Preferred Securities. The guarantee, our

obligations under the Debentures, the indenture pursuant to which

the Debentures were issued and our obligations under the

Amended 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

reviewed at the end of each period. The estimated level of debt is

thousand dollars per share plus accrued and unpaid distributions to

based on an assumed 7 to 1 leverage ratio of debt/equity as

compared to our average finance receivable balance during the

the date fixed for redemption.

applicable period.

Note 13 – Financial Instruments

Net cash proceeds on debt other than secured borrowings as

shown on the Consolidated Statements of Cash Flows for the three

years ended December 31, 2008 was as follows:

2008

2007

2006

Cash payments on notes payable,

net

$ (238) $ (143) $ (19)

Net cash proceeds from issuance of

long-term debt

Cash payments on long-term debt

1,883

(719)

2,254

(297)

1,502

(207)

Net cash proceeds on other debt

$ 926 $1,814 $1,276

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 to reduce earnings

and cash flow volatility resulting from shifts in market rates. We

enter into limited types of derivative contracts, including interest

rate swap agreements, foreign currency spot, forward and swap

contracts and net purchased foreign currency options to manage

interest rate and foreign currency exposures. Our primary foreign

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Scheduled payments due on long-term debt for the next five years

The Credit Facility contains various conditions to borrowing, and

and thereafter are as follows:

2009

2010

2011

2012

2013

Thereafter

Total

affirmative, negative and financial maintenance covenants.

Certain of the more significant covenants are summarized below:

$1,549(1) $962 $802 $1,169 $1,138

$2,520 $8,140

(a) Maximum leverage ratio (debt divided by consolidated

(1) Quarterly total debt maturities for 2009 are $937, $12, $442 and $158 for the first,

second, third and fourth quarters, respectively.

3.75.

The zero coupon notes of $433 due 2022 and $253 due 2023 are

included in the above maturity schedule based on the year of their

first potential put date of 2009 and 2010, respectively.

Credit Facility

(b) Minimum interest coverage ratio (a quarterly test that is

calculated as consolidated EBITDA divided by consolidated interest

expense) may not be less than 3.00:1.

subsidiaries, (ii) certain fundamental changes to corporate

borrowings and no outstanding letters of credit.

In February 2008, we exercised our right to request a one-year

extension of the maturity date of the Credit Facility. Lenders

representing approximately $1.4 billion (or approximately 70%)

agreed to the extension and the portion represented by these

Lenders now has a maturity date of April 30, 2013, with the

remaining portion of the Credit Facility to mature on April 30, 2012.

The Credit Facility is available, without sublimit, to certain of our

qualifying subsidiaries and includes provisions that would allow us

to increase the overall size of the Credit Facility up to an aggregate

amount of $2.5 billion. Our obligations under the Credit Facility are

unsecured and are not currently guaranteed by any of our

subsidiaries. In the event that any of our subsidiaries borrows

under the Credit Facility, its borrowings thereunder would be

guaranteed by us.

In October 2008, we amended our Credit Facility to increase the

permitted leverage ratio (debt/consolidated EBITDA) and modify

the pricing on borrowings. The following description of the key

terms and conditions of the Credit Facility reflect the changes from

the amendment.

Borrowings under the Credit Facility bear interest at LIBOR plus an

all-in spread that will vary between 1.25% and 4.00% subject to

our credit rating and our percentage utilization of the facility, in

rating and utilization, the all-in spread was 1.75% as of

December 31, 2008.

The Credit Facility also contains various events of default, the

occurrence of which could result in a termination by the lenders

and the acceleration of all our obligations under the Credit Facility.

These events of default include, without limitation: (i) payment

defaults, (ii) breaches of covenants under the Credit Facility

(certain of which breaches do not have any grace period),

(iii) cross-defaults and acceleration to certain of our other

obligations and (iv) a change of control of Xerox.

Private Placement Transaction

In September 2008, we issued $250 of zero coupon notes in a

private placement transaction. The bonds mature in 2023 and the

final amount due at maturity is $709. The bonds are putable

annually at the option of the bond holder beginning in September

2010.

Senior Notes Offerings

In April 2008, we issued $400 of 5.65% senior notes due 2013 (the

“2013 Senior Notes”) at 99.996 percent of par and $1.0 billion of

6.35% senior notes due 2018 (the “2018 Senior Notes”) at 99.856

percent of par, resulting in net proceeds of approximately $1,390.

The 2013 Senior Notes accrue interest at the rate of 5.65% per

annum, payable semiannually, and as a result of the discount, have

Senior Notes accrue interest at the rate of 6.35% per annum,

payable semiannually, and as a result of the discount, have a

weighted average effective interest rate of 6.37%. Debt issuance

costs of approximately $10 were deferred. The 2013 Senior Notes

and 2018 Senior Notes are subordinated to our secured

each case, at the time of borrowing. Based upon our current credit

a weighted average effective interest rate of 5.65%. The 2018

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

indebtedness and rank equally with our other existing senior
unsecured indebtedness. Proceeds from the offering were used to
repay borrowings under the Credit Facility and for general
corporate purposes.

EBITDA) calculated quarterly and at the date of each borrowing of

Guarantees

At December 31, 2008, we have issued guarantees of $139 to our
foreign subsidiaries. Of this amount, $67 is related to indebtedness
of our foreign subsidiaries and is included in our Consolidated
Balance Sheet as of December 31, 2008 with the remainder
primarily representing letters of credit. In addition, as of December
31, 2008, $55 of letters of credit have been issued in connection
with insurance guarantees.

The borrowing capacity under our $2 billion Credit Facility was $1.7

structure, (iii) changes in nature of business and (iv) limitations on

billion at December 31, 2008, reflecting $246 outstanding

debt incurred by certain subsidiaries.

Interest

Interest paid on our short-term debt, long-term debt and liabilities
to subsidiary trusts issuing preferred securities amounted to $527,
$552 and $512 for the years ended December 31, 2008, 2007 and
2006, respectively.

Interest expense and interest income for the three years ended
December 31, 2008 was as follows:

Interest expense(1)
Interest income(2)

2008

$567
$833

2007

$579
$877

2006

$544
$909

(1)

(2)

Includes Equipment financing interest expense, as well as, non-financing interest expense
included in Other expenses, net in the Consolidated Statements of Income.
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 the estimated level of debt required
to support our net finance receivables. The estimated cost of funds
is based on a blended rate for term and duration comparable to
available borrowing rates for a BBB rated company, which are
reviewed at the end of each period. The estimated level of debt is
based on an assumed 7 to 1 leverage ratio of debt/equity as
compared to our average finance receivable balance during the
applicable period.

Net cash proceeds on debt other than secured borrowings as
shown on the Consolidated Statements of Cash Flows for the three
years ended December 31, 2008 was as follows:

2008

2007

2006

Cash payments on notes payable,

net

$ (238) $ (143) $ (19)

Net cash proceeds from issuance of

long-term debt

Cash payments on long-term debt

1,883
(719)

2,254
(297)

1,502
(207)

Net cash proceeds on other debt

$ 926 $1,814 $1,276

Note 12 – Liability to Subsidiary Trust Issuing
Preferred Securities

The Liability to Subsidiary Trust Issuing Preferred Securities included
in our Consolidated Balance Sheets of $648 and $632 as of
December 31, 2008 and 2007, respectively, reflects our obligations
to Xerox Capital Trust I (“Trust I”) as a result of their loans to us from
proceeds related to their issuance of preferred securities. This
subsidiary is not consolidated in our financial statements because
we are not the primary beneficiary of the trust.

In 1997, 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, was $54 in 2008, 2007 and 2006. We
have guaranteed, on a subordinated basis, distributions and other
payments due on the Preferred Securities. The guarantee, our
obligations under the Debentures, the indenture pursuant to which
the Debentures were issued and our obligations under the
Amended 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.

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 to reduce earnings
and cash flow volatility resulting from shifts in market rates. We
enter into limited types of derivative contracts, including interest
rate swap agreements, foreign currency spot, forward and swap
contracts and net purchased foreign currency options to manage
interest rate and foreign currency exposures. Our primary foreign

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

currency market exposures include the Yen, Euro, and Pound
Sterling. 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.

We are required to recognize all derivative instruments as either
assets or liabilities at fair value in the balance sheet. As permitted,
certain of these derivative contracts have been designated for
hedge accounting treatment. Certain of our derivatives that do not
qualify for hedge accounting are effective as economic hedges.
These derivative contracts are likewise required to be recognized
each period at fair value and therefore do result in 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. The related
cash flow impacts of all of our derivative activities are reflected as
cash flows from operating activities.

By their nature, all derivative instruments involve, to varying
degrees, elements of market and credit risk. 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.

Interest Rate Risk Management

We use interest rate swap agreements 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.

Fair Value Hedges

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting
loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings. As of December 31, 2008 and 2007, pay
variable/receive fixed interest rate swaps with notional amounts of $675 and $1.1 billion with a net asset (liability) fair value of $53 and
$(6), 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
2008, 2007, or 2006. The following is a summary of our fair value hedges at December 31, 2008:

Debt Instrument

Year First
Designated

Notional
Amount

Notes due 2016
Senior Notes due 2011
Liability to Capital Trust I

Total

2004
2004
2005

$250
125
300

$675

Weighted
Average
Interest
Rate Paid

5.43%
5.28%
5.64%

Net
Fair
Value

$39
8
6

$53

Interest
Rate Received

7.20%
6.88%
8.00%

Basis

Libor
Libor
Libor

Maturity

2016
2011
2027

Cash Flow Hedges

During 2008, pay fixed/receive variable interest rate swaps with

notional amounts of $150 and a net liability fair value of $2 were

designated and accounted for as cash flow hedges. The swaps

were structured to hedge the LIBOR interest rate of the floating

Senior Notes due 2009 by converting it from a variable rate

instrument to a fixed rate instrument. No ineffective portion was

At December 31, 2008, we had outstanding forward exchange and

purchased option contracts with gross notional values of $2.6

billion which is reflective of the amounts that are normally

outstanding at any point during the year. The following is a

summary of the primary hedging positions and corresponding fair

values held as of December 31, 2008:

recorded to earnings during 2008 and all components of the

Currency Hedged (Buy/Sell)

derivative gain or loss was included in the assessment of hedged

effectiveness.

Terminated Swaps

During the period from 2004 to 2008, we terminated several

interest rate swaps which had been designated as fair value

hedges of certain debt instruments. These terminated interest rate

swaps had an aggregate notional value of $4.2 billion including

$1.6 billion terminated in 2008. The associated net fair value

adjustments to the debt instruments are being amortized to

interest expense over the remaining term of the related notes. In

2008, 2007 and 2006, the amortization of these fair value

adjustments reduced interest expense by $12, $9 and $9,

U.K. Pound Sterling/Euro

Euro/U.S. Dollar

U.S. Dollar/Euro

Swedish Kronor/Euro

Swiss Franc/Euro

Japanese Yen/U.S. Dollar

Japanese Yen/Euro

Euro/U.K. Pound Sterling

U.S. Dollar/Canadian Dollar

Canadian Dollar/Euro

Canadian Dollar/U.S. Dollar

All Other

Total

Gross

Notional

Value

$ 628

Fair Value

Asset

(Liability)(1)

$(85)

555

308

112

184

110

243

149

180

(6)

(9)

(8)

—

(2)

$2,600

$(93)

respectively, and we expect to record a net decrease in interest

(1)

Represents the net receivable (payable) amount included in the Consolidated Balance

expense of $116 in future years through 2027.

Sheet at December 31, 2008.

Foreign Exchange Risk Management

Cash Flow Hedges

We may use certain derivative instruments to manage the

exposures associated with the foreign currency exchange risks

discussed below.

Foreign Currency Denominated Assets and Liabilities

We designate a portion of our foreign currency derivative contracts

as cash flow hedges of our foreign currency denominated

inventory purchases and sales. The changes in fair value for these

contracts were reported in Accumulated other comprehensive loss

and reclassified to Cost of sales and revenue in the period or

periods during which the related inventory was sold to a third party.

We generally utilize forward foreign exchange contracts and

No amount of ineffectiveness was recorded in the Consolidated

purchased option contracts to hedge these exposures. Changes in

Statements of Income for these designated cash flow hedges and

the value of these currency derivatives are recorded in earnings

all components of each derivative’s gain or loss was included in the

together with the offsetting foreign exchange gains and losses on

assessment of hedge effectiveness. As of December 31, 2008, the

the underlying assets and liabilities.

net liability fair value of these contracts was $1.

Forecasted Purchases and Sales in Foreign Currency

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. A portion of these contracts are designated as cash-flow

hedges.

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

currency market exposures include the Yen, Euro, and Pound

By their nature, all derivative instruments involve, to varying

Sterling. The fair market values of all our derivative contracts

degrees, elements of market and credit risk. The market risk

change with fluctuations in interest rates and/or currency rates and

associated with these instruments resulting from currency

are designed so that any changes in their values are offset by

exchange and interest rate movements is expected to offset the

changes in the values of the underlying exposures. Derivative

market risk of the underlying transactions, assets and liabilities

financial instruments are held solely as risk management tools and

being hedged. We do not believe there is significant risk of loss in

not for trading or speculative purposes.

We are required to recognize all derivative instruments as either

assets or liabilities at fair value in the balance sheet. As permitted,

certain of these derivative contracts have been designated for

hedge accounting treatment. Certain of our derivatives that do not

qualify for hedge accounting are effective as economic hedges.

These derivative contracts are likewise required to be recognized

each period at fair value and therefore do result in 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. The related

cash flow impacts of all of our derivative activities are reflected as

cash flows from operating activities.

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.

Interest Rate Risk Management

We use interest rate swap agreements 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.

Fair Value Hedges

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting

loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings. As of December 31, 2008 and 2007, pay

variable/receive fixed interest rate swaps with notional amounts of $675 and $1.1 billion with a net asset (liability) fair value of $53 and

$(6), 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

2008, 2007, or 2006. The following is a summary of our fair value hedges at December 31, 2008:

Debt Instrument

Year First

Designated

Notional

Amount

Notes due 2016

Senior Notes due 2011

Liability to Capital Trust I

Total

2004

2005

$250

125

300

$675

Weighted

Average

Interest

Rate Paid

5.43%

5.28%

5.64%

Net

Fair

Value

$39

$53

Interest

Rate Received

7.20%

6.88%

8.00%

Basis

Libor

Maturity

2016

2011

2027

Cash Flow Hedges

During 2008, pay fixed/receive variable interest rate swaps with
notional amounts of $150 and a net liability fair value of $2 were
designated and accounted for as cash flow hedges. The swaps
were structured to hedge the LIBOR interest rate of the floating
Senior Notes due 2009 by converting it from a variable rate
instrument to a fixed rate instrument. No ineffective portion was
recorded to earnings during 2008 and all components of the
derivative gain or loss was included in the assessment of hedged
effectiveness.

Terminated Swaps

During the period from 2004 to 2008, we terminated several
interest rate swaps which had been designated as fair value
hedges of certain debt instruments. These terminated interest rate
swaps had an aggregate notional value of $4.2 billion including
$1.6 billion terminated in 2008. The associated net fair value
adjustments to the debt instruments are being amortized to
interest expense over the remaining term of the related notes. In
2008, 2007 and 2006, the amortization of these fair value
adjustments reduced interest expense by $12, $9 and $9,
respectively, and we expect to record a net decrease in interest
expense of $116 in future years through 2027.

At December 31, 2008, we had outstanding forward exchange and
purchased option contracts with gross notional values of $2.6
billion which is reflective of the amounts that are normally
outstanding at any point during the year. The following is a
summary of the primary hedging positions and corresponding fair
values held as of December 31, 2008:

Currency Hedged (Buy/Sell)

U.K. Pound Sterling/Euro
Euro/U.S. Dollar
U.S. Dollar/Euro
Swedish Kronor/Euro
Swiss Franc/Euro
Japanese Yen/U.S. Dollar
Japanese Yen/Euro
Euro/U.K. Pound Sterling
U.S. Dollar/Canadian Dollar
Canadian Dollar/Euro
Canadian Dollar/U.S. Dollar
All Other

Total

Gross
Notional
Value

$ 628
555
308
112
184
110
243
42
16
149
73
180

$2,600

Fair Value
Asset
(Liability)(1)

$(85)
3
(6)
(9)
4
6
(8)
1
—
2
1
(2)

$(93)

(1)

Represents the net receivable (payable) amount included in the Consolidated Balance
Sheet at December 31, 2008.

Foreign Exchange Risk Management

Cash Flow Hedges

We may use certain derivative instruments to manage the
exposures associated with the foreign currency exchange risks
discussed below.

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.

We designate a portion of our foreign currency derivative contracts
as cash flow hedges of our foreign currency denominated
inventory purchases and sales. The changes in fair value for these
contracts were reported in Accumulated other comprehensive loss
and reclassified to Cost of sales and revenue in the period or
periods during which the related inventory was sold to a third party.
No amount of ineffectiveness was recorded in the Consolidated
Statements of Income for these designated cash flow hedges and
all components of each derivative’s gain or loss was included in the
assessment of hedge effectiveness. As of December 31, 2008, the
net liability fair value of these contracts was $1.

Forecasted Purchases and Sales in Foreign Currency

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. A portion of these contracts are designated as cash-flow
hedges.

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

The following tables provide a summary of the fair value amounts of derivative instruments and gains and losses on derivative instruments
at and for the years ended December 31, 2008 and 2007, respectively.

Non Designated Derivatives for the Years Ended December 31, 2008 and 2007

Fair Values of Derivative Instruments at December 31, 2008 and 2007

Designation of Derivatives

Derivatives designated as hedging instruments

Derivatives NOT designated as hedging instruments

Balance Sheet Location

Other long-term assets:
Interest Rate Swaps

Other current liabilities:
Interest Rate Swaps
Foreign Exchange Contracts – Forwards

Total

Other long-term liabilities:
Interest Rate Swaps

Other current assets:
Foreign Exchange Contracts – Forwards
Foreign Exchange Contracts – Options

Total

Other current liabilities:
Foreign Exchange Contracts – Forwards

Total Derivative Assets
Total Derivative Liabilities

Total Net Derivative Liabilities

Fair Value

2008

2007

$ 53

$ 2
1

$ 3

$—
—

$—

$ 14

$ 39
—

$ 39

$ 26
1

$ 27

$131

$ 31

$ 92
134

$ 35
45

$ (42)

$(10)

Fair Value Hedges and Cash Flow Hedges for the Years Ended December 31, 2008 and 2007

Derivatives in Fair Value Hedging Relationships

Interest Rate Contracts

Location of Gain (Loss)
Recognized In Income

Interest expense

Derivative Gain (Loss)
Recognized in Income

Hedged Item Gain (Loss)
Recognized in Income

2008

$206

2007

$36

2008

2007

$(206)

$(36)

Derivatives in Cash Flow Hedging Relationships

Interest rate contracts
Foreign exchange contracts – forwards

Total Cash Flow Hedges

Derivative Gain (Loss)
Recognized in OCI
(Effective Portion)

2008

2007

$(2)
4

$ 2

$ 9
—

$ 9

Location of Derivative
Gain (Loss) Reclassified
from AOCI into Income
(Effective Portion)

Interest expense
Cost of sales

Gain (Loss) Reclassified
from AOCI to Income
(Effective Portion)

2008

$—

$ 2

2007

$10
(1)

$ 9

Note: No amount of ineffectiveness was recorded in the Consolidated Statements of Income for these designated cash flow hedges and
all components of each derivative’s gain or loss was included in the assessment of hedge effectiveness.

Derivatives Not designated as hedging instruments

Location of Derivative Gain (Loss)

Foreign exchange contracts – forwards

Foreign exchange contracts – options

Other expense

Total Non Designated Derivatives

2008

$(143)

(4)

$(147)

2007

$(10)

$ (7)

Accumulated Other Comprehensive Loss (“AOCL”)

The following table provides a summary of the activity associated

with all of our designated cash flow hedges (interest rate and

foreign currency) reflected in AOCL for the three years ended

December 31, 2008):

• Level 3 – Inputs are derived from valuation techniques in which

one or more significant inputs or value drivers are unobservable.

The following table represents our assets and liabilities measured

at fair value on a recurring basis as of December 31, 2008 and the

basis for that measurement:

Beginning balance, net of tax

Changes in fair value gain (loss)

Reclass to earnings

Ending balance, net of tax

Year Ended December 31,

2008

2007

2006

$ — $ 1

(1)

(5)

(1)

$ — $ — $1

Total

Quoted Prices

Significant

Fair Value

Measurement

December 31,

2008

in Active

Markets for

Identical Asset

(Level 1)

Other

Significant

Observable

Unobservable

Inputs

(Level 2)

Inputs

(Level 3)

Derivative

Assets

Derivative

Liabilities

$ 92

$134

$—

$ 92

$134

$—

Fair Value of Financial Assets and Liabilities

As discussed in Note 1 – Summary of Significant Accounting

Policies, we adopted FAS 157 on January 1, 2008, which among

other things, requires enhanced disclosures about assets and

liabilities measured at fair value on a recurring basis. Our adoption

of FAS 157 was limited to financial assets and liabilities, which

primarily relate to our derivative contracts.

FAS 157 includes a fair value hierarchy that is intended to increase

consistency and comparability in fair value measurements and

related disclosures. The fair value hierarchy is based on inputs to

valuation techniques that are used to measure fair value that are

either observable or unobservable. Observable inputs reflect

assumptions market participants would use in pricing an asset or

liability based on market data obtained from independent sources

while unobservable inputs reflect a reporting entity’s pricing based

upon their own market assumptions.

The fair value hierarchy consists of the following three levels:

• Level 1 – Inputs are quoted prices in active markets for identical

assets or liabilities.

We utilize the income approach to measure fair value for our

derivative assets and liabilities. The income approach uses pricing

models that rely on market observable inputs such as yield curves,

currency exchange rates and forward prices, and therefore are

classified as Level 2.

The estimated fair values of our other financial assets and

liabilities not measured at fair value on a recurring basis at

December 31, 2008 and 2007 were as follows:

Cash and cash equivalents

$1,229 $1,229 $1,099 $1,099

2008

2007

Carrying

Amount

Fair

Value

Carrying

Amount

Fair

Value

2,184

1,610

6,774

2,184

1,593

5,918

2,457

525

6,939

2,457

525

7,176

Accounts receivable, net

Short-term debt

Long-term debt

Liability to subsidiary trust

issuing preferred securities

648

555

632

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

• Level 2 – Inputs are quoted prices for similar assets or liabilities

Long-term debt, as well as our Liability to subsidiary trust issuing

in an active market, quoted prices for identical or similar assets

preferred securities, was estimated based on quoted market prices

or liabilities in markets that are not active, inputs other than

for publicly traded securities or on the current rates offered to us

quoted prices that are observable and market-corroborated

for debt of similar maturities. The difference between the fair value

inputs which are derived principally from or corroborated by

and the carrying value represents the theoretical net premium or

observable market data.

discount we would pay or receive to retire all debt at such date.

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

The following tables provide a summary of the fair value amounts of derivative instruments and gains and losses on derivative instruments

Non Designated Derivatives for the Years Ended December 31, 2008 and 2007

at and for the years ended December 31, 2008 and 2007, respectively.

Derivatives Not designated as hedging instruments

Location of Derivative Gain (Loss)

Foreign exchange contracts – forwards
Foreign exchange contracts – options

Other expense
Other expense

Total Non Designated Derivatives

2008

$(143)
(4)

$(147)

2007

$(10)
3

$ (7)

Accumulated Other Comprehensive Loss (“AOCL”)

The following table provides a summary of the activity associated
with all of our designated cash flow hedges (interest rate and
foreign currency) reflected in AOCL for the three years ended
December 31, 2008):

• Level 3 – Inputs are derived from valuation techniques in which
one or more significant inputs or value drivers are unobservable.

The following table represents our assets and liabilities measured
at fair value on a recurring basis as of December 31, 2008 and the
basis for that measurement:

Beginning balance, net of tax
Changes in fair value gain (loss)
Reclass to earnings

Ending balance, net of tax

Year Ended December 31,
2006
2007
2008

$ — $ 1
4
(5)

1
(1)

(1)
1

$ — $ — $1

Total
Fair Value
Measurement
December 31,
2008

Quoted Prices
in Active
Markets for
Identical Asset
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Derivative
Assets

Derivative

Liabilities

$ 92

$134

$—

$ 92

$134

$—

Fair Value of Financial Assets and Liabilities

As discussed in Note 1 – Summary of Significant Accounting
Policies, we adopted FAS 157 on January 1, 2008, which among
other things, requires enhanced disclosures about assets and
liabilities measured at fair value on a recurring basis. Our adoption
of FAS 157 was limited to financial assets and liabilities, which
primarily relate to our derivative contracts.

FAS 157 includes a fair value hierarchy that is intended to increase
consistency and comparability in fair value measurements and
related disclosures. The fair value hierarchy is based on inputs to
valuation techniques that are used to measure fair value that are
either observable or unobservable. Observable inputs reflect
assumptions market participants would use in pricing an asset or
liability based on market data obtained from independent sources
while unobservable inputs reflect a reporting entity’s pricing based
upon their own market assumptions.

The fair value hierarchy consists of the following three levels:

• Level 1 – Inputs are quoted prices in active markets for identical

assets or liabilities.

• Level 2 – Inputs are quoted prices for similar assets or liabilities
in an active market, quoted prices for identical or similar assets
or liabilities in markets that are not active, inputs other than
quoted prices that are observable and market-corroborated
inputs which are derived principally from or corroborated by
observable market data.

We utilize the income approach to measure fair value for our
derivative assets and liabilities. The income approach uses pricing
models that rely on market observable inputs such as yield curves,
currency exchange rates and forward prices, and therefore are
classified as Level 2.

The estimated fair values of our other financial assets and
liabilities not measured at fair value on a recurring basis at
December 31, 2008 and 2007 were as follows:

2008

2007

Carrying
Amount

Fair
Value

Carrying
Amount

Fair
Value

Cash and cash equivalents
Accounts receivable, net
Short-term debt
Long-term debt
Liability to subsidiary trust

$1,229 $1,229 $1,099 $1,099
2,457
525
7,176

2,184
1,593
5,918

2,184
1,610
6,774

2,457
525
6,939

issuing preferred securities

648

555

632

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 our Liability to subsidiary trust 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.

Fair Values of Derivative Instruments at December 31, 2008 and 2007

Designation of Derivatives

Balance Sheet Location

Derivatives designated as hedging instruments

Other long-term assets:

Derivatives NOT designated as hedging instruments

Other current assets:

Foreign Exchange Contracts – Forwards

Interest Rate Swaps

Other current liabilities:

Interest Rate Swaps

Total

Other long-term liabilities:

Interest Rate Swaps

Foreign Exchange Contracts – Forwards

Foreign Exchange Contracts – Options

Total

Other current liabilities:

Total Derivative Assets

Total Derivative Liabilities

Total Net Derivative Liabilities

Fair Value

2008

2007

$ 53

$ 2

$ 3

$—

—

$—

$ 14

$ 39

—

$ 39

$ 26

$ 27

$ 92

134

$ 35

$ (42)

$(10)

Foreign Exchange Contracts – Forwards

$131

$ 31

Fair Value Hedges and Cash Flow Hedges for the Years Ended December 31, 2008 and 2007

Derivatives in Fair Value Hedging Relationships

Interest Rate Contracts

Location of Gain (Loss)

Recognized In Income

Interest expense

Derivative Gain (Loss)

Recognized in Income

Hedged Item Gain (Loss)

Recognized in Income

2008

$206

2007

$36

2008

2007

$(206)

$(36)

Derivatives in Cash Flow Hedging Relationships

Interest rate contracts

Foreign exchange contracts – forwards

Total Cash Flow Hedges

Derivative Gain (Loss)

Recognized in OCI

(Effective Portion)

2008

2007

$(2)

$ 2

$ 9

—

$ 9

Location of Derivative

Gain (Loss) Reclassified

from AOCI into Income

(Effective Portion)

Interest expense

Cost of sales

Gain (Loss) Reclassified

from AOCI to Income

(Effective Portion)

2008

$—

$ 2

2007

$10

(1)

$ 9

Note: No amount of ineffectiveness was recorded in the Consolidated Statements of Income for these designated cash flow hedges and

all components of each derivative’s gain or loss was included in the assessment of hedge effectiveness.

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

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.
December 31 is the measurement date for all of our other post-retirement benefit plans, including all of our domestic plans. Refer to
Note 1 – “New Accounting Standards and Accounting Changes” for further information regarding recent accounting changes for our
benefit plans. Information regarding our benefit plans is presented below:

Pension Benefits

Retiree Health

2008

2007

2008

2007

Change in Benefit Obligation
Benefit obligation, January 1
Service cost
Interest cost
Plan participants’ contributions
Plan amendments
Actuarial gain
Acquisitions
Currency exchange rate changes
Curtailments
Benefits paid/settlements
Other *

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
Acquisitions
Currency exchange rate changes
Benefits paid/settlements
Other *

Fair value of plan assets, December 31

Net funded status (including under-funded and

non-funded plans) at December 31

Amounts recognized in the Consolidated Balance Sheets:
Other long-term assets
Accrued compensation and benefit costs
Pension and other benefit liabilities
Post-retirement medical benefits

Net amounts recognized

$10,458
209
(5)
13
1
(550)
20
(1,090)
3
(657)
93

$ 8,495

$ 9,805
(1,527)
299
13
20
(1,049)
(657)
19

$ 6,923

$ 10,467
237
578
12
11
(508)
—
331
(1)
(669)
—

$10,458

$ 9,217
667
298
12
—
280
(669)
—

$ 9,805

$ 1,501
14
84
31
(219)
(251)
—
(23)
—
(135)
—

$ 1,002

$ 1,592
17
87
20
—
(114)
—
21
—
(122)
—

$ 1,501

$—

—
105
30
—
—
(135)
—

—
102
20
—
—
(122)
—

$—

$ (1,572)

$ (653)

$(1,002)

$(1,501)

61
(48)
(1,585)
—

$ (1,572)

322
(48)
(927)
—

$—

(106)
—
(896)

$—

(105)
—
(1,396)

$ (653)

$(1,002)

$(1,501)

Other reflects adjustments associated with the change in measurement dates for several European countries as required by FAS 158. See Note 1 – Summary of Significant Accounting Policies
for additional information.

The pre-tax amounts recognized in Accumulated other comprehensive (income) loss consist of:

Net actuarial loss (gain)
Prior service (credit) cost

Total

Xerox 2008 Annual Report

Pension Benefits

Retiree Health

2008

$ 1,818
(192)

$ 1,626

2007

$ 1,032
(212)

820

2008

(85)
(186)

$ (271)

2007

169
11

$ 180

The accumulated benefit obligation for all defined benefit pension

Our domestic retirement defined benefit plans provide employees

plans was $7,902 and $9,748 at December 31, 2008 and 2007,

a benefit, depending on eligibility, at the greater of (i) the benefit

respectively.

Information for pension plans with an accumulated benefit

obligation in excess of plan assets is presented below:

Aggregate projected benefit obligation

Aggregate accumulated benefit obligation

Aggregate fair value of plan assets

2008

2007

$5,374

5,051

3,821

$1,193

1,109

399

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).

Components of Net Periodic Benefit Cost

Service cost

Interest cost(1)

Expected return on plan assets(2)

Recognized net actuarial loss

Amortization of prior service credit

Recognized curtailment/settlement loss

Net periodic defined benefit cost

Defined contribution plans

Total Net Periodic Benefit Costs

Other Changes in Plan Assets and Benefit Obligations

Recognized in Other Comprehensive Income:

Net actuarial loss (gain)

Prior service cost (credit)

Amortization of net actuarial (loss) gain

Amortization of prior service (cost) credit

Total recognized in other comprehensive income(3)

Total Recognized in Net Periodic Benefit Cost and Other

Pension Benefits

Retiree Health

2008

2007

2006

2008

2007

2006

$ 209

$ 237

$ 244

$ 14

$ 17

732

(802)

104

(16)

355

(21)

—

$ 19

(13)

117

——

(12)

——

102

——

$ 254

$ 315

$ 425

$ 77

$ 102

$117

(5)

(80)

(20)

174

1,062

(70)

1,013

578

(668)

(20)

235

(499)

(108)

(582)

(244)

(219)

—

(114)

—

(10)

(442)

(112)

Comprehensive Income

$1,267

$(267)

$(365)

$ (10)

(1)

Interest cost includes interest expense on non-TRA obligations of $408, $374, and $340 and interest expense (income) directly allocated to TRA participant accounts of $(413), $204, and $392

(2) Expected return on plan assets includes expected investment income on non-TRA assets of $493, $464, and $410 and actual investment income (expense) on TRA assets of $(413), $204, and

for the years ended December 31, 2008, 2007 and 2006, respectively.

$392 for the years ended December 31, 2008, 2007 and 2006, respectively.

(3) Amount represents the pre-tax effect included within other comprehensive income. The net of tax amount and effect of translation adjustments as well as our share of Fuji Xerox benefit plan

changes are included within the Consolidated Statements of Common Shareholders’ Equity. The net after-tax loss (gain) included in other comprehensive (loss) income for the two years ended

December 31, 2008 was $286 and $(382), respectively.

The net actuarial loss and prior service credit for the defined

Pension plan assets consist of both defined benefit plan assets and

benefit pension plans that will be amortized from Accumulated

assets legally restricted to the TRA accounts. The combined

other comprehensive loss into net periodic benefit cost over the

investment results for these plans, along with the results for our

next fiscal year are $20 and $(20), respectively. The net actuarial

other defined benefit plans, are shown above in the actual return

loss and prior service credit for the retiree health benefit plans that

on plan assets caption. To the extent that investment results relate

will be amortized from accumulated other comprehensive loss into

to TRA, such results are charged directly to these accounts as a

net periodic benefit cost over the next fiscal year are less than $1

component of interest cost.

and $(42) respectively.

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

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.

December 31 is the measurement date for all of our other post-retirement benefit plans, including all of our domestic plans. Refer to

Note 1 – “New Accounting Standards and Accounting Changes” for further information regarding recent accounting changes for our

benefit plans. Information regarding our benefit plans is presented below:

Change in Benefit Obligation

Benefit obligation, January 1

Plan participants’ contributions

Service cost

Interest cost

Plan amendments

Actuarial gain

Acquisitions

Currency exchange rate changes

Curtailments

Benefits paid/settlements

Other *

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

Acquisitions

Currency exchange rate changes

Benefits paid/settlements

Other *

Net funded status (including under-funded and

non-funded plans) at December 31

Amounts recognized in the Consolidated Balance Sheets:

Other long-term assets

Accrued compensation and benefit costs

Pension and other benefit liabilities

Post-retirement medical benefits

Net amounts recognized

for additional information.

Net actuarial loss (gain)

Prior service (credit) cost

Total

Xerox 2008 Annual Report

Pension Benefits

Retiree Health

2008

2007

2008

2007

$10,458

$ 10,467

$ 1,501

$ 1,592

237

578

(508)

—

331

(1)

(669)

—

667

298

—

280

(669)

—

(219)

(251)

—

(23)

—

(135)

—

105

—

(135)

—

(114)

(122)

—

102

—

(122)

$ 8,495

$10,458

$ 1,002

$ 1,501

$ 9,217

$—

209

(5)

(550)

(1,090)

(657)

$ 9,805

(1,527)

299

(1,049)

(657)

$ (1,572)

$ (653)

$(1,002)

$(1,501)

(48)

(1,585)

—

$ (1,572)

322

(48)

(927)

—

$—

(106)

—

(896)

$—

(105)

—

(1,396)

$ (653)

$(1,002)

$(1,501)

Pension Benefits

Retiree Health

2008

$ 1,818

(192)

$ 1,626

2007

$ 1,032

(212)

820

2008

(85)

(186)

$ (271)

2007

169

$ 180

Other reflects adjustments associated with the change in measurement dates for several European countries as required by FAS 158. See Note 1 – Summary of Significant Accounting Policies

The pre-tax amounts recognized in Accumulated other comprehensive (income) loss consist of:

Fair value of plan assets, December 31

$ 6,923

$ 9,805

$—

The accumulated benefit obligation for all defined benefit pension
plans was $7,902 and $9,748 at December 31, 2008 and 2007,
respectively.

Information for pension plans with an accumulated benefit
obligation in excess of plan assets is presented below:

Aggregate projected benefit obligation
Aggregate accumulated benefit obligation
Aggregate fair value of plan assets

$5,374
5,051
3,821

$1,193
1,109
399

2008

2007

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).

Components of Net Periodic Benefit Cost
Service cost
Interest cost(1)
Expected return on plan assets(2)
Recognized net actuarial loss
Amortization of prior service credit
Recognized curtailment/settlement loss

Net periodic defined benefit cost
Defined contribution plans

Total Net Periodic Benefit Costs

Other Changes in Plan Assets and Benefit Obligations

Recognized in Other Comprehensive Income:

Net actuarial loss (gain)
Prior service cost (credit)
Amortization of net actuarial (loss) gain
Amortization of prior service (cost) credit
Total recognized in other comprehensive income(3)

Total Recognized in Net Periodic Benefit Cost and Other

Pension Benefits
2007

2008

2006

2008

Retiree Health
2007

$ 209
(5)
(80)
36
(20)
34

174
80

$ 237
578
(668)
75
(20)
33

235
80

$ 244
732
(802)
104
(16)
93

355
70

$ 14
84
—
—
(21)
—

77
—

$ 17
87
——
10
(12)
——

102

——

2006

$ 19
92

19
(13)

117

$ 254

$ 315

$ 425

$ 77

$ 102

$117

1,062
1
(70)
20
1,013

(499)
5
(108)
20
(582)

(244)
(219)
—
21
(442)

(114)
—
(10)
12
(112)

Comprehensive Income

$1,267

$(267)

$(365)

$ (10)

(1)

Interest cost includes interest expense on non-TRA obligations of $408, $374, and $340 and interest expense (income) directly allocated to TRA participant accounts of $(413), $204, and $392
for the years ended December 31, 2008, 2007 and 2006, respectively.

(2) Expected return on plan assets includes expected investment income on non-TRA assets of $493, $464, and $410 and actual investment income (expense) on TRA assets of $(413), $204, and

$392 for the years ended December 31, 2008, 2007 and 2006, respectively.

(3) Amount represents the pre-tax effect included within other comprehensive income. The net of tax amount and effect of translation adjustments as well as our share of Fuji Xerox benefit plan

changes are included within the Consolidated Statements of Common Shareholders’ Equity. The net after-tax loss (gain) included in other comprehensive (loss) income for the two years ended
December 31, 2008 was $286 and $(382), respectively.

The net actuarial loss and prior service credit for the defined
benefit pension plans that will be amortized from Accumulated
other comprehensive loss into net periodic benefit cost over the
next fiscal year are $20 and $(20), respectively. The net actuarial
loss and prior service credit for the retiree health benefit plans that
will be amortized from accumulated other comprehensive loss into
net periodic benefit cost over the next fiscal year are less than $1
and $(42) respectively.

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.

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Xerox 2008 Annual Report

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Plan Amendment

In October 2008, we amended our domestic retiree health benefit
plan to eliminate the subsidy currently paid to current and future
Medicare-eligible retirees effective January 1, 2010. The
amendment resulted in a net decrease of approximately $225 in
the benefit obligation and a corresponding after-tax increase to
shareholders equity. The amendment is also expected to decrease
pre-tax net retiree health benefit expense by approximately $50 in
2009. Retiree health expense may also be impacted by other
factors, including but not limited to changes in the discount rate
and health care costs in the future.

Plan Assets

Current Allocation and Investment Targets
As of the 2008 and 2007 measurement dates, the global pension
plan assets were $6.9 billion and $9.8 billion, respectively. These
assets were invested among several asset classes. None of the
investments include debt or equity securities of Xerox Corporation.
The amount and percentage of assets invested in each asset class
as of December 31, 2008 and 2007 is shown below:

Asset Value

Percentage of
Total Assets

2008

2007

2008

2007

$3,042
3,296
465
120

$6,923

$ 5,060
3,973
720
52

$9,805

44%
47
7
2

52%
40
7
1

100%

Asset Category
Equity securities
Debt securities
Real estate
Other

Total

Our pension plan assets at December 31, 2008, were as follows:
U.S. $3.2 billion; U.K. $2.2 billion; Canada $0.4 billion and Other
$1.1 billion.

Investment strategy: The target asset allocations for our
worldwide plans for 2008 were 50% invested in equities, 42%
invested in fixed income, 7% invested in real estate and 1%
invested in Other. The target asset allocations for our worldwide
plans for 2007 were 50% invested in equities, 42% invested in
fixed income, 7% invested in real estate and 1% invested in Other.

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.

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 diversification and rebalancing. Peer data and
historical returns are reviewed periodically to assess
reasonableness and appropriateness.

Contributions: We expect to contribute approximately $108 to
our worldwide defined benefit pension plans and approximately
$105 to our retiree health benefit plans in 2009. The 2009
expected pension plan contributions do not include any planned
contribution for our domestic tax-qualified defined benefit plans
because none are required due to the availability of a credit
balance which results from funding prior to 2008 in excess of
minimum requirements. This credit balance can be utilized in lieu
of any 2009 pension contributions. However, once the January 1,
2009 actuarial valuations and projected results as of the end of the
2009 measurement year are available, the desirability of
additional contributions will be reassessed. Based on these results,
we may voluntarily decide to contribute to these plans. In 2008
and 2007, after making this assessment, we contributed $165 and
$158, respectively, to our domestic tax qualified plans 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 during the following years:

2009
2010
2011
2012
2013
Years 2014-2018

Pension
Benefits

$ 557
606
603
636
633
3,300

Retiree
Health

$105
99
99
98
97
445

Assumptions

Note 15 – Income and Other Taxes

Weighted-average assumptions used to determine benefit

(Loss) income before income taxes for the three years ended

obligations at the plan measurement dates:

December 31, 2008 were as follows:

Pension Benefits

Retiree Health

2008

2007

2006

2008

2007

2006

Discount rate

6.3% 5.9% 5.3% 6.3% 6.2% 5.8%

Rate of compensation

increase

3.9

4.1

4.1 —(1) —(1) — (1)

Domestic (loss) income

Foreign income

2008

2007

$(662) $ 667

548

771

2006

$429

379

(Loss) income before income taxes

$(114) $1,438

$808

(Benefits) provisions for income taxes for the three years ended

(1) Rate of compensation increase is not applicable to the retiree health benefits as

December 31, 2008 were as follows:

compensation levels do not impact earned benefits.

Weighted-average assumptions used to determine net periodic

benefit cost for years ended December 31:

Federal income taxes

Pension Benefits

Retiree Health

2009 2008 2007

2006

2009 2008 2007

2006

Foreign income taxes

Discount rate 6.3% 5.9% 5.3% 5.2% 6.3% 6.2% 5.8% 5.6%

Expected

return on

plan assets

Rate of

compensation

7.4

7.6

7.8 —(1) —(1) —(1) —(1)

Current

Deferred

Current

Deferred

Current

Deferred

State income taxes

2008

2007

2006

$ (26)

(285)

$ 30

$(448)

118

(43)

144

120

(9)

increase

3.9

4.1

3.9 —(2) —(2) —(2) —(2)

Total

$(231)

$400

$(288)

(1) Expected return on plan assets is not applicable to retiree health benefits as these plans are

(2) Rate of compensation increase is not applicable to retiree health benefits as compensation

not funded.

levels do not impact earned benefits.

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, 2008 was as follows:

Assumed health care cost trend rates at December 31,

U.S. federal statutory income tax rate

35.0% 35.0% 35.0%

2008

2007

Health care 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

9.4%

5.0%

2013

10.4%

5.0%

2013

Assumed health care cost trend rates have a significant effect on

the amounts reported for the health care plans. A one-percentage-

point change in assumed health care cost trend rates would have

the following effects:

One-percentage-point

increase

decrease

Effect on total service and

interest cost

components

Effect on post-retirement

benefit obligation

$ 6

$ (5)

(61)

respectively.

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

Other foreign, including earnings

taxed at different rates

Other

2008

2007

2006

(13.5)

11.1

(14.6)

25.4

58.5

5.9

103.2

(8.4)

0.9

1.1

1.0

1.3

(4.2)

(0.6)

(7.4)

0.7

1.4

(1.8)

1.4

1.8

(62.5)

(0.9)

(10.5)

0.5

Effective income tax rate

202.6% 27.8% (35.6)%

On a consolidated basis, we paid a total of $194, $104, and $76 in

income taxes to federal, foreign and state jurisdictions during the

three years ended December 31, 2008, 2007 and 2006,

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Assumptions

Note 15 – Income and Other Taxes

Weighted-average assumptions used to determine benefit
obligations at the plan measurement dates:

(Loss) income before income taxes for the three years ended
December 31, 2008 were as follows:

Pension Benefits

Retiree Health

2008

2007

2006

2008

2007

2006

6.3% 5.9% 5.3% 6.3% 6.2% 5.8%

Domestic (loss) income
Foreign income

2008

2007

$(662) $ 667
771

548

2006

$429
379

(Loss) income before income taxes

$(114) $1,438

$808

(Benefits) provisions for income taxes for the three years ended
December 31, 2008 were as follows:

Discount rate
Rate of compensation

increase

3.9

4.1

4.1 —(1) —(1) — (1)

(1) Rate of compensation increase is not applicable to the retiree health benefits as

compensation levels do not impact earned benefits.

Weighted-average assumptions used to determine net periodic
benefit cost for years ended December 31:

Pension Benefits

Retiree Health

Federal income taxes

Current
Deferred

2009 2008 2007

2006

2009 2008 2007

2006

Foreign income taxes

Discount rate 6.3% 5.9% 5.3% 5.2% 6.3% 6.2% 5.8% 5.6%
Expected

return on
plan assets

Rate of

compensation
increase

7.4

7.6

7.8 —(1) —(1) —(1) —(1)

3.9

4.1

3.9 —(2) —(2) —(2) —(2)

Current
Deferred
State income taxes
Current
Deferred

Total

2008

2007

2006

$ (26)
(285)

$ 30
92

$(448)
94

118
4

1
(43)

144
120

2
12

50
(9)

11
14

$(231)

$400

$(288)

(1) Expected return on plan assets is not applicable to retiree health benefits as these plans are

not funded.

(2) Rate of compensation increase is not applicable to retiree health benefits as compensation

levels do not impact earned benefits.

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, 2008 was as follows:

Assumed health care cost trend rates at December 31,

2008

2007

Health care 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

9.4%

5.0%

2013

10.4%

5.0%

2013

Assumed health care cost trend rates have a significant effect on
the amounts reported for the health care plans. A one-percentage-
point change in assumed health care cost trend rates would have
the following effects:

One-percentage-point
increase

One-percentage-point
decrease

Effect on total service and

interest cost
components

Effect on post-retirement
benefit obligation

$ 6

$ (5)

(61)

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
Other foreign, including earnings

taxed at different rates

Other

2008

2007

2006

35.0% 35.0% 35.0%
0.9
(13.5)
1.1
11.1

1.4
(1.8)

(14.6)
25.4

1.0
1.3

1.4
1.8

58.5
5.9

103.2
(8.4)

(4.2)
(0.6)

(7.4)
0.7

(62.5)
(0.9)

(10.5)
0.5

Effective income tax rate

202.6% 27.8% (35.6)%

On a consolidated basis, we paid a total of $194, $104, and $76 in
income taxes to federal, foreign and state jurisdictions during the
three years ended December 31, 2008, 2007 and 2006,
respectively.

Xerox 2008 Annual Report

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Plan Amendment

In October 2008, we amended our domestic retiree health benefit

plan to eliminate the subsidy currently paid to current and future

Medicare-eligible retirees effective January 1, 2010. The

amendment resulted in a net decrease of approximately $225 in

the benefit obligation and a corresponding after-tax increase to

shareholders equity. The amendment is also expected to decrease

pre-tax net retiree health benefit expense by approximately $50 in

2009. Retiree health expense may also be impacted by other

factors, including but not limited to changes in the discount rate

and health care costs in the future.

Plan Assets

Current Allocation and Investment Targets

As of the 2008 and 2007 measurement dates, the global pension

plan assets were $6.9 billion and $9.8 billion, respectively. These

assets were invested among several asset classes. None of the

investments include debt or equity securities of Xerox Corporation.

The amount and percentage of assets invested in each asset class

as of December 31, 2008 and 2007 is shown below:

Asset Value

Percentage of

Total Assets

2008

2007

2008

2007

$3,042

3,296

465

120

$ 5,060

3,973

720

44%

52%

$6,923

$9,805

100%

Our pension plan assets at December 31, 2008, were as follows:

U.S. $3.2 billion; U.K. $2.2 billion; Canada $0.4 billion and Other

Asset Category

Equity securities

Debt securities

Real estate

Other

Total

$1.1 billion.

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.

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 diversification and rebalancing. Peer data and

historical returns are reviewed periodically to assess

reasonableness and appropriateness.

Contributions: We expect to contribute approximately $108 to

our worldwide defined benefit pension plans and approximately

$105 to our retiree health benefit plans in 2009. The 2009

expected pension plan contributions do not include any planned

contribution for our domestic tax-qualified defined benefit plans

because none are required due to the availability of a credit

balance which results from funding prior to 2008 in excess of

minimum requirements. This credit balance can be utilized in lieu

of any 2009 pension contributions. However, once the January 1,

2009 actuarial valuations and projected results as of the end of the

2009 measurement year are available, the desirability of

additional contributions will be reassessed. Based on these results,

we may voluntarily decide to contribute to these plans. In 2008

Investment strategy: The target asset allocations for our

and 2007, after making this assessment, we contributed $165 and

worldwide plans for 2008 were 50% invested in equities, 42%

$158, respectively, to our domestic tax qualified plans to make

invested in fixed income, 7% invested in real estate and 1%

them 100% funded on a current liability basis under the ERISA

invested in Other. The target asset allocations for our worldwide

funding rules.

plans for 2007 were 50% invested in equities, 42% invested in

fixed income, 7% invested in real estate and 1% invested in Other.

Estimated future benefit payments: The following benefit

payments, which reflect expected future service, as appropriate,

We employ a total return investment approach whereby a mix of

are expected to be paid during the following years:

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

2009

2010

2011

2012

2013

consideration involves the use of long-term measures that address

both return and risk. The investment portfolio contains a diversified

Years 2014-2018

Pension

Benefits

$ 557

606

603

636

633

3,300

Retiree

Health

$105

445

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Total income tax (benefit) expense for the three years ended
December 31, 2008 was allocated as follows:

Pre-tax income
Common shareholders’ equity:

Defined benefit plans/minimum

pension liability

Stock option and incentive plans, net
Translation adjustments and other

Total

2008

2007

2006

$(231) $ 400 $(288)

(183)
(2)
10

222
(22)
24

(432)
(25)
(9)

$(406) $624 $(754)

Unrecognized Tax Benefits and Audit Resolutions

In 2006, the FASB issued Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes – an Interpretation of FASB
Statement No. 109” (“FIN 48”) which we adopted on January 1,
2007. FIN 48 clarifies the accounting for uncertainty in income
taxes by prescribing a minimum recognition threshold for a tax
position taken or expected to be taken in a tax return that is
required to be met before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition,
measurement, classification, interest and penalties, accounting in
interim periods, disclosure and transition. The cumulative effect of
adopting FIN 48 of $2 was recorded as a reduction to Retained
earnings. The total amount of unrecognized tax benefits as of the
date of adoption was $287.

Due to the extensive geographical scope of our operations, we are
subject to ongoing tax examinations in numerous jurisdictions.
Accordingly, we may record incremental tax expense based upon
the more-likely-than-not outcomes of any uncertain tax positions.
In addition, when applicable, we adjust the previously recorded tax
expense to reflect examination results when the position is
effectively settled. Our ongoing assessments of the more-likely-
than-not outcomes of the examinations and related tax positions
require judgment and can increase or decrease our effective tax
rate, as well as impact our operating results. The specific timing of
when the resolution of each tax position will be reached is
uncertain. As of December 31, 2008, we do not believe that there
are any positions for which it is reasonably possible that the total
amount of unrecognized tax benefits will significantly increase or
decrease within the next 12 months.

Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:

Balance at January 1
Additions from acquisitions
Additions related to current year
Additions related to prior years positions
Reductions related to prior years positions
Settlements with taxing authorities (1)
Reductions related to lapse of statute of

limitations

Currency

2008

$303
—
12
13
(65)
(28)

(45)
(20)

2007

$287
4
33
78
(33)
(66)

(14)
14

Balance at December 31

$170

$303

(1) Majority of settlements did not result in the utilization of cash.

Included in the balance at December 31, 2008 and 2007 are $67
and $137, respectively, of tax positions that are highly certain of
realizability but for which there is uncertainty about the timing or
may be reduced through an indirect benefit from other taxing
jurisdictions. Because of the impact of deferred tax accounting,
other than for the possible incurrence of interest and penalties, the
disallowance of these positions would not affect the annual
effective tax rate.

We have filed claims in certain jurisdictions to assert our position
should the law be clarified by judicial means. At this point in time,
we believe it is unlikely that we will receive any benefit from these
types of claims but we will continue to analyze as the issues
develop. Accordingly, we have not included any benefit for these
types of claims in the amount of unrecognized tax benefits.

We recognized interest and penalties accrued on unrecognized tax
benefits as well as interest received from favorable settlements
within income tax expense. We had $22 and $23 accrued for the
payment of interest and penalties associated with unrecognized
tax benefits at December 31, 2008 and 2007, respectively.

We file income tax returns in the U.S. federal jurisdiction and
various foreign jurisdictions. In the U.S. we are no longer subject to
U.S. federal income tax examinations by tax authorities for years
before 2007. With respect to our major foreign jurisdictions, we are
no longer subject to tax examinations by tax authorities before
2000.

Audit Resolution

The tax effects of temporary differences that give rise to

In 2006, we recognized an income tax benefits of $472 from the

significant portions of the deferred taxes at December 31, 2008

favorable resolution of certain tax issues associated with the

and 2007 were as follows:

finalization of our 1999-2003 Internal Revenue Service (“IRS”)

audit as well as an income tax benefits of $46 related to the

favorable resolution of certain tax matters associated with the

finalization of foreign tax audits. The recorded benefits did not

result in a significant cash refund, but it did increase tax credit

carryforwards and reduced taxes otherwise potentially due.

Deferred Income Taxes

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

In substantially all instances, deferred income taxes have not been

Allowance for doubtful accounts

provided on the undistributed earnings of foreign subsidiaries and

Restructuring reserves

other foreign investments carried at equity. The amount of such

earnings included in consolidated retained earnings at

December 31, 2008 was approximately $7.5 billion. These earnings

Pension

Other

have been indefinitely reinvested and we currently do not plan to

Valuation allowance

initiate any action that would precipitate the payment of income

taxes thereon. It is not practicable to estimate the amount of

Total

additional tax that might be payable on the foreign earnings. Our

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.

Tax effect of future taxable income

Unearned income and installment

Intangibles and goodwill

sales

Other

Total

Total deferred taxes, net

2008

2007

$ 930

$ 895

392

249

486

249

552

248

373

182

577

292

576

216

434

249

100

181

3,833

(628)

3,593

(747)

$ 3,205

$ 2,846

$(1,119)

$(1,283)

(160)

(53)

(142)

(40)

(1,332)

(1,465)

$ 1,873

$ 1,381

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, 2008 and 2007 amounted to $305 and $200,

respectively.

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 net change

in the total valuation allowance for the years ended December 31,

2008 and 2007 was a decrease of $119 and an increase of $100,

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.

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Total income tax (benefit) expense for the three years ended

Unrecognized Tax Benefits

December 31, 2008 was allocated as follows:

A reconciliation of the beginning and ending amount of

Pre-tax income

Common shareholders’ equity:

Defined benefit plans/minimum

2008

2007

2006

$(231) $ 400 $(288)

unrecognized tax benefits is as follows:

Balance at January 1

Additions from acquisitions

pension liability

Stock option and incentive plans, net

Translation adjustments and other

(183)

(2)

222

(22)

(432)

Additions related to current year

(25)

(9)

Additions related to prior years positions

Reductions related to prior years positions

Total

$(406) $624 $(754)

Unrecognized Tax Benefits and Audit Resolutions

In 2006, the FASB issued Interpretation No. 48, “Accounting for

Uncertainty in Income Taxes – an Interpretation of FASB

Statement No. 109” (“FIN 48”) which we adopted on January 1,

2007. FIN 48 clarifies the accounting for uncertainty in income

taxes by prescribing a minimum recognition threshold for a tax

position taken or expected to be taken in a tax return that is

required to be met before being recognized in the financial

statements. FIN 48 also provides guidance on derecognition,

measurement, classification, interest and penalties, accounting in

interim periods, disclosure and transition. The cumulative effect of

adopting FIN 48 of $2 was recorded as a reduction to Retained

earnings. The total amount of unrecognized tax benefits as of the

date of adoption was $287.

Due to the extensive geographical scope of our operations, we are

subject to ongoing tax examinations in numerous jurisdictions.

Accordingly, we may record incremental tax expense based upon

the more-likely-than-not outcomes of any uncertain tax positions.

In addition, when applicable, we adjust the previously recorded tax

expense to reflect examination results when the position is

effectively settled. Our ongoing assessments of the more-likely-

than-not outcomes of the examinations and related tax positions

require judgment and can increase or decrease our effective tax

rate, as well as impact our operating results. The specific timing of

when the resolution of each tax position will be reached is

uncertain. As of December 31, 2008, we do not believe that there

are any positions for which it is reasonably possible that the total

amount of unrecognized tax benefits will significantly increase or

decrease within the next 12 months.

2008

$303

2007

$287

—

(65)

(28)

(45)

(20)

(33)

(66)

(14)

Settlements with taxing authorities (1)

Reductions related to lapse of statute of

limitations

Currency

Balance at December 31

$170

$303

(1) Majority of settlements did not result in the utilization of cash.

Included in the balance at December 31, 2008 and 2007 are $67

and $137, respectively, of tax positions that are highly certain of

realizability but for which there is uncertainty about the timing or

may be reduced through an indirect benefit from other taxing

jurisdictions. Because of the impact of deferred tax accounting,

other than for the possible incurrence of interest and penalties, the

disallowance of these positions would not affect the annual

effective tax rate.

We have filed claims in certain jurisdictions to assert our position

should the law be clarified by judicial means. At this point in time,

we believe it is unlikely that we will receive any benefit from these

types of claims but we will continue to analyze as the issues

develop. Accordingly, we have not included any benefit for these

types of claims in the amount of unrecognized tax benefits.

We recognized interest and penalties accrued on unrecognized tax

benefits as well as interest received from favorable settlements

within income tax expense. We had $22 and $23 accrued for the

payment of interest and penalties associated with unrecognized

tax benefits at December 31, 2008 and 2007, respectively.

We file income tax returns in the U.S. federal jurisdiction and

various foreign jurisdictions. In the U.S. we are no longer subject to

U.S. federal income tax examinations by tax authorities for years

before 2007. With respect to our major foreign jurisdictions, we are

no longer subject to tax examinations by tax authorities before

2000.

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Audit Resolution
In 2006, we recognized an income tax benefits of $472 from the
favorable resolution of certain tax issues associated with the
finalization of our 1999-2003 Internal Revenue Service (“IRS”)
audit as well as an income tax benefits of $46 related to the
favorable resolution of certain tax matters associated with the
finalization of foreign tax audits. The recorded benefits did not
result in a significant cash refund, but it did increase tax credit
carryforwards and reduced taxes otherwise potentially due.

Deferred Income Taxes

In substantially all instances, deferred income taxes have not been
provided on the undistributed earnings of foreign subsidiaries and
other foreign investments carried at equity. The amount of such
earnings included in consolidated retained earnings at
December 31, 2008 was approximately $7.5 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
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, 2008
and 2007 were as follows:

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
Pension
Other

Valuation allowance

Total

Tax effect of future taxable income

Unearned income and installment

sales

Intangibles and goodwill
Other

Total

Total deferred taxes, net

2008

2007

$ 930
392
249
486
249
552
248
84
88
373
182

$ 895
577
292
576
216
434
249
100
15
58
181

3,833
(628)

3,593
(747)

$ 3,205

$ 2,846

$(1,119)
(160)
(53)

$(1,283)
(142)
(40)

(1,332)

(1,465)

$ 1,873

$ 1,381

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, 2008 and 2007 amounted to $305 and $200,
respectively.

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 net change
in the total valuation allowance for the years ended December 31,
2008 and 2007 was a decrease of $119 and an increase of $100,
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.

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

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, 2008, we had tax credit carryforwards of $552
available to offset future income taxes, of which $213 are
available to carryforward indefinitely while the remaining $339 will
begin to expire, if not utilized, in 2009. We also had net operating
loss carryforwards for income tax purposes of $345 that will expire
in 2009 through 2024, if not utilized, and $2.3 billion available to
offset future taxable income indefinitely.

Note 16 – Contingencies

Brazil Tax and Labor Contingencies

Our Brazilian operations are involved in various litigation matters
and have received or been the subject of numerous governmental
assessments related to indirect and other taxes as well as disputes
associated with former employees and contract labor. 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 matters and intend to
vigorously defend our position. Based on the opinion of legal
counsel and current reserves for those matters deemed probable of
loss, we do not believe that the ultimate resolution of these
matters will materially impact our results of operations, financial
position or cash flows. The labor matters principally relate to claims
made by former employees and contract labor for the equivalent
payment of all social security and other related labor benefits, as
well as consequential tax claims, as if they were regular employees.
Following our assessment of the most recent trend in the outcomes
of these matters, we reassessed the probable estimated loss and,
as a result, recorded an additional reserve of $36 in 2008. As of
December 31, 2008, the total amounts related to the unreserved
portion of the tax and labor contingencies, inclusive of any related
interest, amounted to approximately $839, with the decrease from
December 31, 2007 balance of $1.1 billion primarily related to
currency partially offset by the additional reserve. In connection
with the above 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, 2008

we had $167 of escrow cash deposits for matters we are disputing
and there are liens on certain Brazilian assets with a net book value
of $30 and additional letters of credit of approximately $88.
Generally, any escrowed amounts would be refundable and any
liens would be removed to the extent the matters are resolved in
our favor. We routinely assess all 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.

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 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.

The following is a summary of significant developments in
litigation matters:

• Carlson v. Xerox Corporation, et al. – settlement reached,

approved by the district court and paid.

• In re Xerox Corp. ERISA Litigation – settlement reached and

preliminary court approval granted.

• Florida State Board of Administration, et al v. Xerox
Corporation, et al. – settlement reached and paid.

• National Union Fire Insurance Company v. Xerox

Corporation, et al. – settlement reached and payment made to
Xerox.

• Digwamaje et al. v. IBM et al. – amended complaint drops

Xerox as a defendant.

• Warren, et al. v. Xerox Corporation – settlement received final

court approval and was paid.

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 is a class action on

behalf of all persons and entities who purchased Xerox Corporation

common stock during the period October 22, 1998 through

October 7, 1999 inclusive (“Class Period”) and who suffered a loss

as a result of misrepresentations or omissions by Defendants as

alleged by Plaintiffs (the “Class”). The Class 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 complaint further alleges that the

alleged scheme: (i) deceived the investing public regarding 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 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. In 2001, the Court denied the

defendants’ motion for dismissal of the complaint. The plaintiffs’

motion for class certification was denied by the Court in 2006,

without prejudice to refiling. In February 2007, the Court granted

the motion of the International Brotherhood of Electrical Workers

Welfare Fund of Local Union No. 164, Robert W. Roten, Robert

Agius (“Agius”) and Georgia Stanley to appoint them as additional

lead plaintiffs. In July 2007, the Court denied plaintiffs’ renewed

motion for class certification, without prejudice to renewal after

the Court holds a pre-filing conference to identify factual disputes

the Court will be required to resolve in ruling on the motion. After

that conference and Agius’s withdrawal as lead plaintiff and

proposed class representative, in February 2008 plaintiffs filed a

second renewed motion for class certification. In April 2008,

Defendants filed their response and motion to disqualify Milberg

LLP as a lead counsel. On September 30, 2008, the Court entered

an order certifying the class and denying the appointment of

Milberg LLP as a lead counsel. The parties have filed motions to

exclude certain expert testimony. Briefing with respect to those

motions is complete. The Court has not yet rendered a decision. On

November 6, 2008, the defendants filed a motion for summary

judgment, which has not yet been fully briefed. The individual

defendants and we deny any wrongdoing and are vigorously

defending the action. In the course of litigation, we periodically

engage in discussions with plaintiffs’ counsel for possible

resolution of this matter. Should developments cause a change in

our determination as to an unfavorable outcome, or result in a final

adverse judgment or a settlement for a significant amount, there

could be a material adverse effect on our results of operations,

cash flows and financial position in the period in which such

change in determination, judgment or settlement occurs.

Carlson v. Xerox Corporation, et al.: A consolidated securities law

action (consisting of 21 cases) was 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. Plaintiffs

purported to bring this case as a class action on behalf of a 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”). Two claims were asserted:

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; and the other alleging that the individual

defendants are also liable as “controlling persons” of the Company

pursuant to Section 20(a) of the 1934 Act. Plaintiffs claimed that

the defendants participated in a fraudulent 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 alleged that this scheme

deceived the investing public regarding the true state of the

Company’s financial condition and caused the plaintiffs and other

members of the purported Class to purchase the Company’s

common stock and bonds at artificially inflated prices. On

March 27, 2008, the Court granted preliminary approval of an

agreement to settle this case, pursuant to which the Company

agreed to make cash payments totaling $670 and KPMG agreed to

make cash payments totaling $80. The individual defendants and

the Company did not admit any wrongdoing as a part of the

settlement. On January 15, 2009, the Court entered an order and

final judgment approving the settlement, awarding attorneys’ fees

and expenses, and dismissing the action with prejudice. The

Company’s portion of the settlement amount has been paid. On

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Although realization is not assured, we have concluded that it is

we had $167 of escrow cash deposits for matters we are disputing

more-likely-than-not that the deferred tax assets for which a

and there are liens on certain Brazilian assets with a net book value

valuation allowance was determined to be unnecessary, will be

of $30 and additional letters of credit of approximately $88.

realized in the ordinary course of operations based on the available

Generally, any escrowed amounts would be refundable and any

positive and negative evidence, including scheduling of deferred

liens would be removed to the extent the matters are resolved in

tax liabilities and projected income from operating activities. The

our favor. We routinely assess all these matters as to probability of

amount of the net deferred tax assets considered realizable,

ultimately incurring a liability against our Brazilian operations and

however, could be reduced in the near term if actual future income

record our best estimate of the ultimate loss in situations where we

or income tax rates are lower than estimated, or if there are

assess the likelihood of an ultimate loss as probable.

differences in the timing or amount of future reversals of existing

taxable or deductible temporary differences.

Legal Matters

At December 31, 2008, we had tax credit carryforwards of $552

As more fully discussed below, we are involved in a variety of

available to offset future income taxes, of which $213 are

claims, lawsuits, investigations and proceedings concerning

available to carryforward indefinitely while the remaining $339 will

securities law, intellectual property law, environmental law,

begin to expire, if not utilized, in 2009. We also had net operating

employment law and the Employee Retirement Income Security

loss carryforwards for income tax purposes of $345 that will expire

Act (“ERISA”). We determine whether an estimated loss from a

in 2009 through 2024, if not utilized, and $2.3 billion available to

contingency should be accrued by assessing whether a loss is

offset future taxable income indefinitely.

Note 16 – Contingencies

Brazil Tax and Labor Contingencies

Our Brazilian operations are involved in various litigation matters

and have received or been the subject of numerous governmental

assessments related to indirect and other taxes as well as disputes

associated with former employees and contract labor. 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 matters and intend to

vigorously defend our position. Based on the opinion of legal

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.

counsel and current reserves for those matters deemed probable of

The following is a summary of significant developments in

loss, we do not believe that the ultimate resolution of these

litigation matters:

matters will materially impact our results of operations, financial

position or cash flows. The labor matters principally relate to claims

made by former employees and contract labor for the equivalent

• Carlson v. Xerox Corporation, et al. – settlement reached,

approved by the district court and paid.

payment of all social security and other related labor benefits, as

• In re Xerox Corp. ERISA Litigation – settlement reached and

well as consequential tax claims, as if they were regular employees.

preliminary court approval granted.

Following our assessment of the most recent trend in the outcomes

of these matters, we reassessed the probable estimated loss and,

as a result, recorded an additional reserve of $36 in 2008. As of

• Florida State Board of Administration, et al v. Xerox

Corporation, et al. – settlement reached and paid.

December 31, 2008, the total amounts related to the unreserved

• National Union Fire Insurance Company v. Xerox

portion of the tax and labor contingencies, inclusive of any related

Corporation, et al. – settlement reached and payment made to

interest, amounted to approximately $839, with the decrease from

Xerox.

December 31, 2007 balance of $1.1 billion primarily related to

currency partially offset by the additional reserve. In connection

with the above proceedings, customary local regulations may

• Digwamaje et al. v. IBM et al. – amended complaint drops

Xerox as a defendant.

require us to make escrow cash deposits or post other security of

• Warren, et al. v. Xerox Corporation – settlement received final

up to half of the total amount in dispute. As of December 31, 2008

court approval and was paid.

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 is a class action on
behalf of all persons and entities who purchased Xerox Corporation
common stock during the period October 22, 1998 through
October 7, 1999 inclusive (“Class Period”) and who suffered a loss
as a result of misrepresentations or omissions by Defendants as
alleged by Plaintiffs (the “Class”). The Class 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 complaint further alleges that the
alleged scheme: (i) deceived the investing public regarding 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 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. In 2001, the Court denied the
defendants’ motion for dismissal of the complaint. The plaintiffs’
motion for class certification was denied by the Court in 2006,
without prejudice to refiling. In February 2007, the Court granted
the motion of the International Brotherhood of Electrical Workers
Welfare Fund of Local Union No. 164, Robert W. Roten, Robert
Agius (“Agius”) and Georgia Stanley to appoint them as additional
lead plaintiffs. In July 2007, the Court denied plaintiffs’ renewed
motion for class certification, without prejudice to renewal after
the Court holds a pre-filing conference to identify factual disputes
the Court will be required to resolve in ruling on the motion. After
that conference and Agius’s withdrawal as lead plaintiff and
proposed class representative, in February 2008 plaintiffs filed a
second renewed motion for class certification. In April 2008,
Defendants filed their response and motion to disqualify Milberg

LLP as a lead counsel. On September 30, 2008, the Court entered
an order certifying the class and denying the appointment of
Milberg LLP as a lead counsel. The parties have filed motions to
exclude certain expert testimony. Briefing with respect to those
motions is complete. The Court has not yet rendered a decision. On
November 6, 2008, the defendants filed a motion for summary
judgment, which has not yet been fully briefed. The individual
defendants and we deny any wrongdoing and are vigorously
defending the action. In the course of litigation, we periodically
engage in discussions with plaintiffs’ counsel for possible
resolution of this matter. Should developments cause a change in
our determination as to an unfavorable outcome, or result in a final
adverse judgment or a settlement for a significant amount, there
could be a material adverse effect on our results of operations,
cash flows and financial position in the period in which such
change in determination, judgment or settlement occurs.

Carlson v. Xerox Corporation, et al.: A consolidated securities law
action (consisting of 21 cases) was 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. Plaintiffs
purported to bring this case as a class action on behalf of a 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”). Two claims were asserted:
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; and the other alleging that the individual
defendants are also liable as “controlling persons” of the Company
pursuant to Section 20(a) of the 1934 Act. Plaintiffs claimed that
the defendants participated in a fraudulent 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 alleged that this scheme
deceived the investing public regarding the true state of the
Company’s financial condition and caused the plaintiffs and other
members of the purported Class to purchase the Company’s
common stock and bonds at artificially inflated prices. On
March 27, 2008, the Court granted preliminary approval of an
agreement to settle this case, pursuant to which the Company
agreed to make cash payments totaling $670 and KPMG agreed to
make cash payments totaling $80. The individual defendants and
the Company did not admit any wrongdoing as a part of the
settlement. On January 15, 2009, the Court entered an order and
final judgment approving the settlement, awarding attorneys’ fees
and expenses, and dismissing the action with prejudice. The
Company’s portion of the settlement amount has been paid. On

Xerox 2008 Annual Report

Text.indd 83

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

February 9, 2009, three class members filed a notice of appeal of
the Court’s January 15, 2009 order and final judgement and ruling
on motion for award of attorneys fees.

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. Four additional class
actions were subsequently filed, and the five actions were
consolidated as In Re Xerox Corporation ERISA Litigation. 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 defendants 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 alleges that the defendants breached
their fiduciary duties under ERISA to protect the Plan’s assets and
act in the interest of Plan participants. Specifically, plaintiffs allege
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
retirement assets in Xerox stock. The plaintiffs filed a Second
Consolidated Amended Complaint, alleging that some or all
defendants breached their ERISA fiduciary duties during 1997-
2002 by (1) maintaining the Xerox Stock Fund as an investment
option under the Plan; (2) failing to monitor the conduct of Plan
fiduciaries; and (3) misleading Plan participants about Xerox stock
as an investment option under the Plans. The complaint does not
specify the amount of damages sought, but demands that the
losses to the Plans 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. On January 28, 2009. the
Court granted preliminary approval of an agreement to settle this
case, the terms of which are within the amount previously reserved
by the Company for this matter. The Company and the other
defendants do not admit any wrongdoing as a part of the
settlement, which is subject to final Court approval and other
conditions. A fairness hearing has been scheduled for April 13,
2009.

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 complaint on the
Company was deemed effective as of December 6, 2002. The

purported class includes all persons who lived in South Africa at any
time from 1948 until the present and purportedly suffered
damages as a result of human rights violations and crimes against
humanity through the system of apartheid. The defendants
included the Company and a number of other corporate
defendants who were accused of providing material assistance 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 claimed
violations of the Alien Tort Claims Act, the Torture Victims
Protection Act and RICO. They also asserted human rights
violations and crimes against humanity. Plaintiffs sought
compensatory damages in excess of $200 billion and punitive
damages in excess of $200 billion. On October 27, 2008, plaintiffs
filed an amended complaint that did not name the Company as a
defendant, so the Company is no longer a party to the action.

Arbitration between MPI Technologies, Inc. and MPI Tech S.A.
and Xerox Canada Ltd. and Xerox Corporation: In an
arbitration proceeding the hearing of which commenced in
January 2005, MPI Technologies, Inc. and MPI Tech S.A.
(collectively “MPI”) sought damages from the Company and Xerox
Canada Ltd. (“XCL”) for royalties owed under a license agreement
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. In September 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. In December 2005, the arbitration panel
rendered its decision on the applicable rate of pre-judgment
interest resulting in an award of $13 for pre- and post-judgment
interest. In 2006, Xerox’s application for judicial review of the
award, seeking to have the award set aside in its entirety, was
denied by the Ontario Superior Court in Toronto and Xerox
released all monies and software it had placed in escrow. In
January 2007, Xerox and XCL served an arbitration claim against
MPI seeking a declaratory award concerning the preclusive effect
of the remedy awarded by the prior arbitration panel. In
March 2007, MPI delivered to Xerox a statement of defense and
counterclaim in response to Xerox’s arbitration claim. MPI claims
entitlement to an unspecified amount of damages for royalties. In
addition, MPI claims damages of $50 for alleged “misuse” of its
licensed software by Xerox after December 2006. MPI also claims
entitlement to unspecified amounts of pre and post-judgment
interest and its costs of the arbitration. A panel of three arbitrators
has been appointed to hear the dispute. The panel heard oral
arguments relating to preliminary dispositive motions on

May 20-21, 2008. The panel’s decision was released on August 28,

that occurred over a period of several years, much of which

2008, in which the panel determined that MPI is precluded from

occurred before we obtained majority ownership of these

advancing certain claims to royalties in respect of Xerox’s Version 8

operations in mid-1999. These matters include misappropriations

software and its derivatives, but that certain other claims being

of funds and payments to other companies that may have been

advanced by MPI are not precluded. A hearing relating to most of

inaccurately recorded on the subsidiary’s books and certain alleged

the issues raised in the current arbitration, other than damages

improper payments in connection with sales to government

issues relating to one of MPI’s claims that has been bifurcated, is

customers. These transactions were not material to the Company’s

expected to take place in October 2009. Should developments

financial statements. We reported these transactions to the Indian

cause a change in our determination as to an unfavorable

authorities, the U.S. Department of Justice (“DOJ”) and to the SEC.

outcome, or result in a final adverse judgment or a settlement for a

In 2005, the private Indian investigator engaged by the Indian

significant amount, there could be a material adverse effect on our

Ministry of Company Affairs completed an investigation of these

results of operations, cash flows and financial position in the period

matters and issued a report (“Report”). A copy of the Report was

in which such change in determination, judgment or settlement

provided to our Indian subsidiary, which was asked by the Indian

occurs. Based on the present stage of the proceeding, it is not

Ministry of Company Affairs to comment on the Report. The

possible to estimate the amount of any material loss or range of

Report addresses the previously disclosed misappropriation of

material loss that might result from any of the claims advanced in

funds and alleged improper payments and includes allegations

such counterclaim.

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

alleged that Xerox had 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 did not specify the amount

of damages sought, plaintiffs sought, on behalf of themselves and

the classes they sought to represent, front and back pay,

compensatory and punitive damages, and attorneys’ fees. A

settlement agreement was reached, the terms of which are not

material to Xerox. On September 22, 2008, an Order and Judgment

of Final Approval of the Settlement was entered. The Company

denies any wrongdoing as part of the settlement. The period for

appeal has expired and the settlement is now final.

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.

India

that Xerox India Ltd.’s senior officials and the Company were

aware of such activities. The Report also asserts 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 India Ltd. available to the DOJ and the SEC.

On November 17, 2005, Xerox India Ltd. filed its reply with the

Ministry of Company Affairs (or “MCA”). Xerox sent copies of the

reply to the SEC and DOJ in the United States. In its reply, Xerox

India Ltd. argued that the alleged violations of Indian Company

Law by means of alleged improper payments and alleged defaults/

failures of the Xerox India Ltd. board of directors were generally

unsubstantiated and without any basis in law. Further, Xerox India

Ltd. stated that the Report’s findings of other alleged violations

were unsubstantiated and unproven. The MCA will consider our

reply and will let us know their conclusions. There is the possibility of

fines or criminal penalties if conclusive proof of wrongdoing is

found. We have told the MCA that Xerox’s conduct in voluntarily

disclosing the initial information and readily and willingly

submitting to investigation, coupled with the non-availability of

earlier records, warrants complete closure and early settlement. In

January 2006, we learned that the MCA had issued a “Show Cause

Notice” to certain former executives of Xerox India Ltd. seeking a

response to allegations of potential violations of the Indian

Companies Act. We also learned that Xerox India Ltd. had received

a formal Notice of Enquiry from the Indian Monopolies & Restrictive

Trade Practices Commission (“MRTP Commission”) alleging that

Xerox India Ltd. committed unfair trading practices arising from the

events described in the Report. Xerox India Ltd. filed its reply to the

Notice of Enquiry and the investigating officer subsequently filed

his response to our reply. At a hearing in August 2007, Xerox India

In recent years we became aware of a number of matters at our

Ltd. argued that the Enquiry is not maintainable under the

Indian subsidiary, Xerox India Ltd. (formerly Xerox Modicorp Ltd.),

Commission’s jurisdiction. The issue of maintainability of the Notice

Xerox 2008 Annual Report

Text.indd 84

3/18/09 5:59:42 PM

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

February 9, 2009, three class members filed a notice of appeal of

purported class includes all persons who lived in South Africa at any

the Court’s January 15, 2009 order and final judgement and ruling

time from 1948 until the present and purportedly suffered

on motion for award of attorneys fees.

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. Four additional class

actions were subsequently filed, and the five actions were

consolidated as In Re Xerox Corporation ERISA Litigation. 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 defendants 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

damages as a result of human rights violations and crimes against

humanity through the system of apartheid. The defendants

included the Company and a number of other corporate

defendants who were accused of providing material assistance 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 claimed

violations of the Alien Tort Claims Act, the Torture Victims

Protection Act and RICO. They also asserted human rights

violations and crimes against humanity. Plaintiffs sought

compensatory damages in excess of $200 billion and punitive

damages in excess of $200 billion. On October 27, 2008, plaintiffs

filed an amended complaint that did not name the Company as a

defendant, so the Company is no longer a party to the action.

Board, the Finance Committee of the Board of Directors, and the

Arbitration between MPI Technologies, Inc. and MPI Tech S.A.

Treasurer. The complaint alleges that the defendants breached

and Xerox Canada Ltd. and Xerox Corporation: In an

their fiduciary duties under ERISA to protect the Plan’s assets and

arbitration proceeding the hearing of which commenced in

act in the interest of Plan participants. Specifically, plaintiffs allege

January 2005, MPI Technologies, Inc. and MPI Tech S.A.

that the defendants failed to provide accurate and complete

(collectively “MPI”) sought damages from the Company and Xerox

material information to participants concerning Xerox stock,

Canada Ltd. (“XCL”) for royalties owed under a license agreement

including accounting practices which allegedly artificially inflated

between MPI and XCL (the “Agreement”) and breach of fiduciary

the value of the stock, and misled participants regarding the

duty, breach of confidence, equitable royalties and punitive

soundness of the stock and the prudence of investing their

damages and disgorgement of profits and injunctive relief with

retirement assets in Xerox stock. The plaintiffs filed a Second

Consolidated Amended Complaint, alleging that some or all

the arbitration panel rendered its decision, holding in part that the

defendants breached their ERISA fiduciary duties during 1997-

Agreement had been assigned to Xerox and that no punitive

2002 by (1) maintaining the Xerox Stock Fund as an investment

damages should be granted, and awarded MPI approximately $89,

option under the Plan; (2) failing to monitor the conduct of Plan

plus interest thereon. In December 2005, the arbitration panel

fiduciaries; and (3) misleading Plan participants about Xerox stock

rendered its decision on the applicable rate of pre-judgment

as an investment option under the Plans. The complaint does not

interest resulting in an award of $13 for pre- and post-judgment

specify the amount of damages sought, but demands that the

interest. In 2006, Xerox’s application for judicial review of the

losses to the Plans be restored, which it describes as “millions of

award, seeking to have the award set aside in its entirety, was

dollars.” It also seeks other legal and equitable relief, as

denied by the Ontario Superior Court in Toronto and Xerox

appropriate, to remedy the alleged breaches of fiduciary duty, as

released all monies and software it had placed in escrow. In

well as interest, costs and attorneys’ fees. On January 28, 2009. the

January 2007, Xerox and XCL served an arbitration claim against

Court granted preliminary approval of an agreement to settle this

MPI seeking a declaratory award concerning the preclusive effect

case, the terms of which are within the amount previously reserved

of the remedy awarded by the prior arbitration panel. In

by the Company for this matter. The Company and the other

March 2007, MPI delivered to Xerox a statement of defense and

defendants do not admit any wrongdoing as a part of the

counterclaim in response to Xerox’s arbitration claim. MPI claims

settlement, which is subject to final Court approval and other

entitlement to an unspecified amount of damages for royalties. In

conditions. A fairness hearing has been scheduled for April 13,

addition, MPI claims damages of $50 for alleged “misuse” of its

2009.

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 complaint on the

Company was deemed effective as of December 6, 2002. The

licensed software by Xerox after December 2006. MPI also claims

entitlement to unspecified amounts of pre and post-judgment

interest and its costs of the arbitration. A panel of three arbitrators

has been appointed to hear the dispute. The panel heard oral

arguments relating to preliminary dispositive motions on

May 20-21, 2008. The panel’s decision was released on August 28,
2008, in which the panel determined that MPI is precluded from
advancing certain claims to royalties in respect of Xerox’s Version 8
software and its derivatives, but that certain other claims being
advanced by MPI are not precluded. A hearing relating to most of
the issues raised in the current arbitration, other than damages
issues relating to one of MPI’s claims that has been bifurcated, is
expected to take place in October 2009. Should developments
cause a change in our determination as to an unfavorable
outcome, or result in a final adverse judgment or a settlement for a
significant amount, there could be a material adverse effect on our
results of operations, cash flows and financial position in the period
in which such change in determination, judgment or settlement
occurs. Based on the present stage of the proceeding, it is not
possible to estimate the amount of any material loss or range of
material loss that might result from any of the claims advanced in
such counterclaim.

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
alleged that Xerox had 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 did not specify the amount
of damages sought, plaintiffs sought, on behalf of themselves and
the classes they sought to represent, front and back pay,
compensatory and punitive damages, and attorneys’ fees. A
settlement agreement was reached, the terms of which are not
material to Xerox. On September 22, 2008, an Order and Judgment
of Final Approval of the Settlement was entered. The Company
denies any wrongdoing as part of the settlement. The period for
appeal has expired and the settlement is now final.

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.

India

In recent years we became aware of a number of matters at our
Indian subsidiary, Xerox India Ltd. (formerly 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 alleged
improper payments in connection with sales to government
customers. These transactions were not material to the Company’s
financial statements. We reported these transactions to the Indian
authorities, the U.S. Department of Justice (“DOJ”) and to the SEC.
In 2005, the private Indian investigator engaged by the Indian
Ministry of Company Affairs completed an investigation of these
matters and issued a report (“Report”). A copy of the Report was
provided to our Indian subsidiary, which was asked by the Indian
Ministry of Company Affairs to comment on the Report. The
Report addresses the previously disclosed misappropriation of
funds and alleged improper payments and includes allegations
that Xerox India Ltd.’s senior officials and the Company were
aware of such activities. The Report also asserts 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 India Ltd. available to the DOJ and the SEC.

On November 17, 2005, Xerox India Ltd. filed its reply with the
Ministry of Company Affairs (or “MCA”). Xerox sent copies of the
reply to the SEC and DOJ in the United States. In its reply, Xerox
India Ltd. argued that the alleged violations of Indian Company
Law by means of alleged improper payments and alleged defaults/
failures of the Xerox India Ltd. board of directors were generally
unsubstantiated and without any basis in law. Further, Xerox India
Ltd. stated that the Report’s findings of other alleged violations
were unsubstantiated and unproven. The MCA will consider our
reply and will let us know their conclusions. There is the possibility of
fines or criminal penalties if conclusive proof of wrongdoing is
found. We have told the MCA that Xerox’s conduct in voluntarily
disclosing the initial information and readily and willingly
submitting to investigation, coupled with the non-availability of
earlier records, warrants complete closure and early settlement. In
January 2006, we learned that the MCA had issued a “Show Cause
Notice” to certain former executives of Xerox India Ltd. seeking a
response to allegations of potential violations of the Indian
Companies Act. We also learned that Xerox India Ltd. had received
a formal Notice of Enquiry from the Indian Monopolies & Restrictive
Trade Practices Commission (“MRTP Commission”) alleging that
Xerox India Ltd. committed unfair trading practices arising from the
events described in the Report. Xerox India Ltd. filed its reply to the
Notice of Enquiry and the investigating officer subsequently filed
his response to our reply. At a hearing in August 2007, Xerox India
Ltd. argued that the Enquiry is not maintainable under the
Commission’s jurisdiction. The issue of maintainability of the Notice

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

of Enquiry has been framed as the preliminary issue, which was
argued in hearings held on November 17, 2008 and February 3,
2009; the matter is now fixed for further arguments on April 17,
2009. Our Indian subsidiary is contesting the Notice of Enquiry and
has been fully cooperating with the authorities.

Other 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 considerable
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, 2008, 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 and services
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.

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, including 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

issuance under our incentive compensation plans, 48 million shares

limited product warranty if negotiated by the customer. We also

were reserved for debt to equity exchanges and 2 million shares

issue warranties for certain of our lower-end products in the Office

were reserved for the conversion of convertible debt.

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 December 31, 2008 were $39, $40 and $43,

respectively. Total product warranty liabilities as of December 31,

2008 and 2007 were $27 and $26, respectively.

Note 17 – Shareholders’ Equity

Preferred Stock

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.

We grant PSs and RSUs in order to continue to attract and retain

employees and to better align employee interest with those of our

shareholders. Each of these awards is subject to settlement with

newly issued shares of our common stock. At December 31, 2008

and 2007, 15 million and 19 million shares, respectively, were

Stock-based compensation expense for the three years ended

December 31, 2008 was as follows:

As of December 31, 2008, we had no preferred stock shares or

preferred stock purchase rights outstanding. We are authorized to

available for grant of awards.

issue approximately 22 million shares of cumulative preferred

stock, $1.00 par value.

Common Stock

We have 1.75 billion authorized shares of common stock, $1 par

value. At December 31, 2008, 90 million shares were reserved for

Stock-based compensation expense, pre-tax

Stock-based compensation expense, net of tax

2008

2007

2006

$85

$89

$64

Restricted stock units: Compensation expense is based upon the grant date market price and is recorded over the vesting period. RSU

awards vest three years from the date of the grant. A summary of the activity for RSUs as of December 31, 2008, 2007 and 2006, and

changes during the years then ended, is presented below (shares in thousands):

Nonvested Restricted Stock Units

Outstanding at January 1

Granted

Vested

Cancelled

2008

Weighted

Average Grant

2007

Weighted

Average Grant

2006

Weighted

Average Grant

Date Fair

Value

$16.78

13.63

16.92

15.98

8,635

4,444

(935)

(448)

Date Fair

Value

$ 15.71

18.17

13.65

16.42

5,491

4,256

(686)

(426)

8,635

Date Fair

Value

$ 15.69

15.18

13.70

13.45

$15.71

11,696

5,923

(3,350)

(232)

14,037

Outstanding at December 31

$15.43

11,696

$16.78

At December 31, 2008, the aggregate intrinsic value of RSUs

Performance shares: We grant officers and selected executives

outstanding was $112. The total intrinsic value of RSUs vested

PSs whose vesting is contingent upon meeting pre-determined

during 2008, 2007 and 2006 was $54, $16 and $10, respectively.

Diluted Earnings per Share (“EPS”) and Core Cash Flow from

The actual tax benefit realized for the tax deductions for vested

Operations targets. These shares entitle the holder to one share of

RSUs totaled $18, $3 and $3 for the years ended December 31,

common stock, payable after a three-year period and the

2008, 2007 and 2006, respectively.

At December 31, 2008, there was $105 of total unrecognized

compensation cost related to nonvested RSUs, which is expected to

be recognized ratably over a remaining weighted-average

contractual term of 1.6 years.

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.

Xerox 2008 Annual Report

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

of Enquiry has been framed as the preliminary issue, which was

• Guarantees of our performance in certain sales and services

argued in hearings held on November 17, 2008 and February 3,

contracts to our customers and indirectly the performance of

2009; the matter is now fixed for further arguments on April 17,

third parties with whom we have subcontracted for their

2009. Our Indian subsidiary is contesting the Notice of Enquiry and

services. This includes indemnifications to customers for losses

has been fully cooperating with the authorities.

that may be sustained as a result of the use of our equipment at

Other 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

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

made.

property such as patents, environmental matters, and other

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

limited in terms of time and/or amount, and in some instances, we

may have recourse against third parties for certain payments we

guarantee the performance of others if specified triggering events

obligations under these agreements and guarantees may be

indemnifications. The ultimate effect on future financial results is

Patent Indemnifications

not subject to reasonable estimation because considerable

In most sales transactions to resellers of our products, we

uncertainty exists as to the final outcome of these claims. However,

indemnify against possible claims of patent infringement caused

while the ultimate liabilities resulting from such claims may be

by our products or solutions. These indemnifications usually do not

significant to results of operations in the period recognized,

include limits on the claims, provided the claim is made pursuant to

management does not anticipate they will have a material adverse

the procedures required in the sales contract.

effect on the Company’s consolidated financial position or

liquidity. As of December 31, 2008, we have accrued our estimate

Indemnification of Officers and Directors

of liability incurred under our indemnification arrangements and

Our corporate by-laws require that, except to the extent expressly

guarantees.

Agreements

Indemnifications Provided as Part of Contracts and

paid in settlement, including legal fees and all appeals, incurred in

prohibited by law, we must indemnify Xerox Corporation’s officers

and directors against judgments, fines, penalties and amounts

connection with civil or criminal action or proceedings, as it relates

We are a party to the following types of agreements pursuant to

to their services to Xerox Corporation and our subsidiaries.

which we may be obligated to indemnify the other party with

Although the by-laws provide no limit on the amount of

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

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

obligations to pay rent. Typically, these relate to such matters as

adequate title to assets sold, intellectual property rights,

Company.

specified environmental matters and certain income taxes

Product Warranty Liabilities

arising prior to the date of acquisition.

In connection with our normal sales of equipment, including those

• 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.

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

• Agreements to indemnify various service providers, trustees and

term or the expected useful life under a cash sale. The service

bank agents from any third party claims related to their

agreements involve the payment of fees in return for our

performance on our behalf, with the exception of claims that

performance of repairs and maintenance. As a consequence, we do

result from third-party’s own willful misconduct or gross

not have any significant product warranty obligations including

negligence.

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 December 31, 2008 were $39, $40 and $43,
respectively. Total product warranty liabilities as of December 31,
2008 and 2007 were $27 and $26, respectively.

Note 17 – Shareholders’ Equity

Preferred Stock

As of December 31, 2008, we had no preferred stock shares or
preferred stock purchase rights outstanding. We are authorized to
issue approximately 22 million shares of cumulative preferred
stock, $1.00 par value.

Common Stock

issuance under our incentive compensation plans, 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.

We grant PSs and RSUs in order to continue to attract and retain
employees and to better align employee interest with those of our
shareholders. Each of these awards is subject to settlement with
newly issued shares of our common stock. At December 31, 2008
and 2007, 15 million and 19 million shares, respectively, were
available for grant of awards.

Stock-based compensation expense for the three years ended
December 31, 2008 was as follows:

2008

2007

2006

We have 1.75 billion authorized shares of common stock, $1 par
value. At December 31, 2008, 90 million shares were reserved for

Stock-based compensation expense, pre-tax
Stock-based compensation expense, net of tax

$85
52

$89
55

$64
39

Restricted stock units: Compensation expense is based upon the grant date market price and is recorded over the vesting period. RSU
awards vest three years from the date of the grant. A summary of the activity for RSUs as of December 31, 2008, 2007 and 2006, and
changes during the years then ended, is presented below (shares in thousands):

Nonvested Restricted Stock Units

Outstanding at January 1
Granted
Vested
Cancelled

Outstanding at December 31

2008

2007

2006

Weighted
Average Grant
Date Fair
Value

$16.78
13.63
16.92
15.98

$15.43

Weighted
Average Grant
Date Fair
Value

$ 15.71
18.17
13.65
16.42

$16.78

Weighted
Average Grant
Date Fair
Value

$ 15.69
15.18
13.70
13.45

$15.71

5,491
4,256
(686)
(426)

8,635

8,635
4,444
(935)
(448)

11,696

11,696
5,923
(3,350)
(232)

14,037

At December 31, 2008, the aggregate intrinsic value of RSUs
outstanding was $112. The total intrinsic value of RSUs vested
during 2008, 2007 and 2006 was $54, $16 and $10, respectively.
The actual tax benefit realized for the tax deductions for vested
RSUs totaled $18, $3 and $3 for the years ended December 31,
2008, 2007 and 2006, respectively.

At December 31, 2008, there was $105 of total unrecognized
compensation cost related to nonvested RSUs, which is expected to
be recognized ratably over a remaining weighted-average
contractual term of 1.6 years.

Performance shares: We grant officers and selected executives
PSs whose vesting is contingent upon meeting pre-determined
Diluted Earnings per Share (“EPS”) and Core 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.

Xerox 2008 Annual Report

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Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

A summary of the activity for PSs as of December 31, 2008, 2007 and 2006, and changes during the years then ended, is presented below
(shares in thousands):

The following table provides information relating to stock option

Treasury Stock

exercises for the three years ended December 31, 2008:

Nonvested Performance Shares

Outstanding at January 1
Granted
Vested
Cancelled

Outstanding at December 31

2008

2007

2006

Weighted
Average Grant
Date Fair
Value

$16.16
13.67
14.87
16.05

$15.39

6,585
3,696
(2,734)
(169)

7,378

Weighted
Average Grant
Date Fair
Value

$ 15.04
18.48

15.41

2,052
2,588

——
(69)

$16.16

4,571

Weighted
Average Grant
Date Fair
Value

$ 14.87
15.17

14.95

$15.04

4,571
2,160

——

(146)

6,585

At December 31, 2008, the aggregate intrinsic value of PSs
outstanding was $59. The total intrinsic value of PS’s vested during
2008 was $41. The actual tax benefit realized for the tax
deductions for vested PS’s totaled $13 for the year ended
December 31, 2008.

We account for PSs 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, 2008,
there was $48 of total unrecognized compensation cost related to
nonvested PSs; this cost is expected to be recognized ratably over a
remaining weighted-average contractual term of 1.5 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 issued any new stock options since 2004 and all options currently outstanding are fully vested and exercisable. The following
table provides information relating to the status of, and changes in, outstanding stock options for each of the three years ended
December 31, 2008 (stock options in thousands):

Employee Stock Options

Outstanding at January 1
Cancelled/Expired
Exercised

Outstanding at December 31

2008

2007

2006

Stock
Options

52,424
(6,559)
(680)

45,185

Average
Option
Price

$19.73
50.08
8.89

$15.49

Stock
Options

60,480
(922)
(7,134)

52,424

Average
Option
Price

$ 18.56
24.18
9.22

$19.73

Stock
Options

76,307
(5,478)
(10,349)

60,480

Average
Option
Price

$ 19.40
49.44
8.46

$18.56

Options outstanding and exercisable at December 31, 2008 were as follows (stock options in thousands):

Range of Exercise Prices

$ 4.75 to $6.98
7.13 to 10.69
10.72 to 15.27
16.91 to 21.78
25.38 to 27.00
47.50 to 60.44

Number Outstanding and
Exercisable

Weighted Average
Remaining Contractual Life

Weighted Average
Exercise Price

2,526
18,493
8,024
11,092
3,536
1,514

45,185

2.01
3.37
2.99
1.00
0.94
1.00

$ 4.97
9.23
13.68
21.76
26.19
48.00

At December 31, 2008, the aggregate intrinsic value of stock options outstanding and exercisable was $8.

Total intrinsic value

Cash received

Tax benefit realized for tax deductions

2008.

2008

2007

2006

$61

$72

The Board of Directors has cumulatively authorized programs for

the repurchase of the Company’s common stock totaling $4.5

billion as of December 31, 2008. The $4.5 billion includes

additional authorizations of $1.0 billion in both January and July of

Through December 31, 2008, we have repurchased a cumulative

total of 194.1 million shares at a cost of $2,945 (including

associated fees of $4) under these stock repurchase programs.

Note 18 – Earnings Per Share

December 31, 2008 (shares in thousands):

The following table sets forth the computation of basic and diluted earnings per share of common stock for the three years ended

Basic Earnings per Share:

Net Income

Accrued dividends on Series C Mandatory Convertible Preferred Stock

Adjusted net income available to common shareholders

Weighted Average Common Shares Outstanding

Basic Earnings per Share

Diluted Earnings per Share:

Net Income

Interest on Convertible securities, net

Adjusted net income available to common shareholders

Weighted Average Common Shares Outstanding

Common shares issuable with respect to:

Stock options

Restricted stock and performance shares

Series C Mandatory Convertible Preferred Stock

Convertible securities

Adjusted Weighted Average Shares Outstanding

Diluted Earnings per Share

2008

2007

2006

885,471

0.26

230

—

230

—

230

3,885

6,186

—

1,135

—

1,135

934,903

1.21

1,135

1,136

8,650

7,396

—

1,992

1,210

(29)

1,181

943,852

1.25

1,210

1,211

943,852

9,300

3,980

37,398

1,992

885,471

934,903

895,542

952,941

996,522

0.26

1.19

1.22

The 2008, 2007 and 2006 computation of diluted earnings per

per share of our common stock. In addition, the common shares

share did not include the effects of 29 million, 23 million and

issuable with respect to convertible securities were not included in

27 million stock options, respectively, because their respective

the 2008 computation of diluted EPS because to do so would have

exercise prices were greater than the corresponding market value

been anti-dilutive.

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Notes to the Consolidated

Financial Statements

(in millions, except per share data and

unless otherwise indicated)

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)

Outstanding at December 31

$15.39

6,585

$16.16

4,571

Note 18 – Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share of common stock for the three years ended
December 31, 2008 (shares in thousands):

The following table provides information relating to stock option
exercises for the three years ended December 31, 2008:

Total intrinsic value
Cash received
Tax benefit realized for tax deductions

2008

2007

2006

$4
6
2

$61
65
22

$72
82
25

Treasury Stock

The Board of Directors has cumulatively authorized programs for
the repurchase of the Company’s common stock totaling $4.5
billion as of December 31, 2008. The $4.5 billion includes
additional authorizations of $1.0 billion in both January and July of
2008.

Through December 31, 2008, we have repurchased a cumulative
total of 194.1 million shares at a cost of $2,945 (including
associated fees of $4) under these stock repurchase programs.

Basic Earnings per Share:
Net Income
Accrued dividends on Series C Mandatory Convertible Preferred Stock

Adjusted net income available to common shareholders

Weighted Average Common Shares Outstanding

Basic Earnings per Share

Diluted Earnings per Share:
Net Income
Interest on Convertible securities, net

Adjusted net income available to common shareholders

Weighted Average Common Shares Outstanding
Common shares issuable with respect to:

Stock options
Restricted stock and performance shares
Series C Mandatory Convertible Preferred Stock
Convertible securities

Adjusted Weighted Average Shares Outstanding

Diluted Earnings per Share

2008

2007

2006

230
—

230

1,135
—

1,135

1,210
(29)

1,181

885,471

934,903

943,852

0.26

230
—

230

1.21

1,135

1,136

1.25

1,210

1,211

885,471

934,903

943,852

3,885
6,186
—
—

8,650
7,396
—
1,992

9,300
3,980
37,398
1,992

895,542

952,941

996,522

0.26

1.19

1.22

The 2008, 2007 and 2006 computation of diluted earnings per
share did not include the effects of 29 million, 23 million and
27 million stock options, respectively, because their respective
exercise prices were greater than the corresponding market value

per share of our common stock. In addition, the common shares
issuable with respect to convertible securities were not included in
the 2008 computation of diluted EPS because to do so would have
been anti-dilutive.

A summary of the activity for PSs as of December 31, 2008, 2007 and 2006, and changes during the years then ended, is presented below

(shares in thousands):

Nonvested Performance Shares

Outstanding at January 1

Granted

Vested

Cancelled

2008

2007

2006

Weighted

Average Grant

Date Fair

Value

$16.16

13.67

14.87

16.05

Weighted

Average Grant

Date Fair

Value

$ 15.04

18.48

15.41

4,571

2,160

——

(146)

2,052

2,588

——

(69)

Weighted

Average Grant

Date Fair

Value

$ 14.87

15.17

14.95

$15.04

6,585

3,696

(2,734)

(169)

7,378

At December 31, 2008, the aggregate intrinsic value of PSs

We account for PSs using fair value determined as of the grant

outstanding was $59. The total intrinsic value of PS’s vested during

date. If the stated targets are not met, any recognized

2008 was $41. The actual tax benefit realized for the tax

compensation cost would be reversed. As of December 31, 2008,

deductions for vested PS’s totaled $13 for the year ended

there was $48 of total unrecognized compensation cost related to

December 31, 2008.

nonvested PSs; this cost is expected to be recognized ratably over a

remaining weighted-average contractual term of 1.5 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 issued any new stock options since 2004 and all options currently outstanding are fully vested and exercisable. The following

table provides information relating to the status of, and changes in, outstanding stock options for each of the three years ended

December 31, 2008 (stock options in thousands):

Options outstanding and exercisable at December 31, 2008 were as follows (stock options in thousands):

Employee Stock Options

Outstanding at January 1

Cancelled/Expired

Exercised

Outstanding at December 31

Range of Exercise Prices

$ 4.75 to $6.98

7.13 to 10.69

10.72 to 15.27

16.91 to 21.78

25.38 to 27.00

47.50 to 60.44

2008

2007

2006

Stock

Options

52,424

(6,559)

(680)

45,185

Average

Option

Price

$19.73

50.08

8.89

$15.49

Stock

Options

60,480

(922)

(7,134)

52,424

Average

Option

Price

$ 18.56

24.18

9.22

$19.73

Stock

Options

76,307

(5,478)

(10,349)

60,480

Average

Option

Price

$ 19.40

49.44

8.46

$18.56

Number Outstanding and

Weighted Average

Exercisable

Remaining Contractual Life

Weighted Average

Exercise Price

2,526

18,493

8,024

11,092

3,536

1,514

45,185

2.01

3.37

2.99

1.00

0.94

1.00

$ 4.97

9.23

13.68

21.76

26.19

48.00

At December 31, 2008, the aggregate intrinsic value of stock options outstanding and exercisable was $8.

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Reports of Management

Report of Independent

Registered Public Accounting

Firm

Management’s Responsibility for Financial Statements

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.

Management’s Report on Internal Control Over
Financial Reporting

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, 2008.

Anne M. Mulcahy
Chief Executive Officer

Lawrence A. Zimmerman
Chief Financial Officer

Gary R. Kabureck
Chief Accounting Officer

To the Board of Directors and Shareholders of Xerox Corporation:

exists, and testing and evaluating the design and operating

In our opinion, the accompanying consolidated balance sheets and

the related consolidated statements of income, cash flows and

shareholders’ equity present fairly, in all material respects, the

financial position of Xerox Corporation and its subsidiaries at

effectiveness of internal control based on the assessed risk. Our

audits also included performing such other procedures as we

considered necessary in the circumstances. We believe that our

audits provide a reasonable basis for our opinions.

December 31, 2008 and 2007, and the results of their operations

As discussed in Note 1 to the Consolidated Financial Statements,

and their cash flows for each of the three years in the period ended

the Company adopted the recognition and disclosure provisions of

December 31, 2008 in conformity with accounting principles

Statement of Financial Accounting Standards No. 158, “Employers’

generally accepted in the United States of America. Also in our

Accounting for Defined Benefit Pension and Other Postretirement

opinion, the Company maintained, in all material respects,

Plans, an amendment of FASB Statements No. 87, 88, 106 and

effective internal control over financial reporting as of

132(R)” as of December 31, 2006.

December 31, 2008, based on criteria established in Internal

Control—Integrated Framework issued by the Committee of

Sponsoring Organizations of the Treadway Commission (COSO).

The Company’s management is responsible for these financial

statements, for maintaining effective internal control over

financial reporting and for its assessment of the effectiveness of

internal control over financial reporting, included in the

accompanying Management’s Report on Internal Control Over

Financial Reporting. Our responsibility is to express opinions on

these financial statements and on the Company’s internal control

over financial reporting based on our integrated audits. We

conducted our audits in accordance with the standards of the

Public Company Accounting Oversight Board (United States).

Those standards require that we plan and perform the audits to

obtain reasonable assurance about whether the financial

statements are free of material misstatement and whether

effective internal control over financial reporting was maintained

in all material respects. Our audits of the financial statements

included examining, on a test basis, evidence supporting the

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

statements 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.

amounts and disclosures in the financial statements, assessing the

Because of its inherent limitations, internal control over financial

accounting principles used and significant estimates made by

management, and evaluating the overall financial statement

presentation. Our audit of internal control over financial reporting

included obtaining an understanding of internal control over

financial reporting, assessing the risk that a material weakness

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.

PricewaterhouseCoopers LLP

Stamford, Connecticut

February 13, 2009

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Reports of Management

Report of Independent
Registered Public Accounting
Firm

Management’s Responsibility for Financial Statements

Management’s Report on Internal Control Over

To the Board of Directors and Shareholders of Xerox Corporation:

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

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.

accounting, financial reporting, internal control and audit matters,

December 31, 2008.

Financial Reporting

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

Anne M. Mulcahy

Chief Executive Officer

Lawrence A. Zimmerman

Chief Financial Officer

Gary R. Kabureck

Chief Accounting Officer

In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of income, cash flows and
shareholders’ equity present fairly, in all material respects, the
financial position of Xerox Corporation and its subsidiaries at
December 31, 2008 and 2007, and the results of their operations
and their cash flows for each of the three years in the period ended
December 31, 2008 in conformity with accounting principles
generally accepted in the United States of America. Also in our
opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
The Company’s management is responsible for these financial
statements, for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting. Our responsibility is to express opinions on
these financial statements and on the Company’s internal control
over financial reporting based on our integrated audits. We
conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial
statements are free of material misstatement and whether
effective internal control over financial reporting was maintained
in all material respects. Our audits of the financial statements
included 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. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness

PricewaterhouseCoopers LLP
Stamford, Connecticut
February 13, 2009

exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we
considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.

As discussed in Note 1 to the Consolidated Financial Statements,
the Company adopted the recognition and disclosure provisions of
Statement of Financial Accounting Standards No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement
Plans, an amendment of FASB Statements No. 87, 88, 106 and
132(R)” as of December 31, 2006.

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
statements 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.

Xerox 2008 Annual Report

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Quarterly Results of Operations
(Unaudited)
(in millions, except per share data)

2008
Revenues
Costs and Expenses(1)

(Loss) Income before Income Taxes and Equity Income
Income tax (benefits) expenses(2)
Equity in net income of unconsolidated affiliates(3)

Net (Loss) Income

Basic (Loss) Earnings per Share(4)
Diluted (Loss) Earnings per Share(4)

2007
Revenues
Costs and Expenses

Income before Income Taxes and Equity Income
Income tax expenses
Equity in net income of unconsolidated affiliates(3)

Net Income

Basic Earnings per Share(4)
Diluted Earnings per Share(4)

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

Full
Year

$4,335
4,853

$4,533
4,288

$4,370
4,132

$4,370
4,449

$17,608
17,722

(518)
(246)
28

245
59
29

$ (244)

$ 215

$ (0.27)
$ (0.27)

$ 0.24
$ 0.24

238
15
35

$ 258

$ 0.30
$ 0.29

(79)
(59)
21

$ —
$ —

(114)
(231)
113

230

$ 0.26
$ 0.26

$ 3,836
3,507

$ 4,208
3,893

$ 4,302
3,978

$ 4,882
4,412

$ 17,228
15,790

329
102
6

$ 233

$ 0.25
$ 0.24

315
76
27

$ 266

$ 0.28
$ 0.28

324
97
27

$ 254

$ 0.27
$ 0.27

470
125
37

$ 382

$ 0.41
$ 0.41

1,438
400
97

$ 1,135

$
$

1.21
1.19

(1) Costs and expenses include charges for restructuring and asset impairments and an equipment write-off of $63, $14 and $388 for the second, third and fourth quarters of 2008, respectively. In

addition, the first and fourth quarters of 2008 include $795 and $(21) for litigation matters.

(2) The first, second, third and fourth quarters of 2008 include $304, $20, $5 and $124 of tax benefits, respectively, from the above noted charges. Third quarter 2008 also included a $41 income

tax benefit from the settlement of certain previously unrecognized tax benefits.

(3) The first, second, third and fourth quarters of 2008 include $10, $3, $2 and $1 of charges, respectively, for our share of Fuji Xerox restructuring charges. The first, third and fourth quarters of

2007 include $23, $5, and $2 of charges, respectively, for our share of Fuji Xerox restructuring charges.

(4) 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.

Five Years in Review

(in millions, except per share data)

Cash, cash equivalents and short-term investments

$ 1,229

$ 1,099

$ 1,536

$ 1,566

$ 3,218

(in millions, except per-share data)

Per-Share Data

Income from continuing operations

Earnings

Basic

Diluted

Basic

Diluted

Operations

Revenues

Sales

Common stock dividends

Service, outsourcing and rentals

Finance income

Research, development and engineering expenses

Selling, administrative and general expenses

Income from continuing operations

Net income

Financial Position

Accounts and finance receivables, net

Inventories

Equipment on operating leases, net

Land, buildings and equipment, net

Total Assets

Consolidated Capitalization

Long-term debt

Total Debt

Short-term debt and current portion of long-term debt

Minorities’ interests in equity of subsidiaries

Liabilities to subsidiary trusts issuing preferred securities(1)

Series C mandatory convertible preferred stock

Common shareholders’ equity

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

Working capital

Current ratio

Service, outsourcing and rentals gross margin

Finance gross margin

Cost of additions to land, buildings and equipment

Depreciation on buildings and equipment

2008

2007(2)

2006

2005

2004

$ 0.26

0.26

$ 0.26

0.26

$ 0.17

1.21

1.19

1.21

1.19

$ 0.0425

1.25

1.22

1.25

1.22

—

0.91

0.90

0.96

0.94

—

0.84

0.78

0.94

0.86

—

$17,608

$ 17,228

$ 15,895

$ 15,701

$ 15,722

8,325

8,485

798

884

4,534

230

9,462

1,232

594

1,419

22,447

1,610

6,774

8,384

120

648

—

6,238

46,541

$ 7.21

$ 7.97

57,100

38.9%

33.7%

41.9%

61.8%

1.5

206

257

8,192

8,214

822

912

4,312

1,135

10,505

1,305

587

1,587

23,543

525

6,939

7,464

103

632

—

8,588

48,261

9.36

$ 16.19

57,400

40.3%

35.9%

42.7%

61.6%

2.1

236

262

7,464

7,591

840

922

4,008

1,210

10,043

1,163

481

1,527

21,709

1,485

5,660

7,145

108

624

—

7,080

40,372

7.48

$ 16.95

53,700

40.6%

35.7%

43.0%

63.7%

1.9

215

277

7,400

7,426

875

943

4,110

933

978

9,886

1,201

431

1,627

21,953

1,139

6,139

7,278

724

889

6,319

53,017

6.79

$ 14.65

55,220

41.2%

36.6%

43.3%

62.7%

2.0

181

280

7,259

7,529

934

914

4,203

776

859

10,573

1,143

398

1,759

24,884

3,074

7,050

10,124

717

889

6,244

55,152

6.53

$ 17.01

58,100

41.6%

37.4%

43.0%

63.1%

1.7

204

305

$ 2,700

$ 4,463

$ 4,056

$ 4,390

$ 4,628

Total Consolidated Capitalization

$15,390

$16,787

$14,957

$15,300

$18,054

(1) For 2005, the amount includes $98 reported in other current liabilities.

(2) 2007 results include the acquisition of GIS. Refer to Note 3 – Acquisitions in the Consolidated Financial Statements.

Xerox 2008 Annual Report

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Quarterly Results of Operations

(Unaudited)

(in millions, except per share data)

2008

Revenues

Costs and Expenses(1)

(Loss) Income before Income Taxes and Equity Income

Income tax (benefits) expenses(2)

Equity in net income of unconsolidated affiliates(3)

Net (Loss) Income

Basic (Loss) Earnings per Share(4)

Diluted (Loss) Earnings per Share(4)

2007

Revenues

Costs and Expenses

Income before Income Taxes and Equity Income

Income tax expenses

Equity in net income of unconsolidated affiliates(3)

Net Income

Basic Earnings per Share(4)

Diluted Earnings per Share(4)

First

Quarter

Second

Quarter

Third

Quarter

Fourth

Quarter

Full

Year

$4,335

4,853

$4,533

4,288

$4,370

4,132

$4,370

4,449

$17,608

17,722

(518)

(246)

245

$ (244)

$ 215

$ (0.27)

$ 0.24

329

102

$ 233

$ 0.25

$ 0.24

315

$ 266

$ 0.28

238

$ 258

$ 0.30

$ 0.29

324

$ 254

$ 0.27

(79)

(59)

$ —

(114)

(231)

113

230

$ 0.26

470

125

$ 382

$ 0.41

1,438

400

$ 1,135

1.21

1.19

$ 3,836

3,507

$ 4,208

3,893

$ 4,302

3,978

$ 4,882

4,412

$ 17,228

15,790

(1) Costs and expenses include charges for restructuring and asset impairments and an equipment write-off of $63, $14 and $388 for the second, third and fourth quarters of 2008, respectively. In

(2) The first, second, third and fourth quarters of 2008 include $304, $20, $5 and $124 of tax benefits, respectively, from the above noted charges. Third quarter 2008 also included a $41 income

addition, the first and fourth quarters of 2008 include $795 and $(21) for litigation matters.

tax benefit from the settlement of certain previously unrecognized tax benefits.

2007 include $23, $5, and $2 of charges, respectively, for our share of Fuji Xerox restructuring charges.

(4) 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.

Five Years in Review
(in millions, except per share data)

(in millions, except per-share data)

Per-Share Data
Income from continuing operations

Basic
Diluted

Earnings

Basic
Diluted

Common stock dividends
Operations
Revenues
Sales
Service, outsourcing and rentals
Finance income

Research, development and engineering expenses
Selling, administrative and general expenses
Income from continuing operations
Net income
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
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(1)
Series C mandatory convertible preferred stock
Common shareholders’ equity

2008

2007(2)

2006

2005

2004

$ 0.26
0.26

$ 0.26
0.26
$ 0.17

$17,608
8,325
8,485
798
884
4,534
230
230

$ 1,229
9,462
1,232
594
1,419
22,447

1,610
6,774

8,384
120
648
—
6,238

1.21
1.19

1.21
1.19
$ 0.0425

$ 17,228
8,192
8,214
822
912
4,312
1,135
1,135

$ 1,099
10,505
1,305
587
1,587
23,543

525
6,939

7,464
103
632
—
8,588

1.25
1.22

1.25
1.22
—

$ 15,895
7,464
7,591
840
922
4,008
1,210
1,210

$ 1,536
10,043
1,163
481
1,527
21,709

1,485
5,660

7,145
108
624
—
7,080

0.91
0.90

0.96
0.94
—

$ 15,701
7,400
7,426
875
943
4,110
933
978

$ 1,566
9,886
1,201
431
1,627
21,953

1,139
6,139

7,278
90
724
889
6,319

0.84
0.78

0.94
0.86
—

$ 15,722
7,259
7,529
934
914
4,203
776
859

$ 3,218
10,573
1,143
398
1,759
24,884

3,074
7,050

10,124
80
717
889
6,244

Total Consolidated Capitalization

$15,390

$16,787

$14,957

$15,300

$18,054

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

46,541
$ 7.21
$ 7.97
57,100
38.9%
33.7%
41.9%
61.8%
$ 2,700
1.5
206
257

$
$

48,261
9.36
$
$ 16.19
57,400
40.3%
35.9%
42.7%
61.6%
$ 4,463
2.1
236
262

$
$

40,372
7.48
$
$ 16.95
53,700
40.6%
35.7%
43.0%
63.7%
$ 4,056
1.9
215
277

$
$

53,017
6.79
$
$ 14.65
55,220
41.2%
36.6%
43.3%
62.7%
$ 4,390
2.0
181
280

$
$

55,152
6.53
$
$ 17.01
58,100
41.6%
37.4%
43.0%
63.1%
$ 4,628
1.7
204
305

$
$

(1) For 2005, the amount includes $98 reported in other current liabilities.
(2) 2007 results include the acquisition of GIS. Refer to Note 3 – Acquisitions in the Consolidated Financial Statements.

Xerox 2008 Annual Report

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Corporate Information

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 and Switzerland exchanges.

Xerox Common Stock Prices and Dividends

New York Stock Exchange composite prices*

2008
High
Low
Dividends Paid

2007
High
Low
Dividends Paid(1)

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

$ 15.82
13.10
0.0425

$ 15.36
13.28
0.0425

$ 18.09
16.53
—

$ 19.40
17.08
—

$ 14.39
11.05
0.0425

$ 19.90
15.79
—

$ 11.30
5.25
0.0425

$ 17.68
15.82
—

*
(1)

Prices as of close of business
In the fourth quarter of 2007, the Board of Directors declared a 4.25 cent per share dividend on common stock payable January 31, 2008 to shareholders of record on December 31, 2007. The
Board of Directors did not declare any other dividends on common stock in 2006 or 2007.

Certifications

We have filed with the SEC the certification required by Section 302 of the Sarbanes-Oxley Act as an exhibit to our 2008 Annual Report on
Form 10-K, and have submitted to the NYSE in 2008 the CEO certification required by the NYSE corporate governance rules.

Xerox 2008 Annual Report

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Corporate Information

Officers

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 and Switzerland exchanges.

Xerox Common Stock Prices and Dividends

New York Stock Exchange composite prices*

First

Quarter

Second

Quarter

Third

Quarter

Fourth

Quarter

$ 15.82

$ 15.36

13.10

0.0425

13.28

0.0425

$ 14.39

11.05

0.0425

$ 11.30

5.25

0.0425

$ 18.09

$ 19.40

$ 19.90

$ 17.68

16.53

—

17.08

—

15.79

—

15.82

—

In the fourth quarter of 2007, the Board of Directors declared a 4.25 cent per share dividend on common stock payable January 31, 2008 to shareholders of record on December 31, 2007. The

Board of Directors did not declare any other dividends on common stock in 2006 or 2007.

We have filed with the SEC the certification required by Section 302 of the Sarbanes-Oxley Act as an exhibit to our 2008 Annual Report on

Form 10-K, and have submitted to the NYSE in 2008 the CEO certification required by the NYSE corporate governance rules.

Dividends Paid

2008

High

Low

2007

High

Low

Dividends Paid(1)

Prices as of close of business

(1)

Certifications

Anne M. Mulcahy
Chairman and
Chief Executive Officer

Ursula M. Burns
President

James A. Firestone
Executive Vice President
President, Corporate Operations

Lawrence A. Zimmerman
Executive Vice President and
Chief Financial Officer

Willem T. Appelo
Senior Vice President
President, Xerox Global Business
and Services Group

M. Stephen Cronin
Senior Vice President
President, Xerox Global Services

Thomas J. Dolan
Senior Vice President
Global Accounts Integration

Don H. Liu
Senior Vice President
General Counsel and Secretary

Michael C. Mac Donald
Senior Vice President
Operational Effectiveness

Jean-Noël Machon
Senior Vice President
President, Developing Markets
Operations

Armando Zagalo de Lima
Senior Vice President
President, Xerox Europe

John E. McDermott
Vice President
Chief Information Officer

Ivy Thomas McKinney
Vice President
Deputy General Counsel

Patricia M. Nazemetz
Vice President
Chief Human Resources
and Ethics Officer

Shaun W. Pantling
Vice President
Director and General Manager,
Xerox Global Services Europe

Russell M. Peacock
Vice President
President, North American Channels Group

Rhonda L. Seegal
Vice President and Treasurer

Sophie V. Vandebroek
Vice President
President, Xerox Innovation Group and
Chief Technology Officer

Leslie F. Varon
Vice President and
Controller

Douglas H. Marshall
Assistant Secretary

Carol A. McFate
Assistant Treasurer and
Chief Investment Officer

Eric Armour
Vice President
President, Global Business and
Strategic Marketing Group

Richard F. Cerrone
Vice President
Marketing Integration

Richard M. Dastin
Vice President
President, Global Product Delivery Group

Kathleen S. Fanning
Vice President
Worldwide Tax

Anthony M. Federico
Vice President
Chief Engineer/Graphic Communications
Executive Liaison

D. Cameron Hyde
Vice President
Senior Vice President,
Global Accounts Operations

Gary R. Kabureck
Vice President and
Chief Accounting Officer

John M. Kelly
Vice President
President, Xerox Global Services
North America

James H. Lesko
Vice President
Investor Relations

Jule E. Limoli
Vice President
President, North American
Agent Operations

Douglas C. Lord
Vice President
President, North American
Solutions Group

Xerox 2008 Annual Report

How to reach us

Xerox Corporation
45 Glover Avenue
Norwalk, CT 06856-4505
203.968.3000

Xerox Europe
Riverview
Oxford Road
Uxbridge
Middlesex
United Kingdom
UB8 1HS
+44.1895.251133

Fuji Xerox Co., Ltd.
Tokyo Midtown West
9-7-3, Akasaka
Minato-ku, Tokyo 107-0052
Japan
+81.3.6271.5111

Products and services

www.xerox.com or by phone:
800 ASK-XEROX (800.275.9376)

Additional information

The Xerox Foundation
e-mail: evelyn.shockley@xerox.com

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 and
Web submission tool on www.xerox.com/ethics
e-mail: ethics@xerox.com

Environment, Health and Safety
Progress Report
800.828.6571
www.xerox.com/environment

Global Citizenship
www.xerox.com/citizenship
e-mail: citizenship@xerox.com

Governance
www.xerox.com/investor

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

Shareholder information

For investor information, including
comprehensive earnings releases:
www.xerox.com/investor or call
888.979.8378.

For shareholder services: call
800.828.6396 (TDD: 800.368.0328)
or 781.575.3222; or write to
Computershare Trust Company, N.A.,
P.O. Box 43078, Providence, RI
02940-3078; or use e-mail available
at www.computershare.com

Annual meeting

Thursday, May 21, 2009, 9:00 a.m. EDT
Xerox Corporate Headquarters
45 Glover Avenue
Norwalk, Connecticut

Proxy material mailed on April 9, 2009,
to shareholders of record March 23, 2009.

Investor contacts

Jason Barnecut, Manager
Investor Relations
jason.barnecut@xerox.com

Jennifer Horsley, Manager
Investor Relations
jennifer.horsley@xerox.com

This annual report is also available online
at www.xerox.com/investor

Electronic delivery enrollment

Xerox offers shareholders the convenience
of electronic delivery including:
• Immediate receipt of the Proxy Statement

and Annual Report
• Online proxy voting

Registered Shareholders, visit
http://www.eTree.com/Xerox

You are a registered shareholder if you have
your stock certificate in your possession or
if the shares are being held by our transfer
agent, Computershare.

Beneficial Shareholders, visit
http://enroll.icsdelivery.com/xrx

You are a beneficial shareholder if you
maintain your position in Xerox within
a brokerage account.

Xerox 2008 Annual Report

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“ Bottom line: yes, we are feeling

the impact of the recession;

yes, we are moving aggressively

to reduce costs, generate cash

and weather the storm; but no,

we are neither giving up on 2009

nor mortgaging our future by

compromising on investments that

will give us momentum as we come

out of the economic downturn.”

Anne M. Mulcahy

Chairman and Chief Executive Officer

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2008 Annual Report

© 2009 Xerox Corporation. All rights reserved. XEROX®, the sphere of connectivity design, DocuColor®, DocuTech®, FreeFlow®, New Business
of Printing®, Phaser®, WorkCentre®, iGen3®, iGen4™, and Xerox Nuvera® are trademarks of, or licensed to Xerox Corporation in the U.S.
and/or other countries. XMPie® is a trademark of XMPie Inc.

002CS18008

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