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    Management’s Discussion and Analysis of Financial Condition and Results of Operations The following Management’s Discussion and Analysis (“MD&A”) Post sale revenue currently represents more than 75 percent of the is intended to help the reader understand the results of operations Company’s revenue and is driven by the amount of equipment installed and financial condition of Xerox Corporation. MD&A is provided at customer locations and the utilization of that equipment. As such, our as a supplement to, and should be read in conjunction with, our critical success factors include equipment installations, which stabilize consolidated financial statements and the accompanying notes. and grow our installed base of equipment at customer locations, page volume growth and higher revenue per page. Key drivers to increase Throughout this document, references to “we,” “our,” the “Company” equipment installations, usage and associated post sale revenue include and “Xerox” refer to Xerox Corporation and its subsidiaries. References the following: to “Xerox Corporation” refer to the stand-alone parent company and do not include its subsidiaries. • Accelerate transition to color • Build on services leadership Executive Overview • Strengthening our leadership in digital production printing. We are a technology and services enterprise and a leader in the global The transition to color is a primary driver to improve revenue per page, document market. We develop, manufacture, market, service and as color documents typically require significantly more toner coverage finance the industry’s broadest portfolio of document equipment, per page than traditional black-and-white printing. We have the broadest software, solutions and services. The global document market continues color portfolio in the industry and leading technologies. Our growing to see significant trends toward color, enterprise print services and services business helps customers reduce their costs. We lead the electronic document management. Our broad portfolio of production, industry with end-to-end managed print services. Lastly, we continue to office and service offerings provide value to our customers and enable create new market opportunities with digital printing as a complement Xerox to lead and grow in the $132 billion market we serve. to traditional offset printing. In 2009, we agreed to acquire Affiliated Computer Services, Inc. (“ACS”). We operate in a global business environment, serving a wide range The acquisition was completed in February 2010. This acquisition trans- of customers, with about 50 percent of our revenue generated from forms us into the world’s leading enterprise for business process and customers outside the U.S. Our markets are competitive. Customers are document management and accelerates our growth in an expanding demanding document services such as assessment consulting, managed market. ACS is one of the largest providers of business process print services, imaging and hosting, and document-intensive business outsourcing (“BPO”) and information technology (“IT”) services and process improvements. Additionally, our customers demand improved solutions to commercial and government clients worldwide. ACS’s technology solutions, such as the ability to print offset-quality color revenues for the calendar year ended December 31, 2009 were $6.6 documents on-demand; improved product functionality, such as the billion and they employed 78,000 people and operated in over 100 ability to print, copy, fax and scan from a single device; and lower prices countries. With the acquisition of ACS we have greatly expanded our for the same functionality. market opportunity. The BPO market is estimated at $150 billion and the ITO market is estimated at $250 billion. Accretive acquisitions and expanded distribution to drive organic growth are also key elements of our business strategy. In addition Our business strategy is built upon an annuity model that yields con- to the ACS acquisition, in 2009 Global Imaging Systems, Inc. (“GIS”) sistent, strong cash flow, expanded earnings and enables us to provide acquired ComDoc, Inc. (“ComDoc”), one of the larger independent good returns to shareholders. The majority of our revenue (supplies, dealers in the U.S., expanding coverage in Ohio, Pennsylvania, New York service, paper, outsourcing, rentals and financing) is recurring, which we and West Virginia. collectively refer to as post sale revenue. This recurring revenue provides a significant degree of stability to our revenue, profits and cash flow. Financial Overview Although we began to see some improvements in our markets in the fourth quarter 2009, we faced significant external challenges in 2009 including: • A worldwide recession driving down demand and volumes; • A credit market crisis impacting access, rates and creating liquidity pressures on our channels and customers; and • The negative effects of currency changes on our revenue and costs. 22 Xerox 2009 Annual Report


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    Management’s Discussion The overall slowdown in business activity reduced print volumes, We continue to maintain debt levels primarily to support our especially in heavily document-driven processes, and our customers, customer financing operations and, at the end of 2009, to fund the in an effort to manage costs, are delaying spending on technology ACS acquisition. Total Debt at December 31, 2009 of $9,264 million upgrades until there are stronger signs of economic improvement. increased $880 million from the prior year as net debt repayments The weak economies in developing markets, like Russia and Eurasia, of approximately $1.8 billion were more than offset by the issuance where access to credit is still quite limited, also impacted our revenues. of $2,750 million in Senior Notes. Our 2009 public offerings included We reacted to these challenges by prioritizing cash generation and $750 million of Senior Notes issued in May and $2.0 billion of Senior taking actions on cost and expense to help mitigate the effects of Notes issued in December. The net proceeds from the December Senior lower revenue. Notes offering were used in connection with the acquisition of ACS. We finished the year with cash and cash equivalents of $3,799 billion, The following is a summary of key 2009 highlights: which included funds subsequently used for the acquisition of ACS. • Delivered strong operating cash flow and reduced spending; Our 2010 priorities include: • Operational performance continues to improve sequentially; • Effective ACS transition, including synergies capture; • Competitive position strengthened through innovative technology and industry-leading Managed Print Services offering; and • Grow revenue and maintain leadership in innovation; • ACS acquisition opens new market opportunities and strengthens • Continue to aggressively manage spending and resize our cost financial position. base to align to current revenues; and • Drive operating cash flow and achieve debt reduction goals. Total revenue of $15,179 million for 2009 declined 14% from the prior year, including a 3-percentage point negative impact from currency. Our 2010 balance sheet and cash flow strategy includes: sustaining Equipment sales of $3,550 million for 2009 decreased 24% from the our working capital improvements; maintaining our investment-grade prior year, primarily reflecting the continued industry-wide slowdown credit ratings; achieving an optimal cost of capital; and effectively in technology spending. Post sale revenue of $11,629 million for 2009 deploying cash to deliver and maximize shareholder value through was down 10% from the prior year, primarily reflecting lower supplies acquisitions and dividends. Our strategy also includes appropriately revenue as distributors maintained lower inventory levels and businesses leveraging our financing assets (finance receivables and equipment implemented their own cost-cutting measures. on operating leases). The benefits from restructuring and operational cost improvements Currency Impacts helped to relieve the pressure from revenue declines. Gross margins of 39.7% for 2009 increased 0.8-percentage points from the prior year To understand the trends in our business, we believe that it is helpful despite the continued effect of higher product costs due to the strength to analyze the impact of changes in the translation of foreign currencies of the Japanese Yen. Selling, administrative and general expenses into U.S. Dollars on revenues and expenses. We refer to this analysis as (“SAG”) for 2009 declined $385 million, reflecting favorable currency, the “currency impact” or “the impact from currency.” Revenues and expenses benefits from restructuring and operational cost improvements, partially from our developing markets are analyzed at actual exchange rates offset by increased bad debt expense. for all periods presented, since these countries generally have volatile currency and inflationary environments, and our operations in these Cash flows from operations of $2,208 million in 2009 were primarily countries have historically implemented pricing actions to recover the driven by working capital improvements. Cash used in investing activities impact of inflation and devaluation. We do not hedge the translation of $343 million reflected well-controlled capital expenditures of $193 effect of revenues or expenses denominated in currencies where the million, as well as $145 million for GIS’s acquisition of ComDoc in the local currency is the functional currency. first quarter of 2009. 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 7% stronger in 2009 and 3% weaker in 2008, each compared to the prior year. As a result, the foreign currency translation impact on revenue was a 3% detriment in 2009 and a 1% benefit in 2008. Xerox 2009 Annual Report 23


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    Management’s Discussion Summary Results Revenue Revenues for the three years ended December 31, 2009 were as follows: Year Ended December 31, Percent Change (in millions) 2009 2008 2007 2009 2008 Equipment sales $ 3,550 $ 4,679 $ 4,753 (24)% (2)% Post sale revenue(1) 11,629 12,929 12,475 (10)% 4% Total Revenue $ 15,179 $17,608 $ 17,228 (14)% 2% Reconciliation to Consolidated Statements of Income Sales $ 6,646 $ 8,325 $ 8,192 Less: Supplies, paper and other sales (3,096) (3,646) (3,439) Equipment Sales $ 3,550 $ 4,679 $ 4,753 Service, outsourcing and rentals $ 7,820 $ 8,485 $ 8,214 Finance income 713 798 822 Add: Supplies, paper and other sales 3,096 3,646 3,439 Post Sale Revenue $ 11,629 $12,929 $ 12,475 Memo: Color (2) $ 5,972 $ 6,669 $ 6,356 (10)% 5% Revenue 2009 – 5% decrease in color post sale revenue including a 3-percentage Revenue decreased 14% compared to the prior year, including point negative impact from currency. The decline was partially driven a 3-percentage point negative impact from currency. Although by lower channel color printer supplies purchases. Color represented moderating in the fourth quarter 2009, worldwide economic 40% and 37% of post sale revenue in 2009 and 2008, excluding weakness negatively impacted our major market segments during GIS,(3) respectively. the year. Total revenues included the following: – 22% decrease in color equipment sales revenue including a • 10% decrease in post sale revenue including a 3-percentage 2-percentage point negative impact from currency and lower point negative impact from currency. The components of post sale installs driven by the impact of the economic environment. revenue decreased as follows: Color sales represented 53% and 50% of total equipment sales in 2009 and 2008, excluding GIS,(3) respectively. – 8% decrease in service, outsourcing and rentals revenue to $7,820 million, reflecting a 3-percentage point negative impact – 10%(4) growth in color pages. Color pages(4) represented from currency and an overall decline in page volume. Total digital 21% and 18% of total pages in 2009 and 2008, respectively. pages declined 6% despite an increase in color pages of 10%. Revenue 2008 – Supplies, paper and other sales of $3,096 million decreased 15% Revenue increased 2% compared to the prior year and was flat when due primarily to currency, which had a 2-percentage point negative including GIS in our 2007 results.(5) Currency had a 1-percentage point impact, and declines in channel supplies purchases, including lower positive impact on total revenues. Total revenues included the following: purchases within developing markets, and lower paper sales. • 4% increase in post sale revenue, or 2% including GIS in our 2007 • 24% decrease in equipment sales revenue, including a 1-percentage results.(5) This included a 1-percentage point benefit from currency. point negative impact from currency. The overall decline in install Growth in GIS, color products and document management services activity was the primary driver, along with price declines of approxi- offset the declines in high-volume black-and-white printing systems, mately 5% across the Production and Office segments. black-and-white multifunction devices and light lens product revenue. • 10% decrease in color revenue(2) including a 2-percentage point The components of post sale revenue increased as follows: negative impact from currency. Color revenue of $5,972 million in – 3% increase in service, outsourcing and rentals revenue to 2009 comprised 43% of total revenue, excluding GIS,(3) compared $8,485 million reflected the full-year inclusion of GIS and growth to 41% in 2008 reflecting: 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. 24 Xerox 2009 Annual Report


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    Management’s Discussion • 2% decrease in equipment sales revenue. There was no impact from • $292 million after-tax charge ($426 million pre-tax) for the currency on equipment sales revenue. When including GIS in our 2007 second, third and fourth quarter 2008 restructuring and asset results,(5) equipment sales revenue decreased 5%, with a 1-percentage impairment actions. point benefit from currency. Overall price declines of between • $24 million after-tax charge ($39 million pre-tax) for an Office 5%–10%, as well as product mix, more than offset overall growth product line equipment write-off. in install activity. • $41 million income tax benefit from the settlement of certain • 5% growth in color revenue.(2) Color revenue of $6,669 million in previously unrecognized tax benefits. 2008 represented 41% of total revenue, excluding GIS,(3) compared to 39% in 2007, reflecting: Application of Critical Accounting Policies – 10% growth in color post sale revenue to $4,590 million. Color In preparing our Consolidated Financial Statements and accounting post sale revenue represented 37% and 35% of post sale revenue for the underlying transactions and balances, we apply various in 2008 and 2007, respectively.(3) accounting policies. Senior management has discussed the development – Color equipment sales revenue declined 4% to $2,079 million. and selection of the critical accounting policies, estimates and related Color equipment sales represented 50% of total equipment sales disclosures included herein with the Audit Committee of the Board in 2008 and 2007, respectively.(3) of Directors. We consider the policies discussed below as critical – 24%(4) growth in color pages. Color pages(4) represented 18% and to understanding our Consolidated Financial Statements, as their 12% of total pages in 2008 and 2007, respectively. application places the most significant demands on management’s (1) Post sale revenue is largely a function of the equipment placed at customer judgment, since financial reporting results rely on estimates of the locations, the volume of prints and copies that our customers make on that effects of matters that are inherently uncertain. In instances where equipment, the mix of color pages and associated services. different estimates could have reasonably been used, we disclosed (2) Color revenues represent a subset of total revenue and excludes the impact the impact of these different estimates on our operations. In certain of GIS’s revenues. (3) As of December 31, 2009 and 2008, total color, color post sale and color instances, like revenue recognition for leases, the accounting rules are equipment sales revenues comprised 39%, 37% and 46%; and 38%, 36% and prescriptive; therefore, it would not have been possible to reasonably 44%, respectively, if calculated on total, total post sale, and total equipment sales use different estimates. Changes in assumptions and estimates are revenues, including GIS. GIS is excluded from the color information presented because reflected in the period in which they occur. The impact of such changes the breakout of the information required to make this computation for all periods could be material to our results of operations and financial condition is not available. (4) Pages include estimates for developing markets, GIS and printers. in any quarterly or annual period. (5) The percentage point impacts from GIS reflect the revenue growth year-over-year after including GIS’s results for 2007 on a pro forma basis. We acquired GIS in Specific risks associated with these critical accounting policies are May 2007. See “Non-GAAP Financial Measures” section for an explanation of this discussed throughout the MD&A, where such policies affect our non-GAAP measure. reported and expected financial results. For a detailed discussion of the application of these and other accounting policies, refer to Note Net Income 1 – Summary of Significant Accounting Policies, in the Consolidated Net income and diluted earnings per share for the three years ended Financial Statements. December 31, 2009 were as follows: Revenue Recognition for Leases (in millions, except per-share amounts) 2009 2008 2007 Our accounting for leases involves specific determinations under Net income attributable to Xerox $ 485 $ 230 $ 1,135 applicable lease accounting standards, which often involve complex Diluted earnings per share $0.55 $ 0.26 $ 1.19 and prescriptive provisions. These provisions affect the timing of revenue recognition for our equipment. If a lease qualifies as a sales- Net Income 2009 type capital lease, equipment revenue is recognized upon delivery or Net income attributable to Xerox of $485 million, or $0.55 per diluted installation of the equipment as sale revenue as opposed to ratably share, included the following: over the lease term. The critical elements that we consider with respect • A $49 million after-tax ($72 million pre-tax) charge, or $0.06 per to our lease accounting are the determination of the economic life diluted share, related to costs associated with the acquisition of ACS. and the fair value of equipment, including the residual value. For • A charge of $46 million, or $0.05 per diluted share, for our share of purposes of determining the economic life, we consider the most Fuji Xerox’s after-tax restructuring charge. objective measure to be the original contract term, since most equip- ment is returned by lessees at or near the end of the contracted term. Net Income 2008 The economic life of most of our products is five years, since this Net income of $230 million, or $0.26 per diluted share, included represents the most frequent contractual lease term for our principal the following: products and only a small percentage of our leases are for original terms • $491 million after-tax charges ($774 million pre-tax) associated longer than five years. There is no significant after-market for our used with securities-related litigation matters, as well as other probable equipment. We believe five years is representative of the period during litigation-related losses, including $36 million for the Brazilian which the equipment is expected to be economically usable, with normal labor-related contingencies. service, for the purpose for which it is intended. Xerox 2009 Annual Report 25


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    Management’s Discussion Revenue Recognition Under Bundled Arrangements Historically, the majority of the bad debt provision relates to our We sell the majority of our products and services under bundled lease finance receivables portfolio. This provision is inherently more difficult arrangements, which typically include equipment, service, supplies to estimate than the provision for trade accounts receivable because and financing components for which the customer pays a single the underlying lease portfolio has an average maturity, at any time, negotiated monthly fixed price for all elements over the contractual of approximately two to three years and contains past-due billed lease term. Typically these arrangements include an incremental, amounts, as well as unbilled amounts. The estimated credit quality variable component for page volumes in excess of contractual page of any given customer and class of customer or geographic location volume minimums, which are often expressed in terms of price per can significantly change during the life of the portfolio. We consider page. Revenues under these arrangements are allocated, considering all available information in our quarterly assessments of the adequacy the relative fair values of the lease and non-lease deliverables included of the provision for doubtful accounts. in the bundled arrangement, based upon the estimated relative fair The current economic environment has increased the risk of non- values of each element. Lease deliverables include maintenance and collection of receivables. We have accordingly considered this executory costs, equipment and financing, while non-lease deliverables increased risk in the evaluation and assessment of our allowance generally consist of supplies and non-maintenance services. Our revenue for doubtful accounts at year-end. Bad debt provisions increased by allocation for lease deliverables begins by allocating revenues to the $103 million in 2009 and reserves as a percentage of trade and finance maintenance and executory costs plus profit thereon. The remaining receivables increased to 4.1% at December 31, 2009 as compared amounts are allocated to the equipment and financing elements. We to 3.4% at December 31, 2008. However, collection risk is somewhat perform analyses of available verifiable objective evidence of equipment mitigated by the fact that our receivables are fairly well dispersed fair value based on cash selling prices during the applicable period. among a diverse customer base both in size and geography. Days sales The cash selling prices are compared to the range of values included in outstanding improved slightly year-over-year. In addition, accounts our lease accounting systems. The range of cash selling prices must be receivable balances greater than 90 days outstanding were about reasonably consistent with the lease selling prices, taking into account 12% of total gross accounts receivables at December 31, 2009, residual values, in order for us to determine that such lease prices are which was relatively flat as compared to the prior year. However, indicative of fair value. we continue to assess our receivable portfolio in light of the current Our pricing interest rates, which are used in determining customer economic environment and its impact on our estimation of the payments, are developed based upon a variety of factors including local adequacy of the allowance for doubtful accounts. prevailing rates in the marketplace and the customer’s credit history, As discussed above, in preparing our Consolidated Financial Statements industry and credit class. We reassess our pricing interest rates quarterly for the three-year period ended December 31, 2009, we estimated based on changes in the local prevailing rates in the marketplace. These our provision for doubtful accounts based on historical experience interest rates have been generally adjusted if the rates vary by 25 basis and customer-specific collection issues. This methodology has been points or more, cumulatively, from the last rate in effect. The pricing consistently applied for all periods presented. During the five-year period interest rates generally equal the implicit rates within the leases, as ended December 31, 2009, our reserve for doubtful accounts ranged corroborated by our comparisons of cash to lease selling prices. from 3.0% to 4.1% of gross receivables. Holding all other assumptions Allowance for Doubtful Accounts and Credit Losses constant, a 1-percentage point increase or decrease in the reserve from the December 31, 2009 rate of 4.1% would change the 2009 provision We perform ongoing credit evaluations of our customers and adjust by approximately $91 million. credit limits based upon customer payment history and current creditworthiness. We continuously monitor collections and payments Pension and Post-retirement Benefit Plan Assumptions from our customers and maintain a provision for estimated credit We sponsor defined benefit pension plans in various forms in several losses based upon our historical experience and any specific customer countries covering substantially all employees who meet eligibility collection issues that have been identified. We cannot guarantee that requirements. Post-retirement benefit plans cover primarily U.S. we will continue to experience credit loss rates similar to those we employees for retirement medical costs. Several statistical and other have experienced in the past. Measurement of such losses requires factors that attempt to anticipate future events are used in calculating consideration of historical loss experience, including the need to adjust the expense, liability and asset values related to our pension and for current conditions, and judgments about the probable effects of post-retirement benefit plans. These factors include assumptions we relevant observable data, including present economic conditions make about the discount rate, expected return on plan assets, rate of such as delinquency rates and financial health of specific customers. increase in healthcare costs, the rate of future compensation increases We recorded bad debt provisions of $291 million, $188 million and and mortality. Differences between these assumptions and actual $134 million in SAG expenses in our Consolidated Statements of Income experiences are reported as net actuarial gains and losses and are for the years ended December 31, 2009, 2008 and 2007, respectively. subject to amortization to net periodic pension cost, generally over the average remaining service lives of the employees participating in the pension plan. 26 Xerox 2009 Annual Report


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    Management’s Discussion Cumulative actuarial losses for our pension plans of $1.8 billion as of Assuming settlement losses in 2010 are consistent with 2009, our December 31, 2009 were flat as compared to December 31, 2008. 2010 net periodic defined benefit pension cost is expected to be Positive returns on plan assets in 2009 as compared to expected returns approximately $70 million higher than 2009, primarily as a result offset a decrease in discount rates. The total actuarial loss will be of a decrease in the discount rate and increased amortization of amortized in the future, subject to offsetting gains or losses that will actuarial losses, which includes the impact of the significant asset change the future amortization amount. losses in 2008. We have utilized a weighted average expected rate of return on plan On a consolidated basis, we recognized net periodic pension cost assets of 7.4% for 2009 and 7.6% for both 2008 and 2007, on a of $270 million, $254 million and $315 million for the years ended worldwide basis. December 31, 2009, 2008 and 2007, respectively. The costs associated with our defined contribution plans, which are included in net periodic During 2009, the actual return on plan assets was $720 million, primarily pension cost, were $38 million, $80 million and $80 million for the years as a result of an improvement in the equity markets. In estimating ended December 31, 2009, 2008 and 2007, respectively. The decrease the 2010 expected rate of return, in addition to assessing recent in 2009 was primarily due to the April 2009 suspension of the 401(k) performance, we considered the historical returns earned on plan assets, match in the U.S. Pension cost is included in several income statement the rates of return expected in the future and our investment strategy components based on the related underlying employee costs. Pension and asset mix with respect to the plans’ funds. The weighted average and post-retirement benefit plan assumptions are included in Note expected rate of return on plan assets we will utilize for 2010 will be 14 – Employee Benefit Plans in the Consolidated Financial Statements. 7.3% as compared to 7.4% in 2009 and 7.6% in 2008. Holding all other assumptions constant, a 0.25% increase or decrease For purposes of determining the expected return on plan assets, we in the discount rate would change the 2010 projected net periodic utilize a calculated value approach in determining the value of the pension cost by $12 million. Likewise, a 0.25% increase or decrease in pension plan assets, as opposed to a fair market value approach. The the expected return on plan assets would change the 2010 projected primary difference between the two methods relates to a systematic net periodic pension cost by $11 million. recognition of changes in fair value over time (generally two years) Income Taxes and Tax Valuation Allowances versus immediate recognition of changes in fair value. Our expected rate We record the estimated future tax effects of temporary differences of return on plan assets is then applied to the calculated asset value to between the tax bases of assets and liabilities and amounts reported in determine the amount of the expected return on plan assets to be used our Consolidated Balance Sheets, as well as operating loss and tax credit in the determination of the net periodic pension cost. The calculated carryforwards. We follow very specific and detailed guidelines in each value approach reduces the volatility in net periodic pension cost that tax jurisdiction regarding the recoverability of any tax assets recorded in can result from using the fair market value approach. The difference our Consolidated Balance Sheets and provide valuation allowances as between the actual return on plan assets and the expected return on required. We regularly review our deferred tax assets for recoverability plan assets is added to, or subtracted from, any cumulative differences considering historical profitability, projected future taxable income, the that arose in prior years. This amount is a component of the net expected timing of the reversals of existing temporary differences and actuarial gain or loss. tax planning strategies. If we continue to operate at a loss in certain Another significant assumption affecting our pension and post- jurisdictions or are unable to generate sufficient future taxable income, retirement benefit obligations and the net periodic pension and other or if there is a material change in the actual effective tax rates or time post-retirement benefit cost is the rate that we use to discount our period within which the underlying temporary differences become future anticipated benefit obligations. The discount rate reflects the taxable or deductible, we could be required to increase the valuation current rate at which the pension liabilities could be effectively settled allowance against all or a significant portion of our deferred tax assets, considering the timing of expected payments for plan participants. In resulting in a substantial increase in our effective tax rate and a material estimating this rate, we consider rates of return on high-quality fixed- adverse impact on our operating results. Conversely, if and when our income investments included in various published bond indices, adjusted operations in some jurisdictions were to become sufficiently profitable to eliminate the effects of call provisions and differences in the timing to recover previously reserved deferred tax assets, we would reduce all and amounts of cash outflows related to the bonds. In the U.S. and or a portion of the applicable valuation allowance in the period when the U.K., which comprise approximately 80% of our projected benefit such determination is made. This would result in an increase to reported obligations, we consider the Moody’s Aa Corporate Bond Index and the earnings in such period. Adjustments to our valuation allowance, International Index Company’s iBoxx Sterling Corporate AA Cash Bond through (credits) charges to income tax expense, were $(11) million, Index, respectively, in the determination of the appropriate discount rate $17 million and $14 million for the years ended December 31, 2009, assumptions. The weighted average discount rate we utilized to measure 2008 and 2007, respectively. There were other (decreases) increases to our pension obligation as of December 31, 2009 and to calculate our our valuation allowance, including the effects of currency, of $55 million, 2010 expense was 5.7%, which is a decrease of 0.6% from 6.3% used $(136) million and $86 million for the years ended December 31, 2009, in determining our 2009 expense. Xerox 2009 Annual Report 27


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    Management’s Discussion 2008 and 2007, respectively, that did not affect income tax expense As a result of our acquisition of GIS, as well as other prior-year in total, as there was a corresponding adjustment to deferred tax assets acquisitions, we have a significant amount of goodwill. Goodwill is or other comprehensive income. Gross deferred tax assets of $3.7 billion tested for impairment annually or more frequently if an event or and $3.8 billion had valuation allowances of $672 million and $628 circumstance indicates that an impairment loss may have been million at December 31, 2009 and 2008, respectively. incurred. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets We are subject to ongoing tax examinations and assessments in various and liabilities to reporting units, assignment of goodwill to reporting jurisdictions. Accordingly, we may incur additional tax expense based units and determination of the fair value of each reporting unit. We upon our assessment of the more-likely-than-not outcomes of such estimate the fair value of each reporting unit using a discounted cash matters. In addition, when applicable, we adjust the previously recorded flow methodology. This requires us to use significant judgment including tax expense to reflect examination results. Our ongoing assessments estimation of future cash flows, which is dependent on internal forecasts, of the more-likely-than-not outcomes of the examinations and related estimation of the long-term rate of growth for our business, the useful tax positions require judgment and can materially increase or decrease life over which cash flows will occur, determination of our weighted our effective tax rate, as well as impact our operating results. average cost of capital for purposes of establishing a discount rate We file income tax returns in the U.S. Federal jurisdiction and various and relevant market data. foreign jurisdictions. In the U.S. we are no longer subject to U.S. Federal Our annual impairment test of goodwill was performed in the income tax examinations by tax authorities for years before 2007. fourth quarter. The estimated fair values of our reporting units were With respect to our major foreign jurisdictions, we are no longer subject based on discounted cash flow models derived from internal earnings to tax examinations by tax authorities for years before 2000. forecasts and assumptions. The assumptions and estimates used Legal Contingencies in those valuations incorporated the current economic environment. We are involved in a variety of claims, lawsuits, investigations and In performing our 2009 impairment test, the following were the overall proceedings concerning securities law, intellectual property law, composite assumptions regarding revenue and expense growth, environmental law, employment law and ERISA, as discussed in Note which were the basis for estimating future cash flows used in the 16 – Contingencies in the Consolidated Financial Statements. We discounted cash flow model: 1) revenue growth 2–4%; 2) gross margin determine whether an estimated loss from a contingency should 39–40%; 3) RD&E 4–5%; 4) SAG 24–25%; and 5) return on sales be accrued by assessing whether a loss is deemed probable and can 8–9%. We believe these estimated assumptions are appropriate for be reasonably estimated. We assess our potential liability by analyzing our circumstances, in line with historical results, consistent with our our litigation and regulatory matters using available information. forecasted long-term business model and give consideration to the We develop our views on estimated losses in consultation with outside current economic environment. Our forecast does not include the counsel handling our defense in these matters, which involves an impact of the ACS acquisition completed in February 2010, since our analysis of potential results, assuming a combination of litigation and impairment test was limited to goodwill as of the fourth quarter 2009. settlement strategies. Should developments in any of these matters Based on these valuations, we determined that the fair values of cause a change in our determination as to an unfavorable outcome our reporting units exceeded their carrying values and no goodwill and result in the need to recognize a material accrual, or should any impairment charge was required during the fourth quarter 2009. of these matters result in a final adverse judgment or be settled for significant amounts, they could have a material adverse effect on Refer to Note 1 – Summary of Significant Accounting Policies – “Goodwill our results of operations, cash flows and financial position in the period and Intangible Assets” for further information regarding our goodwill or periods in which such change in determination, judgment impairment testing, as well as Note 8 – Goodwill and Intangible Assets, or settlement occurs. Net in the Consolidated Financial Statements for further information regarding goodwill by operating segment. Business Combinations and Goodwill The application of the purchase method of accounting for business Operations Review of Segment Revenue combinations requires the use of significant estimates and assumptions and Operating Profit in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration Our reportable segments are consistent with how we manage the between assets that are depreciated and amortized from goodwill. Our business and view the markets we serve. Our reportable segments estimates of the fair values of assets and liabilities acquired are based are Production, Office and Other. See Note 2 – Segment Reporting upon assumptions believed to be reasonable and, when appropriate, in the Consolidated Financial Statements for further discussion on include assistance from independent third-party appraisal firms. our segment operating revenues and segment operating profit. 28 Xerox 2009 Annual Report


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    Management’s Discussion Revenues by segment for the years ended 2009, 2008 and 2007 were as follows: Year Ended December 31, (in millions) Production Office Other Total 2009 Equipment sales $ 1,031 $ 2,363 $ 156 $ 3,550 Post sale revenue 3,514 6,213 1,902 11,629 Total Revenues $ 4,545 $ 8,576 $ 2,058 $ 15,179 Segment Profit (Loss) $ 217 $ 835 $ (274) $ 778 Operating Margin 4.8% 9.7% (13.3)% 5.1% 2008 Equipment sales $ 1,325 $ 3,105 $ 249 $ 4,679 Post sale revenue 3,912 6,723 2,294 12,929 Total Revenues $ 5,237 $ 9,828 $ 2,543 $ 17,608 Segment Profit (Loss) $ 394 $ 1,062 $ (165) $ 1,291 Operating Margin 7.5% 10.8% (6.5)% 7.3% 2007 Equipment sales $ 1,471 $ 3,030 $ 252 $ 4,753 Post sale revenue 3,844 6,443 2,188 12,475 Total Revenues $ 5,315 $ 9,473 $ 2,440 $ 17,228 Segment Profit (Loss) $ 562 $ 1,115 $ (89) $ 1,588 Operating Margin 10.6% 11.8% (3.7)% 9.2% Note: Install activity percentages include the Xerox-branded product shipments to GIS. Production Revenue 2008 Production revenue of $5,237 million decreased 1%, including a Revenue 2009 1-percentage point benefit from currency, reflecting: Production revenue of $4,545 million decreased 13%, including a 3-percentage point negative impact from currency, reflecting: • 2% increase in post sale revenue as growth from color, continuous feed and light production products offset declines in revenue from • 10% decrease in post sale revenue with a 3-percentage point black-and-white high-volume printing systems and light lens devices. negative impact from currency, as declines were driven in part by lower black-and-white page volumes and lower revenue from • 10% decrease in equipment sales revenue, primarily reflecting pricing entry production color products which reflect the weak economic declines in both black-and-white and color production systems, driven environment during the year. in part by weakness in the U.S. • 22% decrease in equipment sales revenue, with a 2-percentage • 1% increase in installs of production color products driven in part point negative impact from currency. The decline in revenue across by Xerox® 700 and iGen4 activity, as well as color continuous feed. all product groups reflects lower installs driven by the weak economic • 6% decline in installs of production black-and-white systems driven environment and delays in customer spending on technology. primarily by declines in installs of light production systems. • 11% decline in installs of production color products, as entry Operating Profit 2009 production color declines were partially offset by increased Xerox® Production operating profit of $217 million decreased $177 million 700 installs and iGen4. from 2008. The decrease is primarily the result of lower gross profit • 22% decline in installs of production black-and-white systems, flow-through from revenue declines which were partially offset by lower reflecting declines in all product groups. RD&E and SAG spending as a result of favorable currency and cost reductions. The improvement in SAG was mitigated by an increase in bad debt provisions. Xerox 2009 Annual Report 29


  • Page 9

    Management’s Discussion Operating Profit 2008 Operating Profit 2009 Production operating profit of $394 million decreased $168 million Office operating profit of $835 million decreased $227 million from from 2007. The decrease is primarily the result of lower revenue 2008, as revenue declines were partially offset by lower RD&E and and lower gross margins due to pricing and product mix, as well as SAG as a result of favorable currency and cost actions. The improvement increased SAG expenses. in SAG was mitigated by an increase in bad debt provisions. Office Operating Profit 2008 Office operating profit of $1,062 million decreased $53 million from Revenue 2009 2007. The decrease was primarily due to lower gross profits reflecting Office revenue of $8,576 million decreased 13%, including a lower margins, as well as higher SAG expenses partially offset by the 2-percentage point negative impact from currency, reflecting: full-year inclusion of GIS. • 8% decrease in post sale revenue with a 3-percentage point negative Other impact from currency. Revenue declined across most product segments and reflects lower channel supplies purchases, including purchases Revenue 2009 within developing markets, which more than offset the growth in GIS. Other revenue of $2,058 million decreased 19%, including a • 24% decrease in equipment sales revenue, including a 1-percentage 2-percentage point negative impact from currency, primarily driven point negative impact from currency. The decline in revenue across by declines in revenue from paper, wide-format systems, and licensing most product groups reflects lower installs driven by the weak and royalty arrangements. Paper comprised approximately 50% of economic environment during this year. the Other segment revenue. • 20% decline in installs of color multifunction devices driven by lower Revenue 2008 overall demand, which more than offset the impact of new products Other revenue of $2,543 million increased 4%, primarily reflecting including the ColorQube and Office version of the Xerox® 700. the full-year inclusion of GIS and increased paper revenue partially • 37% decline in installs of black-and-white copiers and multifunction offset by lower revenue from wide-format systems. There was no devices, including an 83% decline in the low-dollar-value Segment 1 impact from currency. Paper comprised approximately 50% of the products (11–20 ppm), driven primarily by lower activity in developing Other segment revenue. markets, offset by a 4% increase in Segment 2–5 products (21–90 Operating Loss 2009 ppm). Segment 2–5 installs include the Xerox® 4595, a 95 ppm device Other operating loss of $274 million increased $109 million from 2008, with an embedded controller. primarily due to lower revenue, as well as lower interest income and • 34% decline in installs of color printers due to lower demand and equity income. lower sales to OEM partners. Operating Loss 2008 Revenue 2008 Other operating loss of $165 million increased $76 million from 2007, Office revenue of $9,828 million increased 4%, including a 1-percentage reflecting lower wide-format revenue, higher foreign exchange losses point benefit from currency, as well as the benefits from our expansion and lower interest income partially offset by gains on sales of assets. in the SMB market through GIS and Veenman. Revenue for 2008 reflects: • 4% increase in post sale revenue, reflecting the full-year inclusion Costs, Expenses and Other Income of GIS, as well as growth from color multifunction devices, and color Gross Margin printers partially offset by declines in black-and-white digital devices. Office post sale revenue was negatively impacted in the fourth quarter Gross margins by revenue classification were as follows: of 2008 by declines in channel supply purchases, including lower Year Ended December 31, purchases within developing markets. 2009 2008 2007 • 2% increase in equipment sales revenue, reflecting the full-year Sales 33.9% 33.7% 35.9% inclusion of GIS, as well as growth from color digital products which Service, outsourcing and rentals 42.6% 41.9% 42.7% more than offset declines from black-and-white devices, primarily Finance income 62.0% 61.8% 61.6% due to price declines and product mix. Total Gross Margin 39.7% 38.9% 40.3% • 24% color multifunction device install growth led by strong demand Gross Margin 2009 for Xerox® WorkCentre and Phaser products. Total gross margin increased 0.8-percentage points compared to 2008, • 8% increase in installs of black-and-white copiers and multifunction primarily driven by cost improvements enabled by restructuring and our devices, including 8% growth in Segment 1&2 products (11–30 ppm) cost actions, which were partially offset by the 0.5-percentage point and 8% growth in Segment 3–5 products (31–90 ppm). Segment unfavorable impact of transaction currency, primarily the Yen, and price 3–5 installs include the Xerox® 4595, a 95 ppm device with an declines of 1.0-percentage points. embedded controller. • 12% increase in color printer installs. 30 Xerox 2009 Annual Report


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    Management’s Discussion • Sales gross margin increased 0.2-percentage points, primarily • Sales gross margin decreased 2.2-percentage points primarily due to due to the cost improvements and the positive mix of revenues the approximately 2.5-percentage point impact of price declines, as partially offset by the adverse impact of transaction currency on well as channel and product mix. Cost improvements, which historically our inventory purchases of 1.0-percentage point and price declines tend to offset price declines, were limited in 2008 by the adverse of 1.2-percentage points. impact of the strengthening Yen on our inventory purchases. • Service, outsourcing and rentals margin increased 0.7-percentage • Service, outsourcing and rentals margin decreased 0.8-percentage points, primarily due to the positive impact from the reduction in points, primarily due to mix, as price declines of 1.3-percentage points costs driven by our restructuring and cost actions of 1.5-percentage were offset by cost improvements. Mix reflects margin pressure from points. These cost improvements more than offset the approximate document management services. 0.9-percentage points impact of pricing. • Financing income margin of approximately 62% remained • Financing income margin of 62% remained comparable to 2008. comparable to 2007. Gross Margin 2008 • Since a large portion of our inventory procurement is from Japan, 2008 Total gross margin decreased 1.4-percentage points compared the strengthening of the Yen versus the U.S. Dollar and Euro in to 2007, as price declines and mix of approximately 2.0-percentage 2008 significantly impacted our product cost. The Yen strengthened points were only partially offset by cost productivity improvements. Cost approximately 14% against the U.S. Dollar and 6% against the improvements were limited by an unfavorable impact on product costs of Euro in 2008 as compared to 2007. A significant portion of that approximately 0.5-percentage points from the significant strengthening strengthening occurred in the fourth quarter 2008 when the Yen of the Yen versus the U.S. Dollar and Euro. The negative impact of strengthened 17% against the U.S. Dollar and 29% against the 0.3-percentage points from an Office product line equipment write-off Euro as compared to prior year. was offset by positive adjustments related to the capitalized costs for Research, Development and Engineering Expenses (“RD&E”) equipment on operating leases and European product disposal costs. We invest in technological development, particularly in color, and believe our RD&E spending is sufficient to remain technologically competitive. Our R&D is strategically coordinated with that of Fuji Xerox. Year Ended December 31, Change (in millions) 2009 2008 2007 2009 2008 RD&E % Revenue 5.5% 5.0% 5.3% 0.5 pts (0.3) pts R&D $ 713 $ 750 $764 $ (37) $ (14) Sustaining engineering 127 134 148 (7) (14) Total RD&E Expenses $ 840 $ 884 $912 $ (44) $ (28) R&D Investment by Fuji Xerox(1) $ 796 $ 788 $672 $ 8 $ 116 (1) Increase in Fuji Xerox R&D was primarily due to changes in foreign exchange rates. RD&E 2009 RD&E 2008 The decrease in RD&E spending for 2009 reflects our restructuring The decrease in R&D spending for 2008 reflects the capture of and cost actions which consolidated the Production and Office efficiencies following a significant number of new product launches development and engineering infrastructures. over the previous two years, as well as leveraging our current RD&E investments to support our GIS operations. Sustaining engineering costs declined in 2008 due primarily to lower spending related to environmental compliance activities and maturing product platforms in the Production segment. Xerox 2009 Annual Report 31


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    Management’s Discussion Selling, Administrative and General Expenses (“SAG”) Year Ended December 31, Change (in millions) 2009 2008 2007 2009 2008 Total SAG $ 4,149 $ 4,534 $ 4,312 $ (385) $ 222 SAG as a % of Revenue 27.3% 25.7% 25.0% 1.6 pts 0.7 pts Bad Debt Expense $ 291 $ 188 $ 134 $ 103 $ 54 Bad Debt as a % of Revenue 1.9% 1.1% 0.8% 0.8 pts 0.3 pts SAG 2009 Restructuring and Asset Impairment Charges SAG of $4,149 million was $385 million lower than 2008, including For the years ended December 31, 2009, 2008 and 2007, we a $126 million benefit from currency. The SAG decrease was the result recorded net restructuring and asset impairment (credits)/charges of the following: of $(8) million, $429 million and $(6) million, respectively. • $311 million decrease in selling expenses reflecting favorable currency, • Restructuring activity was minimal in 2009, and the credit of benefits from restructuring, an overall reduction in marketing spend $8 million primarily reflected changes in estimates for prior and lower commissions. years’ initiatives. • $177 million decrease in general and administrative (“G&A”) expenses • The 2008 net charge included $357 million related to head count reflecting favorable currency and benefits from restructuring and cost reductions of approximately 4,900 employees, primarily in North actions partially offset by higher compensation accruals. America and Europe, and lease termination and asset impairment • $103 million increase in bad debt expense reflecting increased charges of $72 million, primarily reflecting the exit from certain write-offs in North America and Europe. leased and owned facilities resulting from a rationalization of our SAG 2008 worldwide operating locations. These actions applied equally to SAG of $4,534 million was $222 million higher than 2007, including both North America and Europe, with approximately half focused a $12 million unfavorable impact from currency. The SAG increase on SAG reductions, approximately a third on gross margin was the result of the following: improvements and the remainder focused on the optimization of RD&E investments. Estimated savings from these initiatives • $94 million increase in selling expenses, primarily reflecting the were approximately $250 million in 2009. full-year inclusion of GIS, investments in selling resources and • Restructuring activity was minimal in 2007 and the related credit marketing communications, and unfavorable currency partially of $6 million primarily reflected changes in estimates for prior offset by lower compensation. year’s severance costs. • $75 million increase in G&A expenses, primarily from the full-year inclusion of GIS and unfavorable currency. The restructuring reserve balance as of December 31, 2009 for all programs was $74 million, of which approximately $64 million is expected • $54 million increase in bad debt expense, reflecting increased write- to be spent over the next 12 months. Refer to Note 9 – Restructuring offs, particularly in the fourth quarter 2008, which included several and Asset Impairment Charges in the Consolidated Financial Statements high-value account bankruptcies in the U.S., U.K. and Germany. for further information regarding our restructuring programs. Bad debt expense, which is included in SAG, increased $103 million 2010 Expected Actions in 2009 and reserves as a percentage of trade and finance receivables In connection with our continued objective to align our cost base to increased to 4.1% at December 31, 2009 as compared to 3.4% at current revenues, we expect to record pre-tax restructuring charges of December 31, 2008. These increases reflect the weak worldwide approximately $280 million in 2010, of which $250 million is expected economic conditions and the increased level of customer bankruptcies to be recorded in the first quarter. These actions are expected to in certain industry groups during the year. Bad debts provision and impact all geographies and segments, with approximately equal focus write-offs in the fourth quarter 2009 were flat as compared to the on SAG reductions, gross margin improvements and optimization of prior year. RD&E investments. The restructuring is also expected to involve the rationalization of some of our facilities. 32 Xerox 2009 Annual Report


  • Page 12

    Management’s Discussion Acquisition-Related Costs Currency losses, net: Currency losses primarily result from the re-measurement of foreign currency-denominated assets and liabilities, Acquisition-related costs of $72 million were incurred and expensed the cost of hedging foreign currency-denominated assets and liabilities, during 2009 in connection with our acquisition of ACS. $58 million the mark-to-market of foreign exchange contracts utilized to hedge of the costs relate to the write-off of fees associated with the Bridge those foreign currency-denominated assets and liabilities and the Loan Facility commitment which was terminated as a result of securing mark-to-market impact of hedges of anticipated transactions, primarily permanent financing to fund the acquisition. The remainder of the costs future inventory purchases, for those that we do not apply cash flow represents transaction costs such as banking, legal and accounting fees, hedge accounting treatment. as well as some pre-integration costs such as external consulting services. Consistent with the new accounting guidance with respect to business The 2009 currency losses were primarily due to the significant combinations, adopted in 2009, all acquisition-related costs must be movement in exchange rates among the U.S. Dollar, Euro and Yen expensed as incurred. in the first quarter of 2009, as well as the increased cost of hedging, particularly in developing markets. Worldwide Employment The 2008 currency losses were primarily due to net re-measurement Worldwide employment of 53,600 as of December 31, 2009 decreased losses associated with our Yen-denominated payables, foreign currency- approximately 3,500 from December 31, 2008, primarily reflecting denominated assets and liabilities in our developing markets and the restructuring reductions, partially offset by additional headcount cost of hedging. The currency losses on Yen-denominated payables were related to GIS acquisitions. Worldwide employment was approximately largely limited to the first quarter 2008 as a result of the significant and 57,100 and 57,400 at December 31, 2008 and 2007, respectively. rapid weakening of the U.S. Dollar and Euro versus the Yen. Other Expenses, Net Amortization of intangible assets: The increase in 2009 and 2008 Other expenses, net for the years ended December 31, 2009, 2008 amortization as compared to prior years primarily reflects the full-year and 2007 consisted of the following: amortization of the assets acquired as part of our recent acquisitions. Year Ended December 31, Litigation matters: In 2008 legal matters consisted of the following: (in millions) 2009 2008 2007 • $721 million reflecting provisions for the $670 million court approved Non-financing interest expense $ 256 $ 262 $ 263 settlement of Carlson v. Xerox Corporation (“Carlson”) and other Interest income (21) (35) (55) pending securities-related cases, net of expected insurance recoveries. Gain on sales of businesses On January 14, 2009, the United States Court for the District of and assets (16) (21) (7) Connecticut entered a Final Order and Judgment approving the Currency losses, net 26 34 8 settlement of the Carlson litigation. Amortization of intangible assets 60 54 42 • $36 million for probable losses on Brazilian labor-related contin- Litigation matters 9 781 (6) gencies. Following an assessment of the most recent trend in the All Other expenses, net 31 12 20 outcomes of these matters, we reassessed the probable estimated Total Other Expenses, Net $ 345 $ 1,087 $ 265 loss and, as a result, recorded an additional reserve of $36 million in the fourth quarter of 2008. Non-financing interest expense: 2009 non-financing interest expense • $24 million associated with probable losses from various other legal decreased compared to 2008, as interest expense associated with our matters. $2.0 billion Senior Note offering for the funding of the ACS acquisition was more than offset by lower interest rates on the remaining debt. Refer to Note 16 – Contingencies in the Consolidated Financial Statements for additional information regarding litigation against In 2008, non-financing interest expense was flat compared to 2007, the Company. as the benefit of lower interest rates was offset by higher average non-financing debt balances. All other expenses, net: All Other expenses in 2009 were $19 million higher than the prior year, primarily due to fees associated with the Interest income: Interest income is derived primarily from our invested sale of receivables, as well as an increase in interest expense related to cash and cash equivalent balances. The decline in interest income in Brazil tax and labor contingencies. 2009 and 2008 was primarily due to lower average cash balances and rates of return. Gain on sales of businesses and assets: 2009 and 2008 gain on sales of business and assets primarily consisted of the sales of certain surplus facilities in Latin America. Xerox 2009 Annual Report 33


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    Management’s Discussion Income Taxes Equity in Net Income of Unconsolidated Affiliates Year Ended December 31, 2009 equity in net income of unconsolidated affiliates of $41 million (in millions) 2009 2008 2007 is principally related to our 25% share of Fuji Xerox income. The $72 Pre-tax income (loss) $ 627 $ (79) $ 1,468 million decrease from 2008 is primarily due to Fuji Xerox’s lower net Income tax expense (benefit) 152 (231) 400 income, which has been impacted by the worldwide economic weakness, Effective tax rate 24.2% 292.4% 27.2% and includes $46 million related to our share of Fuji Xerox after-tax restructuring costs. The 2009 effective tax rate of 24.2% was lower than the U.S. statutory tax rate, primarily reflecting the benefit to taxes from the geographical 2008 equity in net income of unconsolidated affiliates of $113 million mix of income before taxes and the related effective tax rates in those increased by $16 million from 2007, primarily due to a $14 million jurisdictions, and the settlement of certain previously unrecognized reduction in our share of Fuji Xerox restructuring charges. tax benefits partially offset by a reduction in the utilization of foreign Subsequent Events tax credits. We have operations in Venezuela where the U.S. Dollar is the functional The 2008 effective tax rate of 292.4% reflected the tax benefits from currency. At December 31, 2009 our Venezuelan operations had certain discrete items including the net provision for litigation matters; approximately 90 million in net Bolivar-denominated monetary assets the second, third and fourth quarter restructuring and asset impairment that were re-measured to U.S. Dollars at the official exchange rate of charges; the product line equipment write-off; and the settlement of 2.15 Bolivars to the Dollar. In January 2010, Venezuela announced a certain previously unrecognized tax benefits. Excluding these items, the devaluation of the Bolivar to an official rate of 4.30 Bolivars to the Dollar adjusted effective tax rate was 20.9%*. The adjusted 2008 effective tax for our products. As a result of this devaluation, we expect to record a rate was lower than the U.S. statutory tax rate, primarily reflecting the loss of approximately $21 million in the first quarter of 2010 for the benefit to taxes from the geographical mix of income before taxes and re-measurement of our net Bolivar-denominated monetary assets. Other the related effective tax rates in those jurisdictions, the utilization of than the loss from re-measurement, we do not expect the devaluation to foreign tax credits and tax law changes. materially impact our results of operations or financial position in 2010, The 2007 effective tax rate of 27.2% was lower than the U.S. statutory since we derive less than 0.5% of our total revenue from Venezuela and rate, primarily reflecting tax benefits from the geographical mix of expect to take actions to lessen the effect of the devaluation. income before taxes and the related effective tax rates in those juris- On January 20, 2010 we acquired Irish Business Systems Limited (“IBS”) dictions and the utilization of foreign tax credits, as well as the resolution for approximately $31 million. This acquisition expands our reach into of other tax matters. These benefits were partially offset by changes the small and mid-size business (SMB) market in Ireland. IBS, with eight in tax law. offices located throughout Ireland, is a managed print services provider Our effective tax rate will change based on nonrecurring events, as well and the largest independent supplier of digital imaging and printing as recurring factors including the geographical mix of income before solutions in Ireland. taxes and the related effective tax rates in those jurisdictions and On February 5, 2010 we completed the acquisition of ACS. Refer to available foreign tax credits. In addition, our effective tax rate will Note 3 – Acquisitions, Note 11 – Debt and Note 17 – Shareholders’ change based on discrete or other nonrecurring events (such as audit Equity for further information regarding the acquisition and associated settlements) that may not be predictable. Including the results from funding for it. ACS, we anticipate that our effective tax rate for 2010 will be approxi- mately 32%, excluding the effects of any discrete events. Recent Accounting Pronouncements Refer to Note 15 – Income and Other Taxes in the Consolidated On January 1, 2009 we adopted SFAS No. 160 “Noncontrolling Interests Financial Statements for additional information. in Consolidated Financial Statements – an amendment of ARB No. 51” (Accounting Standards Codification™ Topic 810-10-65). This guidance * See the “Non-GAAP Measures” section for additional information. requires that minority interests be renamed noncontrolling interests and be presented as a separate component of equity. In addition, the Company must report a consolidated net income (loss) measure that includes the amount attributable to such noncontrolling interests for all periods presented. Refer to Note 1 – Summary of Significant Accounting Policies in the Consolidated Financial Statements for a description of all recent accounting pronouncements, including the respective dates of adoption and the effects on results of operations and financial condition. 34 Xerox 2009 Annual Report


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    Management’s Discussion Capital Resources and Liquidity Cash Flow Analysis The following summarizes our cash flows for the three years ended December 31, 2009, as reported in our Consolidated Statements of Cash Flows in the accompanying Consolidated Financial Statements: Year Ended December 31, Change (in millions) 2009 2008 2007 2009 2008 Net cash provided by operating activities $ 2,208 $ 939 $ 1,871 $ 1,269 $ (932) Net cash used in investing activities (343) (441) (1,612) 98 1,171 Net cash provided by (used in) financing activities 692 (311) (619) 1,003 308 Effect of exchange rate changes on cash and cash equivalents 13 (57) 60 70 (117) Increase (decrease) in cash and cash equivalents 2,570 130 (300) 2,440 430 Cash and cash equivalents at beginning of year 1,229 1,099 1,399 130 (300) Cash and Cash Equivalents at End of Year $ 3,799 $ 1,229 $ 1,099 $ 2,570 $ 130 Cash Flows from Operating Activities • $139 million decrease due to higher restructuring payments related Net cash provided by operating activities was $2,208 million for the to prior years’ actions. year ended December 31, 2009. The $1,269 million increase from • $54 million decrease due to lower accounts payable and accrued 2008 was primarily due to the following: compensation, primarily related to lower purchases and the timing • $587 million increase due to the absence of payments for securities- of payments to suppliers. related litigation settlements. Net cash provided by operating activities was $939 million for the • $433 million increase as a result of lower inventory levels reflecting year ended December 31, 2008. The $932 million decrease from aggressive supply chain actions in light of lower sales volume. 2007 was primarily due to the following: • $410 million increase from accounts receivables reflecting the • $615 million decrease due to net payments for the settlement of benefits from sales of accounts receivables, lower revenue and the securities-related litigation. strong collection effectiveness. • $330 million decrease in pre-tax income before litigation and • $177 million increase due to lower contributions to our defined restructuring. pension benefit plans. The lower contributions are primarily in the • $90 million decrease due to higher net income tax payments, U.S., as no contributions were required due to the availability of primarily resulting from the absence of prior-year tax refunds. prior years’ credit balances. • $74 million decrease primarily due to lower benefit and • $116 million increase due to lower net tax payments. compensation accruals. • $84 million increase due to higher net run-off of finance receivables. • $71 million decrease due to higher inventory levels as a result of • $64 million increase due to lower placements of equipment on lower equipment and supplies sales in 2008. operating leases, reflecting lower install activity. • $136 million increase from accounts receivable due to strong • $440 million decrease in pre-tax income before litigation, restructuring collection effectiveness throughout 2008. and acquisition costs. • $107 million increase from derivatives, primarily due to the termination of certain interest rate swaps in fourth quarter 2008. Xerox 2009 Annual Report 35


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    Management’s Discussion Cash Flows from Investing Activities Net cash used in financing activities was $311 million for the year ended Net cash used in investing activities was $343 million for the year ended December 31, 2008. The $308 million increase from 2007 was primarily December 31, 2009. The $98 million increase from 2008 was primarily due to the following: due to the following: • $1,642 million increase from lower net repayments on secured debt. • $142 million increase due to lower capital expenditures (including 2007 reflects termination of our secured financing programs with internal use software), reflecting very stringent spending controls. GE in the United Kingdom and Canada of $634 million and Merrill • $21 million decrease due to lower cash proceeds from asset sales. Lynch in France for $469 million, as well as the repayment of secured borrowings to DLL of $153 million. The remainder reflects lower Net cash used in investing activities was $441 million for the year payments associated with our GE U.S. secured borrowings. ended December 31, 2008. The $1,171 million increase from 2007 • $888 million decrease from lower net cash proceeds from unsecured was primarily due to the following: debt. 2008 reflects the issuance of $1.4 billion in Senior Notes, • $1,460 million increase due to less cash used for acquisitions. $250 million from a private placement borrowing and net payments 2008 acquisitions included $138 million for Veenman B.V. and of $354 million on the Credit Facility, and $370 million on other debt. Saxon Business Systems, as compared to $1,568 million for GIS 2007 reflects the issuance of $1.1 billion Senior Notes, $400 million and its additional acquisitions in the prior year. from private placement borrowings and net proceeds of $600 million • $192 million decrease due to lower funds from escrow and other on the Credit Facility, offset by net payments of $286 million on restricted investments in 2008. The prior year reflected funds other debt. received from the run-off of our secured borrowing programs. • $180 million decrease due to additional purchases under our • $134 million decrease in other investing cash flows due to the share repurchase program. absence of proceeds from liquidations of short-term investments. • $154 million decrease due to common stock dividend payments. Cash Flows from Financing Activities • $79 million decrease due to lower proceeds from the issuance of Net cash provided by financing activities was $692 million for the common stock, reflecting a decrease in stock option exercises as year ended December 31, 2009. The $1,003 million increase from well as lower related tax benefits. 2008 was primarily due to the following: • $33 million decrease due to share repurchases related to employee withholding taxes on stock-based compensation vesting. • $812 million increase because no purchases were made under our share repurchase program during 2009. Financing Activities, Credit Facility and Capital Markets • $170 million increase from lower net repayments on secured debt. Customer Financing Activities • $21 million increase due to lower share repurchases related to We provide lease equipment financing to the majority of our customers. employee withholding taxes on stock-based compensation vesting. Our lease contracts permit customers to pay for equipment over time • $3 million decrease due to lower net debt proceeds. 2009 reflects rather than at the date of installation. Our investment in these contracts the repayment of $1,029 million for Senior Notes due in 2009, net is reflected in Total finance assets, net. We currently fund our customer payments of $448 million for Zero Coupon Notes, net payments financing activity through cash generated from operations, cash on of $246 million on the Credit Facility, net payments of $35 million hand, borrowings under bank credit facilities and proceeds from capital primarily for foreign short-term borrowings and $44 million of debt markets offerings. issuance costs for the Bridge Loan Facility commitment, which was We have arrangements in certain international countries and domestically recently terminated. These payments were partially offset by net through GIS, where third-party financial institutions independently proceeds of $2,725 million from the issuance of Senior Notes in provide lease financing, on a non-recourse basis to Xerox, directly to May and December 2009. 2008 reflects the issuance of $1.4 billion in our customers. In these arrangements, we sell and transfer title of Senior Notes, $250 million in Zero Coupon Notes and net payments the equipment to these financial institutions. Generally, we have no of $354 million on the Credit Facility and $370 million on other debt. continuing ownership rights in the equipment subsequent to its sale; therefore, the unrelated third-party finance receivable and debt are not included in our Consolidated Financial Statements. 36 Xerox 2009 Annual Report


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    Management’s Discussion The following represents Total finance assets associated with our Financial Instruments lease and finance operations as of December 31, 2009 and 2008: Refer to Note 13 – Financial Instruments in the Consolidated (in millions) 2009 2008 Financial Statements for additional information regarding our (1) derivative financial instruments. Total finance receivables, net $ 7,027 $ 7,278 Equipment on operating leases, net 551 594 Share Repurchase Programs Total Finance Assets, Net $ 7,578 $ 7,872 Refer to Note 17 – Shareholders’ Equity – “Treasury Stock” in the Consolidated Financial Statements for further information regarding (1) Includes (i) billed portion of finance receivables, net, (ii) finance receivables, net our share repurchase programs. and (iii) finance receivables due after one year, net as included in the Consolidated Balance Sheets as of December 31, 2009 and 2008. Dividends The decrease of $294 million in Total finance assets, net includes The Board of Directors declared a 4.25 cent per-share dividend on favorable currency of $224 million. common stock in each quarter of 2009 and 2008. We maintain a certain level of debt, referred to as financing debt, in Credit Facility order to support our investment in our lease contracts. We maintain an In October 2009, in connection with our anticipated acquisition of assumed 7:1 leverage ratio of debt to equity as compared to our finance ACS, we amended our $2.0 billion Credit Facility and entered into a assets for this financing aspect of our business. Based on this leverage, Bridge Loan Facility commitment as noted below. The Credit Facility the following represents the breakdown of Total debt between financing amendment extended the maximum permitted leverage ratio of debt and core debt as of December 31, 2009 and 2008: 4.25x through September 30, 2010, which will change to 4.00x through December 31, 2010 and to 3.75x thereafter. The amendment also (in millions) 2009 2008 included the following changes: (1) Financing debt $ 6,631 $ 6,888 • The definition of principal debt was changed such that principal Core debt(2) 2,633 1,496 debt was calculated as of December 31, 2009 net of cash proceeds Total Debt $ 9,264 $ 8,384 from the Senior Notes issued in connection with the pre-funding of (1) Financing debt includes $6,149 million and $6,368 million as of December 2009 the ACS acquisition. and 2008, respectively, of debt associated with Total finance receivables, net and • A portion of the Credit Facility that had a maturity date of April 30, is the basis for our calculation of “equipment financing interest” expense. The remainder of the financing debt is associated with Equipment on operating leases. 2012 was extended to a maturity date of April 30, 2013, consistent (2) Core debt at December 31, 2009 includes the $2.0 billion Senior Notes issuance with the majority of the facility. Accordingly, after this amendment, which was used to fund the acquisition of ACS. approximately $1.6 billion, or approximately 80% of the Credit Facility, has a maturity date of April 30, 2013. The following summarizes our debt as of December 31, 2009 and 2008: (in millions) 2009 2008 Capital Markets Offerings (3) In 2009 we raised net proceeds of $745 million and $1,980 million Principal debt balance $ 9,122 $ 8,201 through the issuance of Senior Notes of $750 million in May and Net unamortized discount (11) (6) $2.0 billion in December, respectively. The net proceeds from the Fair value adjustments 153 189 Senior Notes issued in December 2009 were used to fund the acquisition Total Debt(3) 9,264 8,384 of ACS. Less: Current maturities and short-term debt (988) (1,610) Refer to Note 3 – Acquisitions in the Consolidated Financial Statements Total Long-term Debt(3) $ 8,276 $ 6,774 for further information regarding the ACS acquisition, as well as Note (3) Total debt at December 31, 2009 includes the $2.0 billion Senior Notes issuance 11 – Debt in the Consolidated Financial Statements for additional which was used to fund the acquisition of ACS. information regarding the Debt activity. Principal debt balance at December 31, 2008 includes short-term debt of $61 million. Refer to Note 11 – Debt in the Consolidated Financial Statements for additional information regarding the above balances. Xerox 2009 Annual Report 37


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    Management’s Discussion Bridge Loan Facility Commitment • Over the past three years we have consistently delivered strong In connection with the agreement to acquire ACS, in September cash flow from operations, driven by the strength of our annuity- 2009 we entered into a commitment for a syndicated $3.0 billion based revenue model. Cash flows from operations were $2,208 Bridge Loan Facility with several banks that was to be used for funding million, $939 million and $1,871 million for the years ended the acquisition in the event the transaction closed prior to obtaining December 31, 2009, 2008 and 2007, respectively. Cash flows permanent financing in the capital markets. Debt issuance costs for from operations in 2008 included $615 million in net payments the Bridge Loan Facility commitment were $58 million. On December for our securities litigation. 4, 2009, the debt commitment was reduced to $500 million following • Our principal debt maturities are in line with historical and our issuance of $2.0 billion of Senior Notes. On January 8, 2010, we projected cash flows and are spread over the next 10 years as terminated the remaining commitment because we concluded we follows (in millions): had sufficient liquidity to complete the ACS acquisition without having Year Amount to borrow under the Bridge Loan Facility. 2010 $ 988 Liquidity and Financial Flexibility 2011 802 We manage our worldwide liquidity using internal cash management 2012 1,101 practices, which are subject to (1) the statutes, regulations and 2013 961 practices of each of the local jurisdictions in which we operate, 2014 819 (2) the legal requirements of the agreements to which we are a 2015 1,000 party and (3) the policies and cooperation of the financial institutions 2016 950 we utilize to maintain and provide cash management services. 2017 500 2018 1,001 Our liquidity is a function of our ability to successfully generate cash 2019 and thereafter 1,000 flows from a combination of efficient operations and access to capital Total $ 9,122 markets. Our ability to maintain positive liquidity going forward depends on our ability to continue to generate cash from operations and access In February 2010, in connection with the closing of our acquisition of to financial markets, both of which are subject to general economic, ACS, we borrowed $649 million under our Credit Facility. financial, competitive, legislative, regulatory and other market factors that are beyond our control. Loan Covenants and Compliance At December 31, 2009 we were in full compliance with the covenants The following is a discussion of our liquidity position as of December and other provisions of the Credit Facility, our Senior Notes and our 31, 2009: Bridge Loan Facility commitment (which was terminated on January • As of December 31, 2009, total cash and cash equivalents was 8, 2010). We have the right to prepay any outstanding loans or to $3.8 billion and our borrowing capacity under our Credit Facility was terminate the Credit Facility without penalty. Failure to be in compliance $2.0 billion, reflecting no outstanding borrowings or letters of credit. with any material provision or covenant of these agreements could have Cash and cash equivalents at December 31, 2009 included the net a material adverse effect on our liquidity and operations and our ability proceeds from the $2.0 billion Senior Notes issued in December to continue to fund our customers’ purchase of Xerox equipment. 2009, which were used to fund the acquisition of ACS. Refer to Note 11 – Debt for further information regarding debt arrangements. Credit Ratings: We are currently rated investment grade by all major rating agencies. As of February 8, 2010 the ratings were as follows: Senior Unsecured Debt Outlook Moody’s Baa2 Stable Standard & Poors BBB- Stable Fitch BBB Negative 38 Xerox 2009 Annual Report


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    Management’s Discussion Contractual Cash Obligations and Other Commercial Commitments and Contingencies At December 31, 2009 we had the following contractual cash obligations and other commercial commitments and contingencies (in millions): 2010 2011 2012 2013 2014 Thereafter Long-term debt, including capital lease obligations(1) $ 988 $ 802 $ 1,101 $ 961 $ 819 $ 4,451 Minimum operating lease commitments(2) 224 181 128 99 70 80 Liability to subsidiary trust issuing preferred securities(3) — — — — — 649 Retiree health payments 103 101 100 100 98 457 Purchase commitments Flextronics(4) 503 — — — — — Fuji Xerox(5) 1,256 — — — — — EDS contracts(6) 113 77 77 77 19 — Other IM service contracts(7) 80 77 61 56 44 18 Total Contractual Cash Obligations $3,267 $ 1,238 $ 1,467 $1,293 $ 1,050 $ 5,655 (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 third 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 amount included in the table reflects our estimate of purchases over the next year and is not a contractual commitment. (5) Fuji Xerox: The amount included in the table reflects our estimate of purchases over the next year and is not a contractual commitment. (6) EDS contract: We have an information management contract with Electronic Data Systems Corp. (“EDS”) through March 2014. Services to be provided under this contract include support for European and Brazilian mainframe system processing and application maintenance through June 2010, as well as workplace and service desk and voice and data network management 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 prior 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. (7) IM (Information Management) services: During 2009 we terminated several agreements with EDS for information management services and entered into new agreements for similar services with several providers. Services to be provided under these contracts include support for data network transport; mainframe application processing, development and support; and mid-range applications processing and support. These contracts have various terms through 2015. Some of the contracts require minimum payments and include termination penalties. The amounts disclosed in this table reflect our estimate of probable minimum payments. Pension and Other Post-retirement Benefit Plans status of our U.S. qualified pension plans and the availability of a credit We sponsor pension and other post-retirement benefit plans that may balance that had resulted from funding in prior periods in excess of require periodic cash contributions. Our 2009 contributions for these minimum requirements. In 2008 we made additional contributions plans were $122 million for pensions and $107 million for our retiree above what was disclosed in the 2007 Annual Report of $165 million health plans. We expect to make contributions of approximately $260 to our U.S. qualified pension plans. million to our worldwide defined benefit pension plans and $103 million Our retiree health benefit plans are non-funded and are almost entirely to our retiree health benefit plans in 2010. Once the January 1, 2010 related to domestic operations. Cash contributions are made each actuarial valuations are finalized for our U.S. qualified pension plans, we year to cover medical claims costs incurred in that year. The amounts will reassess the need for additional contributions for these plans. No reported in the above table as retiree health payments represent our additional contributions were made in 2009, due to the ERISA funded estimated future benefit payments. Xerox 2009 Annual Report 39


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    Management’s Discussion Fuji Xerox estimated. Should developments in any of these areas cause a change in We purchased products, including parts and supplies, from Fuji Xerox our determination as to an unfavorable outcome and result in the need totaling $1.6 billion, $2.1 billion and $1.9 billion in 2009, 2008 and to recognize a material accrual, or should any of these matters result in a 2007, respectively. Our purchase commitments with Fuji Xerox are final adverse judgment or be settled for significant amounts, they could in the normal course of business and typically have a lead time of have a material adverse effect on our results of operations, cash flows three months. Related party transactions with Fuji Xerox are discussed and financial position in the period or periods in which such change in in Note 7 – Investments in Affiliates, at Equity in the Consolidated determination, judgment or settlement occurs. Financial Statements. Unrecognized Tax Benefits Brazil Tax and Labor Contingencies As of December 31, 2009 we had $148 million of unrecognized tax Our Brazilian operations were involved in various litigation matters benefits. This represents the tax benefits associated with various tax and have received or been the subject of numerous governmental positions taken, or expected to be taken, on domestic and international assessments related to indirect and other taxes, as well as disputes tax returns that have not been recognized in our financial statements associated with former employees and contract labor. The tax matters, due to uncertainty regarding their resolution. The resolution or settle- which comprise a significant portion of the total contingencies, princi- ment of these tax positions with the taxing authorities is at various pally relate to claims for taxes on the internal transfer of inventory, stages and therefore we are unable to make a reliable estimate of municipal service taxes on rentals and gross revenue taxes. We are the eventual cash flows by period that may be required to settle these disputing these tax matters and intend to vigorously defend our matters. In addition, certain of these matters may not require cash position. Based on the opinion of legal counsel and current reserves settlement due to the existence of credit and net operating loss for those matters deemed probable of loss, we do not believe that carryforwards, as well as other offsets, including the indirect benefit the ultimate resolution of these matters will materially impact our from other taxing jurisdictions that may be available. results of operations, financial position or cash flows. The labor matters principally relate to claims made by former employees and contract Off-Balance Sheet Arrangements labor for the equivalent payment of all social security and other Although we rarely utilize off-balance sheet arrangements in our related labor benefits, as well as consequential tax claims, as if they operations, we enter into operating leases in the normal course of were regular employees. As of December 31, 2009 the total amounts business. The nature of these lease arrangements is discussed in related to the unreserved portion of the tax and labor contingencies, Note 6 – Land, Buildings and Equipment, Net in the Consolidated inclusive of any related interest, amounted to approximately $1,225 Financial Statements. In addition, we have facilities in the U.S., million, with the increase from the December 31, 2008 balance of Canada and several countries in Europe that enable us to sell, on $839 million primarily related to currency and current-year interest an ongoing basis, certain short-term accounts receivable without indexation. In connection with the above proceedings, customary recourse to third parties. Refer to Note 4 – Receivables, Net in the local regulations may require us to make escrow cash deposits or Consolidated Financial Statements for further information. post other security of up to half of the total amount in dispute. As of December 31, 2009 we had $240 million of escrow cash deposits Refer to Note 16 – Contingencies in the Consolidated Financial for matters we are disputing, and there are liens on certain Brazilian Statements for further information regarding our guarantees, assets with a net book value of $19 million and additional letters of indemnifications and warranty liabilities. credit of approximately $137 million. Generally, any escrowed amounts would be refundable and any liens would be removed to the extent Financial Risk Management the matters are resolved in our favor. We routinely assess all these We are exposed to market risk from foreign currency exchange rates matters as to probability of ultimately incurring a liability against our and interest rates, which could affect operating results, financial Brazilian operations, and record our best estimate of the ultimate loss in position and cash flows. We manage our exposure to these market situations where we assess the likelihood of an ultimate loss as probable. risks through our regular operating and financing activities and, Other Contingencies and Commitments when appropriate, through the use of derivative financial instruments. As more fully discussed in Note 16 – Contingencies in the Consolidated These derivative financial instruments are utilized to hedge economic Financial Statements, we are involved in a variety of claims, lawsuits, exposures, as well as reduce earnings and cash flow volatility resulting investigations and proceedings concerning securities law, intellectual from shifts in market rates. property law, environmental law, employment law and the Employee Recent market events have not required us to materially modify Retirement Income Security Act. In addition, guarantees, indemnifications or change our financial risk management strategies with respect and claims may arise during the ordinary course of business from to our exposures to interest rate and foreign currency risk. Refer to relationships with suppliers, customers and nonconsolidated affiliates. Note 13 – Financial Instruments in the Consolidated Financial Nonperformance under a contract including a guarantee, indemnification Statements for further discussion on our financial risk management. 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 40 Xerox 2009 Annual Report


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    Management’s Discussion Foreign Exchange Risk Management Year Ended December 31, Assuming a 10% appreciation or depreciation in foreign currency (in millions) 2008 2007 Change exchange rates from the quoted foreign currency exchange rates at Equipment Sales Revenue: December 31, 2009, the potential change in the fair value of foreign As Reported $ 4,679 $ 4,753 (2)% currency-denominated assets and liabilities in each entity would not be As Adjusted $ 4,679 $ 4,938 (5)% significant because all material currency asset and liability exposures Post Sale Revenue: were economically hedged as of December 31, 2009. A 10% appreciation As Reported $12,929 $ 12,475 4% or depreciation of the U.S. Dollar against all currencies from the quoted As Adjusted $12,929 $ 12,681 2% foreign currency exchange rates at December 31, 2009 would have a Total Revenues: $689 million impact on our cumulative translation adjustment portion As Reported $17,608 $ 17,228 2% of equity. The net amount invested in foreign subsidiaries and affiliates, As Adjusted $17,608 $ 17,619 — primarily Xerox Limited, Fuji Xerox, Xerox Canada Inc. and Xerox do Brasil, and translated into Dollars using the year-end exchange rates, Adjusted Effective Tax Rate was $6.9 billion at December 31, 2009. The effective tax rate for the year ended December 31, 2008 is dis- cussed using a non-GAAP financial measure that excludes the effect Interest Rate Risk Management of charges associated with an equipment write-off; restructuring and The consolidated weighted-average interest rates related to our total asset impairments; certain litigation matters and the settlement of debt and liability to subsidiary trust issuing preferred securities for 2009, certain previously unrecognized tax benefits. Management believes that 2008 and 2007 approximated 6.1%, 6.6% and 7.1%, respectively. it is helpful to exclude these effects to better understand, analyze and Interest expense includes the impact of our interest rate derivatives. compare 2008’s income tax expense and effective tax rate to the 2007 Virtually all customer-financing assets earn fixed rates of interest. amounts, given the discrete nature and size of these items in 2008. The interest rates on a significant portion of the Company’s term Year Ended December 31, 2008 debt are fixed. Pre-Tax Income Effective (in millions) Income Taxes Tax Rate As of December 31, 2009 $2.4 billion of our total debt carried variable interest rates, including the effect of pay variable interest rate swaps we As Reported $ (79) $ (231) 292.4% are utilizing with the intent to reduce the effective interest rate on our Restructuring and asset fixed coupon debt. impairment charges 426 134 Equipment write-off 39 15 The fair market values of our fixed-rate financial instruments are Provision for securities sensitive to changes in interest rates. At December 31, 2009 a litigation matters 774 283 10% change in market interest rates would change the fair values Tax settlements — 41 of such financial instruments by approximately $274 million. As Adjusted $ 1,160 $ 242 20.9% Non-GAAP Financial Measures Management believes that these non-GAAP financial measures provide We have reported our financial results in accordance with generally an additional means of analyzing the current-period results against accepted accounting principles (“GAAP”). A reconciliation of the the corresponding prior-period results. However, non-GAAP financial following non-GAAP financial measures to the most directly comparable measures should be viewed in addition to, and not as a substitute for, financial measures calculated and presented in accordance with the Company’s reported results prepared in accordance with GAAP. GAAP are set forth below: Adjusted Revenue Forward-Looking Statements We discussed the revenue growth for the year ended December 31, This Annual Report contains forward-looking statements as defined 2008 using non-GAAP financial measures. To understand trends in in the Private Securities Litigation Reform Act of 1995. The words the business, we believe that it is helpful to adjust the revenue growth “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” rates to illustrate the impact of the acquisition of GIS by including their and similar expressions, as they relate to us, are intended to identify estimated revenue for the comparable 2007 period. We refer to this forward-looking statements. These statements reflect management’s adjusted revenue as “As Adjusted” in the following reconciliation table. current beliefs, assumptions and expectations and are subject to a Revenue “As Adjusted” adds GIS’s revenues from January 1, 2007 to number of factors that may cause actual results to differ materially. May 8, 2007 to our 2007 reported revenue. Management believes these Information concerning these factors is included in our 2009 Annual measures give investors an additional perspective on revenue trends, Report on Form 10-K filed with the Securities and Exchange Commission as well as the impact to the Company of the acquisition of GIS that was (“SEC”). We do not intend to update these forward-looking statements, completed in May 2007. except as required by law. Xerox 2009 Annual Report 41


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