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    Xerox Corporation Consolidated Statements of Income Year Ended December 31, (in millions, except per-share data) 2010 2009 2008 Revenues Sales $ 7,234 $ 6,646 $ 8,325 Service, outsourcing and rentals 13,739 7,820 8,485 Finance income 660 713 798 Total Revenues 21,633 15,179 17,608 Costs and Expenses Cost of sales 4,741 4,395 5,519 Cost of service, outsourcing and rentals 9,195 4,488 4,929 Equipment financing interest 246 271 305 Research, development and engineering expenses 781 840 884 Selling, administrative and general expenses 4,594 4,149 4,534 Restructuring and asset impairment charges 483 (8) 429 Acquisition-related costs 77 72 — Amortization of intangible assets 312 60 54 Other expenses, net 389 285 1,033 Total Costs and Expenses 20,818 14,552 17,687 Income (Loss) before Income Taxes and Equity Income 815 627 (79) Income tax expense (benefit) 256 152 (231) Equity in net income of unconsolidated affiliates 78 41 113 Net Income 637 516 265 Less: Net income attributable to noncontrolling interests 31 31 35 Net Income Attributable to Xerox $ 606 $ 485 $ 230 Basic Earnings per Share $ 0.44 $ 0.56 $ 0.26 Diluted Earnings per Share $ 0.43 $ 0.55 $ 0.26 The accompanying notes are an integral part of these Consolidated Financial Statements. 54 Xerox 2010 Annual Report


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    Xerox Corporation Consolidated Balance Sheets December 31, (in millions, except share data in thousands) 2010 2009 Assets Cash and cash equivalents $ 1,211 $ 3,799 Accounts receivable, net 2,826 1,702 Billed portion of finance receivables, net 198 226 Finance receivables, net 2,287 2,396 Inventories 991 900 Other current assets 1,126 708 Total current assets 8,639 9,731 Finance receivables due after one year, net 4,135 4,405 Equipment on operating leases, net 530 551 Land, buildings and equipment, net 1,671 1,309 Investments in affiliates, at equity 1,291 1,056 Intangible assets, net 3,371 598 Goodwill 8,649 3,422 Deferred tax assets, long-term 540 1,640 Other long-term assets 1,774 1,320 Total Assets $30,600 $ 24,032 Liabilities and Equity Short-term debt and current portion of long-term debt $ 1,370 $ 988 Accounts payable 1,968 1,451 Accrued compensation and benefits costs 901 695 Unearned income 371 201 Other current liabilities 1,807 1,126 Total current liabilities 6,417 4,461 Long-term debt 7,237 8,276 Liability to subsidiary trust issuing preferred securities 650 649 Pension and other benefit liabilities 2,071 1,884 Post-retirement medical benefits 920 999 Other long-term liabilities 797 572 Total Liabilities 18,092 16,841 Series A Convertible Preferred Stock 349 — Common stock 1,398 871 Additional paid-in capital 6,580 2,493 Retained earnings 6,016 5,674 Accumulated other comprehensive loss (1,988) (1,988) Xerox shareholders’ equity 12,006 7,050 Noncontrolling interests 153 141 Total Equity 12,159 7,191 Total Liabilities and Equity $30,600 $ 24,032 Shares of common stock issued and outstanding 1,397,578 869,381 The accompanying notes are an integral part of these Consolidated Financial Statements. Xerox 2010 Annual Report 55


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    Xerox Corporation Consolidated Statements of Cash Flows Year Ended December 31, (in millions) 2010 2009 2008 Cash Flows from Operating Activities: Net income $ 637 $ 516 $ 265 Adjustments required to reconcile net income to cash flows from operating activities: Depreciation and amortization 1,097 698 669 Provision for receivables 180 289 199 Provision for inventory 31 52 115 Deferred tax (benefit) expense (2) 120 (324) Net gain on sales of businesses and assets (18) (16) (21) Undistributed equity in net income of unconsolidated affiliates (37) (25) (53) Stock-based compensation 123 85 85 Provision for litigation, net 36 — 781 Payments for litigation, net (36) (28) (615) Restructuring and asset impairment charges 483 (8) 429 Payments for restructurings (213) (270) (131) Contributions to pension benefit plans (237) (122) (299) (Increase) decrease in accounts receivable and billed portion of finance receivables (118) 467 57 Collections of deferred proceeds from sales of receivables 218 — — (Increase) decrease in inventories (151) 319 (114) Increase in equipment on operating leases (288) (267) (331) Decrease in finance receivables 129 248 164 (Increase) decrease in other current and long-term assets (98) 129 (8) Increase in accounts payable and accrued compensation 615 157 211 Decrease in other current and long-term liabilities (9) (100) (174) Net change in income tax assets and liabilities 229 (18) (92) Net change in derivative assets and liabilities 85 (56) 230 Other operating, net 70 38 (104) Net cash provided by operating activities 2,726 2,208 939 Cash Flows from Investing Activities: Cost of additions to land, buildings and equipment (355) (95) (206) Proceeds from sales of land, buildings and equipment 52 17 38 Cost of additions to internal use software (164) (98) (129) Acquisitions, net of cash acquired (1,734) (163) (155) Net change in escrow and other restricted investments 20 (6) 8 Other investing, net 3 2 3 Net cash used in investing activities (2,178) (343) (441) Cash Flows from Financing Activities: Net proceeds (payments) on secured financings 1 (57) (227) Net (payments) proceeds on other debt (3,057) 923 926 Common stock dividends (215) (149) (154) Preferred stock dividends (15) — — Proceeds from issuances of common stock 183 1 6 Excess tax benefits from stock-based compensation 24 — 2 Payments to acquire treasury stock, including fees — — (812) Repurchases related to stock-based compensation (15) (12) (33) Other financing (22) (14) (19) Net cash (used in) provided by financing activities (3,116) 692 (311) Effect of exchange rate changes on cash and cash equivalents (20) 13 (57) (Decrease) increase in cash and cash equivalents (2,588) 2,570 130 Cash and cash equivalents at beginning of year 3,799 1,229 1,099 Cash and Cash Equivalents at End of Year $ 1,211 $ 3,799 $ 1,229 The accompanying notes are an integral part of these Consolidated Financial Statements. 56 Xerox 2010 Annual Report


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    Xerox Corporation Consolidated Statements of Shareholders’ Equity Additional Xerox Non- Common Paid-In Treasury Retained Shareholders’ controlling Total (in millions) Stock(6) Capital Stock(6) Earnings AOCL(1) Equity Interests Equity Balance at December 31, 2007 $ 920 $ 3,176 $ (31) $ 5,288 $ (765) $ 8,588 $ 103 $ 8,691 Net income — — — 230 — 230 35 265 Translation adjustments — — — — (1,364) (1,364) (3) (1,367) Cumulative effect of change in accounting principles — — — (25) — (25) — (25) Changes in benefit plans(2) — — — — (286) (286) — (286) Other unrealized losses, net — — — — (1) (1) — (1) Comprehensive (Loss) Income $ (1,446) $ 32 $ (1,414) (3) Cash dividends declared – common stock — — — (152) — (152) — (152) Stock option and incentive plans 5 55 — — — 60 — 60 Payments to acquire treasury stock — — (812) — — (812) — (812) Cancellation of treasury stock (59) (784) 843 — — — — — Distributions to noncontrolling interests — — — — — — (15) (15) Balance at December 31, 2008 $ 866 $ 2,447 $ — $ 5,341 $ (2,416) $ 6,238 $ 120 $ 6,358 Net income — — — 485 — 485 31 516 Translation adjustments — — — — 595 595 1 596 Changes in benefit plans(2) — — — — (169) (169) — (169) Other unrealized gains — — — — 2 2 — 2 Comprehensive Income $ 913 $ 32 $ 945 (3) Cash dividends declared – common stock — — — (152) — (152) — (152) Stock option and incentive plans 5 67 — — — 72 — 72 Tax loss on stock option and incentive plans, net — (21) — — — (21) — (21) Distributions to noncontrolling interests — — — — — — (11) (11) Balance at December 31, 2009 $ 871 $ 2,493 $ — $ 5,674 $ (1,988) $ 7,050 $ 141 $ 7,191 Net income — — — 606 — 606 31 637 Translation adjustments — — — — (35) (35) — (35) Changes in benefit plans(2) — — — — 23 23 — 23 Other unrealized gains, net — — — — 12 12 — 12 Comprehensive Income $ 606 $ 31 $ 637 ACS acquisition(4) 490 3,825 — — — 4,315 — 4,315 Cash dividends declared – common stock(3) — — — (243) — (243) — (243) Cash dividends declared – preferred stock(5) — — — (21) — (21) — (21) Stock option and incentive plans 37 256 — — — 293 — 293 Tax benefit on stock option and incentive plans, net — 6 — — — 6 — 6 Distributions to noncontrolling interests — — — — — — (19) (19) Balance at December 31, 2010 $ 1,398 $ 6,580 $ — $ 6,016 $(1,988) $ 12,006 $ 153 $ 12,159 (1) Refer to Note 1 “Accumulated Other Comprehensive Loss (AOCL)” section for additional information. (2) Refer to Note 15 – Employee Benefit Plans for additional information. (3) Cash dividends declared on common stock of $0.0425 in each of the four quarters in 2008, 2009 and 2010. (4) Refer to Note 3 – Acquisitions for additional information. (5) Cash dividends declared on preferred stock of $12.22 per share in the first quarter of 2010 and $20 per share in each of the second, third and fourth quarters of 2010. (6) Refer to Note 19 – Shareholders’ Equity for rollforward of shares. The accompanying notes are an integral part of these Consolidated Financial Statements. Xerox 2010 Annual Report 57


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 1 – Summary of Significant Accounting Policies (x) useful lives of intangible assets; (xi) amortization period for customer contract costs; (xii) pension and post-retirement benefit plans; (xiii) References herein to “we,” “us,” “our,” the “Company” and Xerox refer to income tax reserves and valuation allowances; and (xiv) contingency and Xerox Corporation and its consolidated subsidiaries unless the context litigation reserves. Future events and their effects cannot be predicted specifically requires otherwise. with certainty; accordingly, our accounting estimates require the exercise Description of Business and Basis of Presentation of judgment. The accounting estimates used in the preparation of our We are a $22 billion global enterprise for business process and document Consolidated Financial Statements will change as new events occur, as management. We provide essential back-office support through our more experience is acquired, as additional information is obtained and broad portfolio of technology, services and outsourcing offerings. We as our operating environment changes. Actual results could differ from also offer extensive business process outsourcing and information those estimates. technology outsourcing services through Affiliated Computer Services, The following table summarizes certain significant charges that require Inc. (“ACS”), which we acquired in February 2010. We develop, management estimates for the three years ended December 31, 2010: manufacture, market, service and finance a complete range of document Years Ended December 31, equipment, software, solutions and services. Expense/(Income) 2010 2009 2008 Basis of Consolidation Restructuring provisions and The Consolidated Financial Statements include the accounts of Xerox asset impairments $ 483 $ (8) $ 429 Corporation and all of our controlled subsidiary companies. All significant Provisions for receivables(1) 180 289 199 intercompany accounts and transactions have been eliminated. Provisions for litigation and Investments in business entities in which we do not have control, but regulatory matters (4) 9 781 we have the ability to exercise significant influence over operating and Provisions for obsolete and financial policies (generally 20% to 50% ownership) are accounted for excess inventory 31 52 115 using the equity method of accounting. Operating results of acquired Depreciation and obsolescence of businesses are included in the Consolidated Statements of Income from equipment on operating leases 313 329 298 the date of acquisition. Depreciation of buildings We consolidate variable interest entities if we are deemed to be the and equipment 379 247 257 primary beneficiary of the entity. Operating results for variable interest Amortization of internal entities in which we are determined to be the primary beneficiary are use software 70 53 56 included in the Consolidated Statements of Income from the date such Amortization of product software 7 5 — determination is made. Amortization of acquired intangible assets(2) 316 64 58 For convenience and ease of reference, we refer to the financial Amortization of customer statement caption “Income (Loss) before Income Taxes and Equity contract costs 12 — — Income” as “pre-tax income” or “pre-tax loss” throughout the Notes to Defined pension benefits – the Consolidated Financial Statements. net periodic benefit cost 304 232 174 Use of Estimates Other post-retirement benefits – The preparation of our Consolidated Financial Statements, in net periodic benefit cost 32 26 77 accordance with accounting principles generally accepted in the United Deferred tax asset valuation States of America, requires that we make estimates and assumptions allowance provisions 22 (11) 17 that affect the reported amounts of assets and liabilities, as well as the (1) Includes net receivable adjustments of $(8), $(2) and $11 for 2010, 2009 and 2008, disclosure of contingent assets and liabilities at the date of the financial respectively. statements, and the reported amounts of revenues and expenses during (2) Includes amortization of $4 for patents, which is included in cost of sales for each the reporting period. Significant estimates and assumptions are used period presented. for, but not limited to: (i) allocation of revenues and fair values in leases and other multiple element arrangements; (ii) accounting for residual Changes in Estimates values; (iii) economic lives of leased assets; (iv) revenue recognition for In the ordinary course of accounting for items discussed above, we services under the percentage-of-completion method; (v) allowance make changes in estimates as appropriate and as we become aware for doubtful accounts; (vi) inventory valuation; (vii) restructuring and of circumstances surrounding those estimates. Such changes and related charges; (viii) asset impairments; (ix) depreciable lives of assets; refinements in estimation methodologies are reflected in reported results of operations in the period in which the changes are made and, if material, their effects are disclosed in the Notes to the Consolidated Financial Statements. 58 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. New Accounting Standards and Accounting Changes In 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (ASC Topic 820) which defined fair value, established a market-based FASB Establishes Accounting Standards Codification™ framework or hierarchy for measuring fair value and expanded In 2009, the FASB established the Accounting Standards Codification disclosures about fair value measurements. This guidance is applicable (“the Codification” or “ASC”) as the official single source of authoritative whenever another accounting pronouncement requires or permits U.S. generally accepted accounting principles (“GAAP”). All existing assets and liabilities to be measured at fair value. It did not expand or accounting standards are superseded. All other accounting guidance require any new fair value measures; however, the application of this not included in the Codification is considered non-authoritative. statement may change current practice. We adopted this guidance for The Codification also includes all relevant Securities and Exchange financial assets and liabilities effective January 1, 2008 and for non- Commission (“SEC”) guidance organized using the same topical structure financial assets and liabilities effective January 1, 2009. The adoption of in separate sections within the Codification. The FASB updates the this guidance, which primarily affected the valuation of our derivative Codification by issuing Accounting Standard Updates (“ASUs”). contracts, did not have a material effect on our financial condition or The Codification did not change GAAP, but only the way GAAP is results of operations. organized and presented. In order to ease the transition to the Business Combinations Codification, we are providing the Codification cross-reference In 2007, the FASB issued SFAS No. 141 (revised 2007), “Business alongside the references to the standards issued and adopted prior Combinations” (ASC Topic 805). This guidance requires the acquiring to the adoption of the Codification. entity in a business combination to recognize the full fair value of assets Fair Value Accounting acquired and liabilities assumed in the transaction (whether a full or In 2010, the FASB issued ASU No. 2010-06 which amended Fair Value partial acquisition); establishes the acquisition date fair value as the Measurements and Disclosures – Overall (ASC Topic 820-10). This measurement objective for all assets acquired and liabilities assumed; update required a gross presentation of activities within the Level 3 roll- requires expensing of most transaction and restructuring costs; and forward and added a new requirement to disclose transfers in and out requires the acquirer to disclose the information needed to evaluate of Level 1 and 2 measurements. The update also clarified the following and understand the nature and financial effect of the business existing disclosure requirements in ASC 820-10 regarding: i) the level combination. We adopted this guidance effective January 1, 2009 of disaggregation of fair value measurements; and ii) the disclosures and have applied it to all business combinations prospectively from regarding inputs and valuation techniques. This update was effective that date. The impact of ASC Topic 805 on our consolidated financial for our fiscal year beginning January 1, 2010 except for the gross statements depends upon the nature, terms and size of the acquisitions presentation of the Level 3 roll-forward information, which is effective for we consummate in the future. our fiscal year beginning January 1, 2011. The principle impact from this Revenue Recognition update is to expand disclosures regarding our fair value measurements. In 2009, the FASB issued the following ASUs: In 2009, the FASB issued the following updates that provide additional • ASU No. 2009-13, Revenue Recognition (ASC Topic 605) – Multiple- application guidance and require enhanced disclosures regarding fair Deliverable Revenue Arrangements, a consensus of the FASB Emerging value measurements: Issues Task Force. This guidance modified previous requirements by • FSP FAS 157-4, “Determining Fair Value When the Volume and Level allowing the use of the “best estimate of selling price” in the absence of Activity for the Asset or Liability Have Significantly Decreased and of vendor-specific objective evidence (“VSOE”) or verifiable objective Identifying Transactions That Are Not Orderly” (ASC Topic 820-10-65) evidence (“VOE”) (now referred to as TPE standing for third-party • FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of evidence) for determining the selling price of a deliverable. A vendor Other-Than-Temporary Impairments” (ASC Topic 320-10-65) is now required to use its best estimate of the selling price when • FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value more objective evidence of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration of Financial Instruments” (ASC Topic 320-10-65) is no longer permitted. • ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic • ASU No. 2009-14, Software (ASC Topic 985) – Certain Revenue 820) – Measuring Liabilities at Fair Value” Arrangements That Include Software Elements, a consensus of We adopted these updates in 2009 and the adoptions did not have the FASB Emerging Issues Task Force. This guidance modified a material effect on our financial condition or results of operations. the scope of ASC subtopic 985-605 Software-Revenue Recognition to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. Xerox 2010 Annual Report 59


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. We adopted these updates effective for our fiscal year beginning January • ASU 2009-17 which amended Consolidations (ASC Topic 810): 1, 2010 and are applying them prospectively from that date for new Improvements to Financial Reporting by Enterprises Involved or materially modified arrangements. The adoption of these updates with Variable Interest Entities. This update required an analysis to did not have a material effect on our financial condition or results of determine whether a variable interest gives the entity a controlling operations. See “Summary of Accounting Policies – Revenue recognition financial interest in a variable interest entity. It also required an – Multiple Element Arrangements” for further information regarding our ongoing reassessment and eliminates the quantitative approach adoption of ASU No. 2009-13. previously required for determining whether an entity is the primary beneficiary. We adopted this update effective for our fiscal year With respect to the new software guidance in ASU No. 2009-14, the beginning January 1, 2010 and the adoption did not have a material modification in the scope of the industry-specific software revenue effect on our financial condition or results of operations. recognition guidance did not result in a change in the recognition of revenue for our equipment and services. Software included within our Since the implementation of the codification, the FASB has issued equipment and services has generally been considered incidental and several ASUs. Except for the ASUs discussed above, the remaining therefore has been, and will continue to be, accounted for as part of ASUs issued by the FASB entail technical corrections to existing the sale of equipment or services. Most of our equipment have both guidance or affect guidance related to unique/infrequent transactions software and non-software components that function together to deliver or specialized industries/entities and therefore have minimal, if any, the equipment’s essential functionality. The software scope modification impact on the Company. is also not expected to change the recognition of revenue for software Summary of Accounting Policies accessories sold in connection with our equipment or free-standing software sales as these transactions will continue to be accounted for Revenue Recognition under the industry-specific software revenue recognition guidance as We generate revenue through services, the sale and rental of equipment, separate software elements. See “Summary of Accounting Policies – supplies and income associated with the financing of our equipment Revenue Recognition – Software” for further information. sales. Revenue is recognized when earned. More specifically, revenue related to services and sales of our products is recognized as follows: Other Accounting Changes In 2010, the FASB issued the following codification updates: Equipment: Revenues from the sale of equipment, including those from sales-type leases, are recognized at the time of sale or at the inception • ASU 2010-19 which amended Foreign Currency (ASC Topic 830). of the lease, as appropriate. For equipment sales that require us to install The purpose of this update was to codify the SEC staff’s view on the product at the customer location, revenue is recognized when the certain foreign currency issues related to investments in Venezuela. equipment has been delivered and installed at the customer location. See “Foreign Currency Translation and Re-measurement” section Sales of customer-installable products are recognized upon shipment below for further information regarding our operations in Venezuela. or receipt by the customer according to the customer’s shipping terms. • ASU 2010-20 which amended Receivables (ASC Topic 310) and Revenues from equipment under other leases and similar arrangements requires significantly increased disclosures regarding the credit are accounted for by the operating lease method and are recognized as quality of an entity’s financing receivables and its allowance for earned over the lease term, which is generally on a straight-line basis. credit losses. In addition, this update requires an entity to disclose credit quality indicators past due information, and modifications Services: Technical service revenues are derived primarily from of its financing receivables. The disclosures are first effective for our maintenance contracts on our equipment sold to customers and are 2010 Annual Report. The principal impact from this update was recognized over the term of the contracts. A substantial portion of our increased disclosures concerning the details of finance receivables products are sold with full service maintenance agreements for which and the related provisions and reserves for credit losses. See Note the customer typically pays a base service fee plus a variable amount 4 – Receivables, Net for the disclosures required by this update. based on usage. As a consequence, other than the product warranty obligations associated with certain of our low-end products, we do In 2009, the FASB issued the following codification updates: not have any significant product warranty obligations, including any • ASU 2009-16 which amended Transfers and Servicing (ASC Topic 860): obligations under customer satisfaction programs. Accounting for Transfers of Financial Assets. This update removed Revenues associated with outsourcing services are generally recognized the concept of a qualifying special-purpose entity and removed the as services are rendered, which is generally on the basis of the number exception from applying consolidation guidance to these entities. This of accounts or transactions processed. Information technology update also clarified the requirements for isolation and limitations on processing revenues are recognized as services are provided to the portions of financial assets that are eligible for sale accounting. We customer, generally at the contractual selling prices of resources adopted this update effective for our fiscal year beginning January 1, consumed or capacity utilized by our customers. In those service 2010. Certain accounts receivable sale arrangements were modified in arrangements where final acceptance of a system or solution by the order to qualify for sale accounting under this updated guidance. The adoption of this update did not have a material effect on our financial condition or results of operations. 60 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. customer is required, revenue is deferred until all acceptance criteria Revenues earned in excess of related billings are accrued, whereas have been met. Revenues on cost-reimbursable contracts are recognized billings in excess of revenues earned are deferred until the related by applying an estimated factor to costs as incurred, determined by services are provided. We recognize revenues for non-refundable, upfront the contract provisions and prior experience. Revenues on unit-price implementation fees on a straight-line basis over the period between the contracts are recognized at the contractual selling prices as work is initiations of the ongoing services through the end of the contract term. completed and accepted by the customer. Revenues on time-and- Sales to distributors and resellers: We utilize distributors and resellers material contracts are recognized at the contractual rates as the labor to sell certain of our products to end-user customers. We refer to our hours and direct expenses are incurred. distributor and reseller network as our two-tier distribution model. In connection with our services arrangements, we incur costs to originate Sales to distributors and resellers are generally recognized as revenue these long-term contracts and to perform the migration, transition and when products are sold to such distributors and resellers. Distributors setup activities necessary to enable us to perform under the terms of and resellers participate in various cooperative marketing and other the arrangement. We capitalize certain incremental direct costs that are programs, and we record provisions for these programs as a reduction related to the contract origination or transition, implementation and to revenue when the sales occur. Similarly, we account for our estimates setup activities and amortize them over the term of the arrangement. of sales returns and other allowances when the sales occur based on our From time to time, we also provide certain inducements to customers historical experience. in the form of various arrangements, including contractual credits, In certain instances, we may provide lease financing to end-user which are capitalized and amortized as a reduction of revenue over the customers who purchased equipment we sold to distributors or resellers. term of the contract. Customer-related deferred set-up/transition and We compete with other third-party leasing companies with respect to inducement costs are being amortized over a weighted average period the lease financing provided to these end-user customers. of approximately eight years. Initial direct costs of an arrangement are capitalized and amortized over the contractual service period. Supplies: Supplies revenue generally is recognized upon shipment or utilization by customers in accordance with the sales terms. Long-lived assets used in the fulfillment of the arrangements are capitalized and depreciated over the shorter of their useful life or the Software: Most of our equipment has both software and term of the contract if an asset is contract-specific. non-software components that function together to deliver the equipment’s essential functionality and therefore they are accounted Revenues on certain fixed price contracts where we provide information for together as part of the equipment sales or services revenues. technology system development and implementation services are Software accessories sold in connection with our equipment sales, as recognized over the contract term based on the percentage of well as free-standing software sales, are accounted for as separate development and implementation services that are provided during deliverables or elements. In most cases, these software products are the period compared with the total estimated development and sold as part of multiple-element arrangements and include software implementation services to be provided over the entire contract. These maintenance agreements for the delivery of technical service, as well services require that we perform significant, extensive and complex as unspecified upgrades or enhancements on a when-and-if-available design, development, modification or implementation of our customers’ basis. In those software accessory and free-standing software systems. Performance will often extend over long periods, and our arrangements that include more than one element, we allocate the right to receive future payment depends on our future performance revenue among the elements based on vendor-specific objective in accordance with the agreement. During 2010, we recognized evidence (“VSOE”) of fair value. VSOE of fair value is based on the price approximately $270 of revenue using the percentage-of-completion charged when the deliverable is sold separately by us on a regular basis accounting method. and not as part of the multiple-element arrangement. Revenue allocated The percentage-of-completion methodology involves recognizing to software is normally recognized upon delivery, while revenue allocated probable and reasonably estimable revenue using the percentage of to the software maintenance element is recognized ratably over the services completed, on a current cumulative cost to estimated total cost term of the arrangement. basis, using a reasonably consistent profit margin over the period. Due to Leases: The two primary accounting provisions which we use to classify the long-term nature of these projects, developing the estimates of costs transactions as sales-type or operating leases are: 1) a review of the often requires significant judgment. Factors that must be considered lease term to determine if it is equal to or greater than 75% of the in estimating the progress of work completed and ultimate cost of the economic life of the equipment; and 2) a review of the present value projects include, but are not limited to, the availability of labor and labor of the minimum lease payments to determine if they are equal to or productivity, the nature and complexity of the work to be performed greater than 90% of the fair market value of the equipment at the and the impact of delayed performance. If changes occur in delivery, inception of the lease. Our leases in our Latin America operations have productivity or other factors used in developing the estimates of costs historically been recorded as operating leases given the cancellable or revenues, we revise our cost and revenue estimates, which may result nature of the contract or because the recoverability of the lease in increases or decreases in revenues and costs, and such revisions are investment is deemed not to be predictable at lease inception. reflected in income in the period in which the facts that give rise to that revision become known. Xerox 2010 Annual Report 61


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. For purposes of determining the economic life, we consider the Contingent payments, if any, are recognized as revenue in the period most objective measure to be the original contract term, since most when the customer exceeds the minimum copy volumes specified in equipment is returned by lessees at or near the end of the contracted the contract. Revenues under bundled arrangements are allocated term. The economic life of most of our products is five years, since this considering the relative selling prices of the lease and non-lease represents the most frequent contractual lease term for our principal deliverables included in the bundled arrangement. Lease deliverables products and only a small percentage of our leases have original terms include maintenance and executory costs, equipment and financing, longer than five years. We continually evaluate the economic life of while non-lease deliverables generally consist of the supplies and non- both existing and newly introduced products for purposes of this maintenance services. The allocation for the lease deliverables begins determination. Residual values, if any, are established at lease inception by allocating revenues to the maintenance and executory costs plus using estimates of fair value at the end of the lease term. profit thereon. These elements are generally recognized over the term of the lease as service revenue. The remaining amounts are allocated The vast majority of our leases that qualify as sales-type are non- to the equipment and financing elements which are subjected to the cancelable and include cancellation penalties approximately equal accounting estimates noted above under “Leases.” to the full value of the lease receivables. A portion of our business involves sales to governmental units. Governmental units are those Multiple Element Arrangements: We enter into the following revenue entities that have statutorily defined funding or annual budgets that arrangements that may consist of multiple deliverables: are determined by their legislative bodies. Certain of our governmental • Bundled lease arrangements, which typically include both lease contracts may have cancellation provisions or renewal clauses that are deliverables and non-lease deliverables as described above. required by law, such as 1) those dependant on fiscal funding outside of a governmental unit’s control; 2) those that can be cancelled if • Sales of equipment with a related full-service maintenance agreement. deemed in the best interest of the governmental unit’s taxpayers; or • Contracts for multiple types of outsourcing services, as well as 3) those that must be renewed each fiscal year, given limitations that professional and value-added services. For instance, we may contract may exist on entering into multi-year contracts that are imposed by for an implementation or development project and also provide statute. In these circumstances, we carefully evaluate these contracts services to operate the system over a period of time; or we may to assess whether cancellation is remote. The evaluation of a lease contract to scan, manage and store customer documents. agreement with a renewal option includes an assessment as to whether If a deliverable in a multiple-element arrangement is subject to specific the renewal is reasonably assured based on the apparent intent and guidance, such as leased equipment in our bundled lease arrangements our experience of such governmental unit. We further ensure that the (which is subject to specific leasing guidance) or accessory software contract provisions described above are offered only in instances where (which is subject to software revenue recognition guidance), that required by law. Where such contract terms are not legally required, we deliverable is separated from the arrangement based on its relative consider the arrangement to be cancelable and account for the lease selling price (the relative selling price method – see below) and as an operating lease. accounted for in accordance with such specific guidance. The remaining After the initial lease of equipment to our customers, we may enter deliverables in a multiple-element arrangement are accounted for based subsequent transactions with the same customer whereby we extend on the following guidance. the term. Revenue from such lease extensions is typically recognized over A multiple-element arrangement is separated into more than one unit the extension period. of accounting if both of the following criteria are met: Bundled Lease Arrangements: We sell our products and services under • The delivered item(s) has value to the customer on a stand-alone bundled lease arrangements, which typically include equipment, service, basis; and supplies and financing components for which the customer pays a single • If the arrangement includes a general right of return relative to negotiated fixed minimum monthly payment for all elements over the contractual lease term. Approximately 40% of our equipment sales the delivered item(s), delivery or performance of the undelivered revenue is related to sales made under bundled lease arrangements. item(s) is considered probable and substantially in our control. If These arrangements also typically include an incremental, variable these criteria are not met, the arrangement is accounted for as one component for page volumes in excess of contractual page volume unit of accounting and the recognition of revenue is generally upon minimums, which are often expressed in terms of price-per-page. delivery/completion or ratably as a single unit of accounting over the The fixed minimum monthly payments are multiplied by the number contractual service period. of months in the contract term to arrive at the total fixed minimum payments that the customer is obligated to make (“fixed payments”) over the lease term. The payments associated with page volumes in excess of the minimums are contingent on whether or not such minimums are exceeded (“contingent payments”). In applying our lease accounting methodology, we only consider the fixed payments for purposes of allocating to the relative fair value elements of the contract. 62 Xerox 2010 Annual Report


  • Page 10

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Consideration in a multiple-element arrangement is allocated at the Restricted cash amounts at December 31, 2010 and 2009 were inception of the arrangement to all deliverables on the basis of the as follows: relative selling price. When applying the relative selling price method, the 2010 2009 selling price for each deliverable is determined using VSOE of the selling Tax and labor litigation deposits in Brazil $ 276 $ 240 price, or TPE of the selling price. If neither VSOE nor TPE of the selling Escrow and cash collections related price exists for a deliverable, we will use our best estimate of the selling to receivable sales 88 29 price for that deliverable. Other restricted cash 7 20 The new guidance with respect to multiple-element arrangements did Total Restricted Cash and Investments $ 371 $ 289 not change the allocation of arrangement consideration to the units of accounting or the pattern and timing of revenue recognition for those Inventories units. Normally our equipment and services will qualify as separate Inventories are carried at the lower of average cost or market. units of accounting, which are the majority of our multiple-element Inventories also include equipment that is returned at the end of the arrangements. In addition, under previous guidance, consideration for lease term. Returned equipment is recorded at the lower of remaining multiple-element arrangements was allocated based on VSOE or TPE, net book value or salvage value. Salvage value consists of the estimated since products and services are generally sold separately or the selling market value (generally determined based on replacement cost) of price is determinable based on competitor prices for similar deliverables. the salvageable component parts, which are expected to be used in As a result, for substantially all of our multiple-element arrangements, the remanufacturing process. We regularly review inventory quantities we will continue using VSOE or TPE to allocate the arrangement and record a provision for excess and/or obsolete inventory based consideration to each respective deliverable. primarily on our estimated forecast of product demand, production Although infrequent, under previous guidance with respect to multiple- requirements and servicing commitments. Several factors may influence element arrangements, if we were unable to establish the selling the realizability of our inventories, including our decision to exit a price using VSOE or TPE, arrangement consideration was allocated product line, technological changes and new product development. using the residual method or recognized ratably over the contractual The provision for excess and/or obsolete raw materials and equipment service period. However, since the new guidance allows for the use of inventories is based primarily on near-term forecasts of product demand our best estimate of the selling price in our allocation of arrangement and include consideration of new product introductions, as well as consideration if VSOE or TPE is not determinable, we now use our best changes in remanufacturing strategies. The provision for excess and/or estimate of selling price in those infrequent situations. The objective of obsolete service parts inventory is based primarily on projected servicing using estimated selling price-based methodology is to determine the requirements over the life of the related equipment populations. price at which we would transact a sale if the product or service were Land, Buildings and Equipment and Equipment on Operating Leases sold on a stand-alone basis. Accordingly, we determine our best estimate Land, buildings and equipment are recorded at cost. Buildings and of selling price considering multiple factors including, but not limited to, equipment are depreciated over their estimated useful lives. Leasehold geographies, market conditions, competitive landscape, internal costs, improvements are depreciated over the shorter of the lease term or gross margin objectives and pricing practices. Estimated selling price the estimated useful life. Equipment on operating leases is depreciated based methodology generally will apply to an insignificant proportion to estimated salvage value over the lease term. Depreciation is of our arrangements with multiple deliverables. computed using the straight-line method. Significant improvements Cash and Cash Equivalents are capitalized and maintenance and repairs are expensed. Refer to Cash and cash equivalents consist of cash on hand, including Note 5 – Inventories and Equipment on Operating Leases, Net and money-market funds, and investments with original maturities of Note 6 – Land, Buildings and Equipment, Net for further discussion. three months or less. Software – Internal Use and Product Restricted Cash and Investments We capitalize direct costs associated with developing, purchasing or As more fully discussed in Note 17 – Contingencies, various litigation otherwise acquiring software for internal use and amortize these costs matters in Brazil require us to make cash deposits as a condition of on a straight-line basis over the expected useful life of the software, continuing the litigation. In addition, several of our secured financing beginning when the software is implemented (“Internal Use Software”). arrangements and other contracts require us to post cash collateral Costs incurred for upgrades and enhancements that will not result in or maintain minimum cash balances in escrow. These cash amounts additional functionality are expensed as incurred. Useful lives of Internal are classified in our Consolidated Balance Sheets based on when the Use Software generally vary from three to 10 years. cash will be contractually or judicially released (refer to Note 10 – Supplementary Financial Information for classification of amounts). Xerox 2010 Annual Report 63


  • Page 11

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. We also capitalize certain costs related to the development of software charges) of the related operations. If these cash flows are less than the solutions to be sold to our customers upon reaching technological carrying value of such asset, an impairment loss is recognized for the feasibility and amortize these costs based on estimated future revenues difference between estimated fair value and carrying value. Our primary (“Product Software”). In recognition of the uncertainties involved in measure of fair value is based on discounted cash flows. estimating revenue, that amortization is not less than straight-line Treasury Stock amortization over the software’s remaining estimated economic life. We account for repurchased common stock under the cost method Useful lives of Product Software generally vary from three to 10 years. and include such Treasury stock as a component of our Common Amounts capitalized for Product Software are included in Cash Flows shareholders’ equity. Retirement of Treasury stock is recorded as a from Operations. reduction of Common stock and Additional paid-in capital at the time Years Ended December 31, such retirement is approved by our Board of Directors. Additions to: 2010 2009 2008 Research, Development and Engineering (“RD&E”) Internal use software $ 164 $ 98 $ 129 Research, development and engineering costs are expensed as incurred. Product software 70 1 1 Sustaining engineering costs are incurred with respect to ongoing product improvements or environmental compliance after initial product As of December 31, launch. Our RD&E expense for the three years ended December 31, 2010 Capitalized costs, net: 2010 2009 was as follows: Internal use software $ 468 $ 354 2010 2009 2008 Product software 145 10 R&D $ 653 $ 713 $ 750 Goodwill and Other Intangible Assets Sustaining engineering 128 127 134 Goodwill is tested for impairment annually or more frequently if an Total RD&E Expense $ 781 $ 840 $ 884 event or circumstance indicates that an impairment loss may have been incurred. Application of the goodwill impairment test requires judgment, Restructuring Charges including the identification of reporting units, assignment of assets Costs associated with exit or disposal activities, including lease and liabilities to reporting units, assignment of goodwill to reporting termination costs and certain employee severance costs associated units and determination of the fair value of each reporting unit. We with restructuring, plant closing or other activity, are recognized when estimate the fair value of each reporting unit using a discounted cash they are incurred. In those geographies where we have either a formal flow methodology. This requires us to use significant judgment including severance plan or a history of consistently providing severance benefits estimation of future cash flows, which is dependent on internal forecasts, representing a substantive plan, we recognize severance costs when estimation of the long-term rate of growth for our business, the useful they are both probable and reasonably estimable. Refer to Note 9 – life over which cash flows will occur, determination of our weighted Restructuring and Asset Impairment Charges for further information. average cost of capital and relevant market data. Pension and Post-retirement Benefit Obligations Other intangible assets primarily consist of assets obtained in connection We sponsor defined benefit pension plans in various forms in several with business acquisitions, including installed customer base and countries covering employees who meet eligibility requirements. Retiree distribution network relationships, patents on existing technology and health benefit plans cover U.S. and Canadian employees for retiree trademarks. We apply an impairment evaluation whenever events or medical costs. We employ a delayed recognition feature in measuring changes in business circumstances indicate that the carrying value of the costs of pension and post-retirement benefit plans. This requires our intangible assets may not be recoverable. Other intangible assets changes in the benefit obligations and changes in the value of assets set are amortized on a straight-line basis over their estimated economic aside to meet those obligations to be recognized not as they occur, but lives. We believe that the straight-line method of amortization reflects systematically and gradually over subsequent periods. All changes are an appropriate allocation of the cost of the intangible assets to earnings ultimately recognized as components of net periodic benefit cost, except in proportion to the amount of economic benefits obtained annually by to the extent they may be offset by subsequent changes. At any point, the Company. Refer to Note 8 – Goodwill and Intangible Assets, Net for changes that have been identified and quantified but not recognized as further information. components of net periodic benefit cost, are recognized in Accumulated Other Comprehensive Loss, Net of tax. Impairment of Long-Lived Assets We review the recoverability of our long-lived assets, including buildings, Several statistical and other factors that attempt to anticipate future equipment, internal-use software and other intangible assets, when events events are used in calculating the expense, liability and asset values or changes in circumstances occur that indicate that the carrying value of related to our pension and retiree health benefit plans. These factors the asset may not be recoverable. The assessment of possible impairment include assumptions we make about the discount rate, expected return is based on our ability to recover the carrying value of the asset from the on plan assets, rate of increase in healthcare costs, the rate of future expected future pre-tax cash flows (undiscounted and without interest compensation increases, and mortality. Actual returns on plan assets are not immediately recognized in our income statement, due to the delayed recognition requirement. In calculating the expected return 64 Xerox 2010 Annual Report


  • Page 12

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. on the plan asset component of our net periodic pension cost, we Foreign currency losses were $11, $26 and $34 in 2010, 2009 and apply our estimate of the long-term rate of return to the plan assets 2008, respectively, and are included in Other expenses, net in the that support our pension obligations, after deducting assets that are accompanying Consolidated Statements of Income. specifically allocated to Transitional Retirement Accounts (which are We sold our Venezuelan subsidiary during the fourth quarter of 2010 as accounted for based on specific plan terms). part of our restructuring actions – refer to Note 9 – Restructuring and For purposes of determining the expected return on plan assets, we Asset Impairment Charges for further information. Prior to the sale, the utilize a calculated value approach in determining the value of the U.S. Dollar was the functional currency of our Venezuelan operations. pension plan assets, rather than a fair market value approach. The In January 2010, Venezuela announced a devaluation of the Bolivar to primary difference between the two methods relates to systematic an official rate of 4.30 Bolivars to the U.S. Dollar for the majority of our recognition of changes in fair value over time (generally two years) products. As a result of this devaluation, we recorded a currency loss versus immediate recognition of changes in fair value. Our expected of $21 in the first quarter of 2010 for the re-measurement of our net rate of return on plan assets is applied to the calculated asset value Bolivar-denominated monetary assets. During 2010, the ability to obtain to determine the amount of the expected return on plan assets to U.S. Dollars remained severely restricted. As a result, during 2010 we be used in the determination of the net periodic pension cost. The re-measured our net Bolivar-denominated monetary transactions based calculated value approach reduces the volatility in net periodic pension on exchange rates available through alternative markets. The average cost that would result from using the fair market value approach. rate during 2010 was approximately 5.77 Bolivars to the U.S. Dollar. The impact of this change in the exchange rate was not material to our The discount rate is used to present value our future anticipated benefit results for the year since we derived less than 0.5% of our total revenues obligations. In estimating our discount rate, we consider rates of return from Venezuela. on high-quality fixed-income investments included in various published bond indexes, adjusted to eliminate the effects of call provisions and Accumulated Other Comprehensive Loss (“AOCL”) differences in the timing and amounts of cash outflows related to the AOCL is composed of the following for the three years ending bonds, as well as the expected timing of pension and other benefit December 31, 2010: payments. In the U.S. and the U.K., which comprise approximately 2010 2009 2008 75% of our projected benefit obligation, we consider the Moody’s Cumulative translation Aa Corporate Bond Index and the International Index Company’s adjustments $ (835) $ (800) $ (1,395) iBoxx Sterling Corporate AA Cash Bond Index, respectively, in the Benefit plans net actuarial losses determination of the appropriate discount rate assumptions. Refer to and prior service credits(1) (1,167) (1,190) (1,021) Note 15 – Employee Benefit Plans for further information. Other unrealized gains, net 14 2 — Each year, the difference between the actual return on plan assets and Total Accumulated Other the expected return on plan assets, as well as increases or decreases in Comprehensive Loss $(1,988) $ (1,988) $ (2,416) the benefit obligation as a result of changes in the discount rate, are (1) added to or subtracted from any cumulative actuarial gain or loss that Includes our share of Fuji Xerox. arose in prior years. This resultant amount is the net actuarial gain or Note 2 – Segment Reporting loss recognized in Accumulated other comprehensive loss and is subject to subsequent amortization to net periodic pension cost in future periods Our reportable segments are aligned with how we manage the business over the remaining service lives of the employees participating in the and view the markets we serve. In 2010, as a result of our acquisition of pension plan. ACS, we realigned our internal financial reporting structure (refer to Note 3 – Acquisitions for information regarding the ACS acquisition). We now Foreign Currency Translation and Re-measurement report our financial performance based on the following two primary The functional currency for most foreign operations is the local currency. reportable segments – Technology and Services. The Technology Net assets are translated at current rates of exchange and income, segment represents the combination of our former Production and Office expense and cash flow items are translated at average exchange rates segments excluding the document outsourcing business, which was for the applicable period. The translation adjustments are recorded in previously included in these reportable segments. The Services segment Accumulated other comprehensive loss. represents the combination of our document outsourcing business and The U.S. Dollar is used as the functional currency for certain foreign ACS’s business process outsourcing (“BPO”) and information technology subsidiaries that conduct their business in U.S. Dollars. A combination outsourcing (“ITO”) businesses. We believe this realignment will help us of current and historical exchange rates is used in re-measuring the local to better manage our business and view the markets we serve, which are currency transactions of these subsidiaries and the resulting exchange primarily centered around equipment systems and outsourcing services. adjustments are included in income. Our Technology segment operations involve the sale and support of a broad range of document systems from entry level to the high-end. Our Services segment operations involve delivery of a broad range of outsourcing services including document, business processing and IT outsourcing services. Our 2009 and 2008 segment disclosures have been restated to reflect our new 2010 internal reporting structure. Xerox 2010 Annual Report 65


  • Page 13

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Our Technology segment is centered on strategic product groups, which Document outsourcing services include service arrangements that allow share common technology, manufacturing and product platforms. This customers to streamline, simplify and digitize their document-intensive segment includes the sale of document systems and supplies, technical business processes through automation and deployment of software services and product financing. Our products range from: applications and tools and the management of their printing needs. Business process outsourcing services include service arrangements • “Entry,” which includes A4 devices and desktop printers. where we manage a customer’s business activity or process. Information • “Mid-range,” which includes A3 devices that generally serve technology outsourcing services include service arrangements where workgroup environments in mid to large enterprises. Mid-range we manage a customer’s IT-related activities, such as application includes products that fall into the following market categories: management and application development, data center operations or Color 41+ ppm priced at less than $100K and Light Production testing and quality assurance. 91+ppm priced at less than $100K. • “High-end,” which includes production printing and publishing The segment classified as Other includes several units, none of which meets the threshold for separate segment reporting. This group primarily systems that generally serve the graphic communications marketplace includes Xerox Supplies Business Group (predominantly paper sales), and large enterprises. Wide Format Systems, licensing revenues, GIS network integration The Services segment comprises three outsourcing service offerings: solutions and electronic presentation systems, non-allocated Corporate • Document Outsourcing (which includes Managed Print Services) items including non-financing interest, as well as other items included in Other expenses, net. • Business Process Outsourcing • Information Technology Outsourcing. Selected financial information for our Operating segments for the three years ended December 31, 2010 was as follows: Technology Services Other Total 2010(1) Revenues $ 9,790 $ 9,548 $ 1,635 $ 20,973 Finance income 559 89 12 660 Total Segment Revenues $ 10,349 $ 9,637 $ 1,647 $ 21,633 Interest expense $ 212 $ 28 $ 352 $ 592 Segment profit (loss)(2) 1,085 1,132 (342) 1,875 Equity in net income of unconsolidated affiliates 62 16 — 78 2009(1) Revenues $ 9,470 $ 3,373 $ 1,623 $ 14,466 Finance income 597 103 13 713 Total Segment Revenues $ 10,067 $ 3,476 $ 1,636 $ 15,179 Interest expense $ 229 $ 36 $ 262 $ 527 Segment profit (loss)(2) 949 231 (342) 838 Equity in net income of unconsolidated affiliates 33 8 — 41 2008(1) Revenues $ 11,041 $ 3,718 $ 2,051 $ 16,810 Finance income 673 110 15 798 Total Segment Revenues $ 11,714 $ 3,828 $ 2,066 $ 17,608 Interest expense $ 293 $ 5 $ 269 $ 567 Segment profit (loss)(2) 1,288 302 (245) 1,345 Equity in net income of unconsolidated affiliates 90 23 — 113 (1) Asset information on a segment basis is not disclosed as this information is not separately identified and internally reported to our chief executive officer. (2) Depreciation and amortization expense, which is recorded in cost of sales, RD&E and SAG are included in segment profit above. This information is neither identified nor internally reported to our chief executive officer. The separate identification of this information for purposes of segment disclosure is impracticable, as it is not readily available and the cost to develop it would be excessive. 66 Xerox 2010 Annual Report


  • Page 14

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following is a reconciliation of segment profit to pre-tax income (loss) for the three years ended December 31, 2010: 2010 2009 2008 Total Segment Profit $ 1,875 $ 838 $ 1,345 Reconciling items: Restructuring and asset impairment charges (483) 8 (429) Restructuring charges of Fuji Xerox (38) (46) (16) Acquisition-related costs (77) (72) — Amortization of intangible assets (312) (60) (54) Venezuelan devaluation costs (21) — — ACS shareholders’ litigation settlement (36) — — Litigation matters(1) — — (774) Loss on early extinguishment of debt (15) — — Equity in net income of unconsolidated affiliates (78) (41) (113) Equipment write-off and other — — (38) Pre-tax Income (Loss) $ 815 $ 627 $ (79) (1) The 2008 provision for litigation represents $670 for the Carlson v. Xerox Corporation court-approved settlement, as well as provisions for other litigation matters including $36 for the probable loss related to the Brazil labor-related contingencies. Geographic area data is based upon the location of the subsidiary reporting the revenue or long-lived assets and is as follows for the three years ended December 31, 2010: Revenues Long-Lived Assets(1) 2010 2009 2008 2010 2009 2008 United States $ 13,801 $ 8,156 $ 9,122 $ 1,764 $ 1,245 $ 1,386 Europe 5,332 4,971 6,011 741 717 680 Other areas 2,500 2,052 2,475 309 262 248 Total Revenues and Long-Lived Assets $ 21,633 $15,179 $ 17,608 $ 2,814 $ 2,224 $ 2,314 (1) Long-lived assets are comprised of (i) land, buildings and equipment, net, (ii) equipment on operating leases, net, (iii) internal use software, net and (iv) product software, net. Note 3 – Acquisitions Equity transaction: Each outstanding share of ACS Class A and Class B common stock was converted into a combination of 4.935 shares Affiliated Computer Services, Inc. of Xerox common stock and $18.60 in cash for a combined value of On February 5, 2010 (“the acquisition date”), we acquired all of the $60.40 per share, or approximately $6.0 billion based on the closing outstanding equity of ACS in a cash-and-stock transaction valued at price of Xerox common stock of $8.47 on the acquisition date. 489,802 approximately $6.5 billion. ACS provides business process outsourcing thousand shares of Xerox common stock were issued. We also issued and information technology (“ITO”) services and solutions to commercial convertible preferred stock with a liquidation value of $300 and a fair and government clients worldwide. ACS delivers a full range of BPO and value of $349 as of the acquisition date to ACS’s Class B shareholder. IT services, as well as end-to-end solutions to the public and private sectors and supports a variety of industries including education, energy, financial, government, healthcare, retail and transportation. ACS’s revenues for the calendar year ended December 31, 2009 were $6.6 billion and they employed 78,000 people and operated in over 100 countries on the acquisition date. Xerox 2010 Annual Report 67


  • Page 15

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. All ACS stock options outstanding at closing were assumed by Xerox average exercise price of $6.79 per option. The estimated fair value and converted into Xerox stock options. ACS stock options issued prior associated with the Xerox options issued in exchange for the ACS options to August 2009, whether or not then vested and exercisable, became was approximately $222 based on a Black-Scholes valuation model fully vested and exercisable in accordance with preexisting change-in- (refer to Note 19 – Shareholders’ Equity for assumptions). Approximately control provisions. ACS stock options issued in August 2009 will continue $168 of the estimated fair value is associated with options issued prior to vest and become exercisable for Xerox common stock in accordance to August 2009, which became fully vested and exercisable upon the with their original terms. For the August 2009 options, the portion of acquisition in accordance with pre-existing change-in-control provisions, the estimated fair value associated with service prior to the close was was recorded as part of the acquisition fair value. The remaining $54 is recorded as part of the acquisition fair value with the remainder to be associated with options issued in August 2009 which continue to vest recorded as future compensation cost over the remaining vesting period. according to their original terms and therefore is being expensed as Each assumed ACS option became exercisable for 7.085289 Xerox compensation cost over the remaining vesting period which is estimated common shares for a total of 96,662 thousand shares at a weighted to be approximately 3.9 years. Fair value of consideration transferred: The table below details the consideration transferred to acquire ACS (certain amounts reflect rounding adjustments): (shares in millions) Conversion Calculation Estimated Fair Value Form of Consideration ACS Class A shares outstanding as of the acquisition date 92.7 ACS Class B shares outstanding as of the acquisition date 6.6 Total ACS Shares Outstanding 99.3 Xerox stock price as of the acquisition date $ 8.47 Multiplied by the exchange ratio 4.935 Equity Consideration per Common Share Outstanding $ 41.80 $ 4,149 Xerox common stock Cash Consideration per Common Share Outstanding $ 18.60 $ 1,846 Cash ACS stock options exchanged for a Xerox equivalent stock option 13.6 Multiplied by the option exchange ratio 7.085289 Total Xerox Equivalent Stock Options 96.7 $ 168 Xerox stock options Xerox Preferred Stock Issued to ACS Class B Shareholder $ 349 Xerox preferred stock Total Fair Value of Consideration Transferred $ 6,512 Recording of assets acquired and liabilities assumed: The transaction February 5, 2010 has been accounted for using the acquisition method of accounting Assets which requires, among other things, that most assets acquired and Cash and cash equivalents $ 351 liabilities assumed be recognized at their fair values as of the acquisition Accounts receivable 1,344 date. The following table summarizes the assets acquired and liabilities Other current assets 389 assumed as of the acquisition date: Land, buildings and equipment 416 Intangible assets 3,035 Goodwill 5,127 Other long-term assets 258 Liabilities Other current liabilities 645 Deferred revenue 161 Deferred tax liability 990 Debt 2,310 Pension liabilities 39 Other long-term liabilities 263 Net Assets Acquired $6,512 68 Xerox 2010 Annual Report


  • Page 16

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Intangible assets: The following table is a summary of the fair value The following is a summary of the funded position of the assumed ACS estimates of the identifiable intangible assets and their weighted- plans as of the acquisition date, as well as associated weighted-average average useful lives: assumptions used to determine benefit obligations: Estimated Fair Value Estimated Useful Life Estimated Fair Value Customer relationships/contracts $ 2,920 11.6 years Projected benefit obligation $ 142 ACS tradename 100 4 years Fair value of plan assets 111 (1) Buck tradename 10 Net Unfunded Status $ (31) (2) Title plant 5 Total Identifiable Intangible Assets $ 3,035 Amounts recognized in the Consolidated Balance Sheets: (1) Determined to be an indefinite-lived asset. Other long-term assets $ 8 (2) Title plant is not subject to depreciation or charged to earnings based on ASC Topic Pension liabilities (39) 950 – Financial Services – Title Plant, unless circumstances indicate that the carrying amount of the title plant has been impaired. Net Amount Recognized $ (31) Deferred revenue: As part of our purchase price allocation, we revalued Weighted average assumption used to determine benefit obligations at ACS’s existing deferred revenue to fair value based on the remaining the acquisition date and net periodic benefit cost from the acquisition post-acquisition service obligation. The total revaluation adjustment date through December 31, 2010: was $133 ($53 current; $80 non-current) and represented the value for services already rendered for which no future obligation to provide Discount rate 5.7% services remains. Post-acquisition, revenue will accordingly be reduced Expected rate of return on plan assets 6.9% for the value of this adjustment. Accordingly, the remaining balance Rate of compensation increase 3.9% of deferred revenue included in the above of $161 ($145 current; $16 non-current) primarily represents our estimate of the fair value for the Change-in-control liabilities: We assumed liabilities due under remaining service obligation. contractual change-in-control provisions in employment agreements of certain ACS employees and its Chairman of approximately $95 ($15 Deferred taxes: We provided deferred taxes and recorded other tax current; $80 non-current). The liabilities include accruals for related adjustments as part of the accounting for the acquisition primarily excise and other taxes we are obligated to pay on these obligations. related to the estimated fair value adjustments for acquired intangible assets, as well as the elimination of a previously recorded deferred tax Contingent consideration: Although there is no contingent liability associated with ACS’s historical goodwill that was tax deductible. consideration associated with our acquisition of ACS, ACS is obligated to In addition, we also provided deferred taxes of $48 for the outside basis make contingent payments in connection with prior acquisitions upon difference associated with certain foreign subsidiaries of ACS for which satisfaction of certain contractual criteria. Contingent consideration no taxes have been previously provided. We expect to reverse the outside obligations must be recorded at their respective fair value. As of the basis difference primarily through repatriating earnings from those acquisition date, the maximum aggregate amount of ACS’s outstanding subsidiaries in lieu of permanently reinvesting them as well as through contingent obligations to former shareholders of acquired entities the reorganization of those subsidiaries. was approximately $46, of which $11 was recorded representing the estimated fair value of this obligation. We made contingent payments Debt: We repaid $1.7 billion of ACS’s debt and assumed an additional of $8 in 2010 which are reflected within investing activities in the $0.6 billion. The following is a summary of the third-party debt assumed Consolidated Statements of Cash Flows. As of December 31, 2010, the and not repaid in connection with the close of the acquisition: maximum aggregate amount of the outstanding contingent obligations to former shareholders of acquired entities was approximately $5. 4.70% Senior Notes due June 2010 $ 250 5.20% Senior Notes due June 2015 250 Goodwill: Goodwill in the amount of $5.1 billion was recognized for Capital lease obligations and other debt 64 this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future Principal debt balance 564 economic benefits arising from other assets acquired that could not Fair value adjustments 13 be individually identified and separately recognized. Specifically, the Total Debt Assumed But Not Repaid $ 577 goodwill recorded as part of the acquisition of ACS includes: Pension obligations: We assumed several defined benefit pension • The expected synergies and other benefits that we believe will result plans covering the employees of ACS’s human resources consulting and from combining the operations of ACS with the operations of Xerox; outsourcing business in the U.S., U.K., Germany and Canada. The plans in • Any intangible assets that do not qualify for separate recognition such the U.S. and Canada are both funded and unfunded; the plan in the U.K. as the assembled workforce; and is funded; and the plan in Germany is unfunded. • The value of the going-concern element of ACS’s existing businesses (the higher rate of return on the assembled collection of net assets versus acquiring all of the net assets separately). Xerox 2010 Annual Report 69


  • Page 17

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Goodwill of $2.3 billion is deductible for tax purposes as a result of TMS Health: In October 2010, ACS acquired TMS Health (“TMS”), a previous taxable acquisitions made by ACS. While the allocation of U.S.-based teleservices company that provides customer care services to goodwill among reporting units is not complete, we expect the majority the pharmaceutical, biotech and healthcare industries, for approximately of the goodwill will be related to our Services segment. $48 in cash. Through TMS, ACS improves communication between pharmaceutical companies, physicians, consumers and pharmacists. Pro-forma impact of the acquisition: The unaudited pro-forma By providing customer education, product sales and marketing and results presented below include the effects of the ACS acquisition as clinical trial solutions, ACS builds on the IT and BPO services it already if it had been consummated as of January 1, 2010 and 2009. The delivers to the healthcare and pharmaceutical industries. pro-forma results include the amortization associated with an estimate for the acquired intangible assets and interest expense associated ExcellerateHRO, LLP: In July 2010, ACS acquired ExcellerateHRO, LLP with debt used to fund the acquisition, as well as fair value adjustments (“EHRO”), a global benefits administration and relocation services provider, for unearned revenue, software and land, buildings and equipment. for $125 net of cash acquired. This acquisition establishes ACS as one of To better reflect the combined operating results, material non-recurring the world’s largest pension plan administrators and as a leading provider charges directly attributable to the transaction have been excluded. of outsourced health and welfare and relocation services. The purchase In addition, the pro-forma results do not include any anticipated price was primarily allocated to intangible assets (consisting of customer synergies or other expected benefits of the acquisition. Accordingly, relationships of $32 and software of $8) and goodwill of $77 based on the unaudited pro-forma financial information below is not necessarily third-party valuations and management’s estimates. indicative of future results of operations or results that might GIS Acquisitions have been achieved had the acquisition been consummated as of January 1, 2010 or 2009. Georgia Duplicating Products: In September 2010, GIS acquired 2010 2009 Georgia Duplicating Products, an office equipment supplier, for approximately $21 net of cash acquired. Revenue $22,252 $21,781 Net income – Xerox 592 795 ComDoc, Inc.: In February 2009, GIS acquired ComDoc, Inc. (“ComDoc”) Basic earnings per share 0.41 0.57 for approximately $145 in cash. ComDoc is one of the larger independent Diluted earnings per share 0.41 0.56 office technology dealers in the U.S. and expands GIS’s coverage in Ohio, Pennsylvania, New York and West Virginia. GIS also acquired another Note: The pro-forma information presented above is on a different basis business in 2009 for $18 in cash. than the pro-forma information provided in Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Saxon Business Systems: In 2008, GIS acquired Saxon Business Annual Report for the year ended December 31, 2010. Systems, an office equipment supplier in Florida, for approximately $69 in cash, including transaction costs. GIS acquired three other similar Other Acquisitions businesses in 2008 for a total of $17 in cash. Irish Business Systems Limited: In January 2010, we acquired Irish These acquisitions continue the development of GIS’s national network Business Systems Limited (“IBS”) for approximately $29 net of cash of office technology suppliers to serve its expanding base of small and acquired. This acquisition expands our reach into the small and mid-size mid-size businesses. business market in Ireland. IBS has eight offices located throughout Ireland and is a managed print services provider and the largest Summary – Other Acquisitions independent supplier of digital imaging and printing solutions in Ireland. The operating results of the acquisitions described above are not Veenman B.V.: In 2008, we acquired Veenman B.V. (“Veenman”), material to our financial statements and are included within our results expanding our reach into the small and mid-size business market from the respective acquisition dates. Excluding ACS, our remaining in Europe, for approximately $69 (€44 million) in cash, including 2010 acquisitions contributed aggregate revenues of approximately transaction costs. Veenman is the Netherlands’ leading independent $140 to our 2010 total revenues from their respective acquisition dates. distributor of office printers, copiers and multifunction devices serving The ACS acquisitions are included within our Services segment while the small and mid-size businesses. other acquisitions, including the GIS acquisitions, are primarily included within our Technology segment. The purchase prices were primarily ACS Acquisitions allocated to intangible assets and goodwill based on third-party Spur Information Solutions: In November 2010, ACS acquired Spur valuations and management’s estimates. Information Solutions, one of the United Kingdom’s leading providers of computer software used for parking enforcement, for $12 in cash. The acquisition strengthens ACS’s broad portfolio of services that support the transportation industry. 70 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 4 – Receivables, Net Provisions for Losses on Uncollectible Receivables Accounts Receivable Accounts Receivable: The allowance for uncollectible accounts receivables is determined principally on the basis of past collection Accounts receivable, net at December 31, 2010 and 2009 were as experience as well as consideration of current economic conditions and follows: changes in our customer collection trends. 2010 2009 Finance Receivables: Finance receivables include sales-type leases, Amounts billed or billable $ 2,491 $ 1,850 direct financing leases and installment loans. Our finance receivable Unbilled amounts 447 — portfolios are primarily in the US, Canada and Europe. We generally Allowance for doubtful accounts (112) (148) establish customer credit limits and estimate the allowance for credit Accounts Receivable, net $ 2,826 $ 1,702 losses on a country or geographic basis. We establish credit limits based upon an initial evaluation of the Unbilled amounts include amounts associated with percentage-of- customer’s credit quality and adjust that limit accordingly based upon completion accounting, and other earned revenues not currently ongoing credit evaluations of the customer including payment history billable due to contractual provisions. Amounts to be invoiced in the and changes in credit quality. subsequent month for current services provided are included in amounts billable, and at December 31, 2010 and 2009 were approximately The allowance for doubtful accounts and credit losses represents an $1,066 and $603, respectively. estimate of the losses expected to be incurred from the Company’s finance receivable portfolio. The level of the allowance is determined Finance Receivables on a collective basis by applying projected loss rates to our different Finance receivables result from installment arrangements and portfolios by country, which represent our portfolio segments. This sales-type leases arising from the marketing of our equipment. These is the level at which we develop and document our methodology to receivables are typically collateralized by a security interest in the determine allowance for credit losses. This loss rate is primarily based underlying assets. Finance receivables, net at December 31, 2010 and upon historical loss experience adjusted for judgments about the 2009 were as follows: probable effects of relevant observable data including current economic 2010 2009 conditions as well as delinquency trends, resolution rates, the aging of receivables, credit quality indicators and the financial health of Gross receivables $ 7,914 $ 8,427 specific customer classes or groups. The allowance for doubtful finance Unearned income (1,093) (1,197) receivables is inherently more difficult to estimate than the allowance Subtotal 6,821 7,230 for trade accounts receivable because the underlying lease portfolio has Residual values 11 19 an average maturity, at any time, of approximately two to three years Allowance for doubtful accounts (212) (222) and contains past due billed amounts, as well as unbilled amounts. We Finance receivables, net 6,620 7,027 consider all available information in our quarterly assessments of the Less: Billed portion of finance receivables, net (198) (226) adequacy of the allowance for doubtful accounts. The identification of Less: Current portion of finance receivables account-specific exposure is not a significant factor in establishing the not billed, net (2,287) (2,396) allowance for doubtful finance receivables. Our policy and methodology used to establish our allowance for doubtful accounts has been Finance Receivables Due After One Year, net $ 4,135 $ 4,405 consistently applied over all periods presented. Contractual maturities of our gross finance receivables as of December Since our allowance for doubtful Finance receivables is determined 31, 2010 were as follows (including those already billed of $198): by country, the risk characteristics in our finance receivable portfolio 2011 2012 2013 2014 2015 Thereafter Total segments will generally be consistent with the risk factors associated with the economies of those countries/regions. The economies of $2,978 $2,178 $1,527 $862 $330 $39 $ 7,914 the U.S., Canada and Europe continue to recover from the financial economic crises and recession which began in late 2008. Although loss rates across all our portfolio segments have declined in 2010, loss rates continue to be elevated as compared to prior years. Since Europe is composed of varied countries and regional economies, the risk profile within our European portfolio segment is somewhat more diversified due to the varying economic conditions among the countries. Credit losses have increased within southern Europe given the current economic difficulties facing the countries in this region. Xerox 2010 Annual Report 71


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following table is a roll-forward of the allowance for doubtful finance receivables for the years ended December 31, 2010 and 2009, as well as the related investment in finance receivables: United States Canada Europe Other(2) Total Allowance for Credit Losses: Balance December 31, 2008 $ 93 $ 24 $ 78 $ 3 $ 198 Provision 77 21 78 1 177 Charge-offs (79) (19) (73) — (171) Recoveries and other(1) 8 7 4 (1) 18 Balance December 31, 2009 $ 99 $ 33 $ 87 $ 3 $ 222 Provision 47 22 59 — 128 Charge-offs (58) (23) (59) — (140) Recoveries and other(1) 3 5 (6) — 2 Balance December 31, 2010 $ 91 $ 37 $ 81 $ 3 $ 212 Finance receivables collectively evaluated for impairment: December 31, 2009 $3,474 $ 873 $ 2,832 $ 51 $7,230 December 31, 2010 $3,177 $ 872 $ 2,706 $ 66 $6,821 (1) Includes the impacts of foreign currency translation and adjustments to reserves necessary to reflect events of non-payment such as customer accommodations and contract terminations. (2) Includes developing market countries and smaller units. In the U.S. and Canada, customers are further evaluated or segregated Non-investment grade: This rating includes accounts with average by class based on industry sector. The primary customer classes are credit risk that are more susceptible to loss in the event of adverse Finance & Other Services, Government & Education; Graphic Arts; business or economic conditions. This rating generally equates to a S&P Industrial; Healthcare and Other. In Europe, customers are further rating below BBB-. Although we experience higher loss rates associated grouped by class based on the country or region of the customer. with this customer class, we believe the risk is somewhat mitigated by The primary customer classes include the U.K./Ireland, France and the fact that our leases are fairly well dispersed across a large and diverse the following European regions – Central, Nordic and Southern. These customer base. In addition, the higher loss rates are largely offset by groupings or classes are used to understand the nature and extent the higher rates of return we obtain with such leases. Loss rates in this of our exposure to credit risk arising from finance receivables. category are generally in the range of 2% to 4%. We evaluate our customers based on the following credit quality Substandard: This rating includes accounts that have marginal credit indicators: risk such that the customer’s ability to make repayment is impaired or may likely become impaired. We use numerous strategies to mitigate Investment grade: This rating includes accounts with excellent to risk including higher rates of interest, prepayments, personal guarantees, good business credit, asset quality and the capacity to meet financial etc. Accounts in this category include customers who were downgraded, obligations. These customers are less susceptible to adverse effects due during the term of the lease, from investment and non-investment grade to shifts in economic conditions or changes in circumstance. The rating evaluation when the lease was originated. Accordingly there is a distinct generally equates to a Standard & Poors (“S&P”) rating of BBB- or better. possibility for a loss of principal and interest or customer default. The loss Loss rates in this category are normally minimal at less than 1%. rates in this category are around 10%. 72 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The credit quality indicators are updated at least annually. The credit quality of any given customer can significantly change during the life of the portfolio. Details about our finance receivables portfolio based by industry and by credit quality indicators are as follows: As of December 31, 2010 Non- Total Investment investment Finance Grade Grade Substandard Receivables United States: Finance and Other Services $ 360 $ 401 $ 190 $ 951 Government and Education 849 21 7 877 Graphic Arts 147 217 156 520 Industrial 206 91 38 335 Healthcare 134 48 32 214 Other 102 109 69 280 Total United States 1,798 887 492 3,177 Canada: Finance and Other Services 150 127 56 333 Government and Education 127 12 3 142 Graphic Arts 32 35 48 115 Industrial 57 47 30 134 Other 88 47 13 148 Total Canada 454 268 150 872 Europe: France 219 374 82 675 U.K./Ireland 206 164 51 421 Central(1) 297 551 65 913 Southern(2) 263 237 81 581 Nordics(3) 50 63 3 116 Total Europe 1,035 1,389 282 2,706 Other 33 33 — 66 Total $ 3,320 $ 2,577 $ 924 $ 6,821 (1) Switzerland, Germany, Austria, Belgium, Holland. (2) Italy, Greece, Spain, Portugal. (3) Sweden, Norway, Denmark, Finland. The aging of our receivables portfolio is based upon the number of days We generally continue to maintain equipment on lease and provide an invoice is past due. Receivables that were more than 90 days past services to customers that have invoices for finance receivables that due are considered delinquent. Receivable losses are charged against are 90 days or more past due and, as a result of the bundled nature the allowance when management believes the uncollectibility of the of billings, we also continue to accrue interest on those receivables. receivable is confirmed and is generally based on individual credit However, interest revenue for such billings is only recognized if evaluations, results of collection efforts and specific circumstances of the collectability is deemed reasonably assured. customer. Subsequent recoveries, if any, are credited to the allowance. Xerox 2010 Annual Report 73


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The aging of our billed finance receivables is as follows: As of December 31, 2010 Finance 31–90 Total Billed Unbilled Total Receivables Days >90 days Finance Finance Finance >90 Days and Current Past Due Past Due Receivables Receivables Receivables Accruing United States: Finance and Other Services $ 23 $ 5 $ 2 $ 30 $ 921 $ 951 $ 23 Government and Education 26 6 3 35 842 877 40 Graphic Arts 21 3 1 25 495 520 16 Industrial 11 2 1 14 321 335 10 Healthcare 6 2 1 9 205 214 9 Other 8 2 — 10 270 280 8 Total United States 95 20 8 123 3,054 3,177 106 Total Canada 3 3 1 7 865 872 28 Europe: France 1 1 — 2 673 675 5 U.K./Ireland 4 1 1 6 415 421 7 Central 9 2 4 15 898 913 39 Southern 32 10 15 57 524 581 99 Nordics 1 — — 1 115 116 2 Total Europe 47 14 20 81 2,625 2,706 152 Other 2 — — 2 64 66 — Total $ 147 $ 37 $ 29 $ 213 $ 6,608 $ 6,821 $ 286 Accounts Receivable Sales Arrangements Accounts receivable sales for the three years ended December 31, 2010 were as follows: We have facilities in the U.S., Canada and several countries in Europe that enable us to sell to third parties, on an ongoing basis, certain 2010 2009 2008 accounts receivable without recourse. The accounts receivables sold Accounts receivable sales $ 2,374 $ 1,566 $ 717 are generally short-term trade receivables with payment due dates of Deferred proceeds 307 — — less than 60 days. The agreements involve the sale of entire groups Fees associated with sales 15 13 4 of accounts receivable for cash. In certain instances, a portion of the Estimated increase on operating sales proceeds is held back and deferred until collection of the related cash flows(1) 106 309 51 receivables by the purchaser. Such holdbacks are not considered legal (1) Represents the difference between current and prior-year fourth-quarter accounts securities nor are they certificated. Deferred proceeds on accounts receivable sales adjusted for the effects of: (i) the deferred proceeds, (ii) collections receivable sales in 2010 amounted to $307. We report collections on prior to the end of the year and (iii) currency. such receivables as operating cash flows in the Consolidated Statements of Cash Flows, because such receivables are the result of an operating Note 5 – Inventories and Equipment on Operating activity and the associated interest rate risk is de minimis due to its Leases, Net short-term nature. These receivables are included in the caption “Other current assets” in the accompanying Consolidated Balance Sheets and Inventories at December 31, 2010 and 2009 were as follows: were $90 at December 31, 2010. Under most of the agreements, we 2010 2009 also continue to service the sold accounts receivable. When applicable, a Finished goods $ 858 $ 772 servicing liability is recorded for the estimated fair value of the servicing. Work-in-process 46 43 The amounts associated with the servicing liability were not material. Raw materials 87 85 Total Inventories $ 991 $ 900 74 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The transfer of equipment from our inventories to equipment subject Depreciation expense and operating lease rent expense for the years to an operating lease is presented in our Consolidated Statements of ended December 31, 2010, 2009 and 2008 were as follows: Cash Flows in the operating activities section as a non-cash adjustment. 2010 2009 2008 Equipment on operating leases and similar arrangements consists of our Depreciation expense $379 $247 $257 equipment rented to customers and depreciated to estimated salvage Operating lease rent expense(1) 632 267 252 value at the end of the lease term. We recorded $31, $52 and $115 in inventory write-down charges for the years ended December 31, 2010, (1) We lease certain land, buildings and equipment, substantially all of which are 2009 and 2008, respectively. accounted for as operating leases. Equipment on operating leases and the related accumulated Future minimum operating lease commitments that have initial or depreciation at December 31, 2010 and 2009 were as follows: remaining non-cancelable lease terms in excess of one year at December 31, 2010 were as follows: 2010 2009 2011 2012 2013 2014 2015 Thereafter Equipment on operating leases $ 1,561 $ 1,583 Accumulated depreciation (1,031) (1,032) $669 $486 $337 $171 $118 $106 Equipment on Operating Leases, net $ 530 $ 551 We have an information management contract with HP Enterprise Services (“HPES”), the legal successor to Electronic Data Systems Corp., Depreciable lives generally vary from three to four years consistent through March 2014. Services to be provided under this contract with our planned and historical usage of the equipment subject to include support for European mainframe system processing, as well operating leases. Depreciation and obsolescence expense for equipment as workplace, service desk and voice and data network management. on operating leases was $313, $329 and $298 for the years ended Although the HPES contract runs through March 2014, we may choose December 31, 2010, 2009 and 2008, respectively. Our equipment to transfer some of the services to internal Xerox providers before the operating lease terms vary, generally from 12 to 36 months. Scheduled HPES contract ends. There are no minimum payments required under minimum future rental revenues on operating leases with original terms this contract. We can terminate the contract for convenience without of one year or longer are: paying a termination fee by providing 60 days’ prior notice. Should we 2011 2012 2013 2014 2015 Thereafter terminate the contract for convenience, we have an option to purchase $389 $279 $180 $87 $41 $14 the assets placed in service under the HPES contract. Payments to HPES, which are primarily recorded in selling, administrative and general Total contingent rentals on operating leases, consisting principally of expenses, were $98, $198 and $279 for the years ended December 31, usage charges in excess of minimum contracted amounts, for the years 2010, 2009 and 2008, respectively. ended December 31, 2010, 2009 and 2008 amounted to $133, $125 During 2010 and 2009 we terminated several agreements with HPES and $117, respectively. for information management services and either terminated the services or entered into new agreements for similar services with several Note 6 – Land, Buildings and Equipment, Net alternative providers. Services provided under these new contracts Land, buildings and equipment, net at December 31, 2010 and 2009 include mainframe application processing, development and support were as follows: and mid-range applications processing and support. These contracts have various terms through 2015. Some of the contracts require Estimated minimum payments and include termination penalties. Payments for Useful Lives (Years) 2010 2009 information management services which are primarily recorded in selling, administrative and general expenses were $44 and $26 for the Land — $ 63 $ 45 years ended December 31, 2010 and 2009, respectively. Buildings and building equipment 25 to 50 1,133 1,192 Leasehold improvements Varies 455 328 Plant machinery 5 to 12 1,607 1,686 Note 7 – Investments in Affiliates, at Equity Office furniture and equipment 3 to 15 1,306 994 Investments in corporate joint ventures and other companies in which Other 4 to 20 115 100 we generally have a 20% to 50% ownership interest at December 31, Construction in progress — 67 33 2010 and 2009 were as follows: Subtotal 4,746 4,378 2010 2009 Accumulated depreciation (3,075) (3,069) Fuji Xerox $ 1,217 $ 998 Land, Buildings and All other equity investments 74 58 Equipment, net $ 1,671 $ 1,309 Investments in Affiliates, at Equity $ 1,291 $ 1,056 Xerox 2010 Annual Report 75


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Our equity in net income of our unconsolidated affiliates for the three Yen/U.S. Dollar exchange rates used to translate are as follows: years ended December 31, 2010 was as follows: Exchange Basis 2010 2009 2008 2010 2009 2008 Summary of Weighted Fuji Xerox $ 63 $ 30 $ 101 Operations Average Rate 87.64 93.51 103.31 Other investments 15 11 12 Balance Sheet Year-End Rate 81.66 92.46 90.28 Total Equity in Net Income of Transactions with Fuji Xerox Unconsolidated Affiliates $ 78 $ 41 $ 113 We receive dividends from Fuji Xerox, which are reflected as a reduction Fuji Xerox in our investment. Additionally, we have a Technology Agreement with Fuji Xerox whereby we receive royalty payments for their use of our Xerox Fuji Xerox is headquartered in Tokyo and operates in Japan, China, brand trademark, as well as rights to access their patent portfolio in Australia, New Zealand and other areas of the Pacific Rim. Our exchange for access to our patent portfolio. These payments are included investment in Fuji Xerox of $1,217 at December 31, 2010 differs from in Service, outsourcing and rental revenues in the Consolidated Statements our implied 25% interest in the underlying net assets, or $1,335, due of Income. We also have arrangements with Fuji Xerox whereby we primarily to our deferral of gains resulting from sales of assets by purchase inventory from and sell inventory to Fuji Xerox. Pricing of the us to Fuji Xerox, partially offset by goodwill related to the Fuji Xerox transactions under these arrangements is based upon terms the Company investment established at the time we acquired our remaining 20% believes to be conducted at arm’s length. Our purchase commitments with of Xerox Limited from The Rank Group plc. Fuji Xerox are in the normal course of business and typically have a lead Equity in net income of Fuji Xerox is affected by certain adjustments to time of three months. In addition, we pay Fuji Xerox and they pay us for reflect the deferral of profit associated with intercompany sales. These unique research and development costs. adjustments may result in recorded equity income that is different than Transactions with Fuji Xerox for the three years ended December 31, that implied by our 25% ownership interest. Equity income for 2010 and 2010 were as follows: 2009 includes after-tax restructuring charges of $38 and $46, respectively, 2010 2009 2008 primarily reflecting employee-related costs as part of Fuji Xerox’s continued cost-reduction actions to improve its competitive position. Dividends received from Fuji Xerox $ 36 $ 10 $ 56 Condensed financial data of Fuji Xerox for the three calendar years Royalty revenue earned 116 106 112 ended December 31, 2010 was as follows: Inventory purchases from 2010 2009 2008 Fuji Xerox 2,098 1,590 2,150 Summary of Operations Inventory sales to Fuji Xerox 147 133 162 Revenues $ 11,276 $ 9,998 $11,190 R&D payments received from Costs and expenses 10,659 9,781 10,451 Fuji Xerox 1 3 5 R&D payments paid to Fuji Xerox 30 33 34 Income before income taxes 617 217 739 Income tax expense 291 67 287 As of December 31, 2010 and 2009, net amounts due to Fuji Xerox were Net Income 326 150 452 $109 and $114, respectively. Less: Net income – noncontrolling interests 5 1 7 Net Income – Fuji Xerox $ 321 $ 149 $ 445 Balance Sheet Assets: Current assets $ 4,884 $ 4,111 $ 4,734 Long-term assets 5,978 5,457 5,470 Total Assets $ 10,862 $ 9,568 $10,204 Liabilities and Equity: Current liabilities $ 3,534 $ 2,643 $ 3,534 Long-term debt 1,260 1,368 996 Other long-term liabilities 707 1,104 1,095 Noncontrolling interests 22 19 23 Fuji Xerox shareholders’ equity 5,339 4,434 4,556 Total Liabilities and Equity $ 10,862 $ 9,568 $10,204 76 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 8 – Goodwill and Intangible Assets, Net Goodwill In 2010, as a result of our acquisition of ACS, we realigned our internal reporting structure (see Note 2 – Segments for additional information). Our December 31, 2010 goodwill balance was reallocated to properly reflect our new segments and to align goodwill to the reporting units benefiting from the synergies of our acquisitions. The following table presents the changes in the carrying amount of goodwill, by reportable segment, for the three years ended December 31, 2010: Technology Services Other Total Balance at December 31, 2007 $ 2,317 $ 1,122 $ 9 $ 3,448 Foreign currency translation (200) (193) (2) (395) Acquisition of Veenman B.V. 44 — — 44 GIS acquisitions 73 — — 73 Purchase price allocation adjustment – GIS 12 — — 12 Balance at December 31, 2008 $ 2,246 $ 929 $ 7 $ 3,182 Foreign currency translation 61 60 1 122 GIS acquisitions 118 — — 118 Balance at December 31, 2009 $ 2,425 $ 989 $ 8 $ 3,422 Foreign currency translation (25) (22) — (47) Acquisition of Affiliated Computer Services, Inc. (“ACS”) — 5,127 — 5,127 ACS acquisitions — 124 — 124 GIS acquisitions 11 — — 11 Acquisition of Irish Business Systems, Ltd. 14 — — 14 Other — (2) — (2) Balance at December 31, 2010 $ 2,425 $ 6,216 $ 8 $ 8,649 Intangible Assets, Net Intangible assets primarily relate to the Services operating segment. Intangible assets were comprised of the following as of December 31, 2010 and 2009: December 31, 2010 December 31, 2009 Weighted Average Gross Gross Amortization Carrying Accumulated Net Carrying Accumulated Net Period Amount Amortization Amount Amount Amortization Amount Customer base 12 years $ 3,487 $ 464 $ 3,023 $ 525 $ 198 $ 327 Distribution network 25 years 123 54 69 123 49 74 Trademarks(1) 15 years 325 59 266 210 25 185 Technology, patents and non-compete(1) 6 years 47 34 13 40 28 12 Total Intangible Assets $ 3,982 $611 $ 3,371 $ 898 $ 300 $ 598 (1) Includes $10 and $5 of non-amortizable assets within trademarks and technology, respectively, related to the 2010 acquisition of ACS. Amortization expense related to intangible assets was $316, $64 and $58 for the years ended December 31, 2010, 2009 and 2008, respectively. Excluding the impact of additional acquisitions, amortization expense is expected to approximate $345 in 2011, $335 in 2012 and 2013, and $312 in 2014 and 2015. Xerox 2010 Annual Report 77


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 9 – Restructuring and Asset Impairment Charges The net restructuring and asset impairment charges (credits) in the Consolidated Statements of Income totaled $483, $(8) and $429 in 2010, 2009 and 2008, respectively. Detailed information related to restructuring program activity during the three years ended December 31, 2010 is outlined below: Lease Severance and Cancellation and Asset Restructuring Activity Related Costs Other Costs Impairments(1) Total Balance December 31, 2007 $ 71 $ 38 $ — $ 109 Restructuring provision 363 20 53 436 Reversals of prior accruals (6) (1) — (7) Net current year charges(2) 357 19 53 429 Charges against reserve and currency (108) (25) (53) (186) Balance December 31, 2008 320 32 — 352 Restructuring provision 28 9 — 37 Reversals of prior accruals (39) (6) — (45) Net current year charges(2) (11) 3 — (8) Charges against reserve and currency (255) (15) — (270) Balance December 31, 2009 54 20 — 74 Restructuring provision 470 28 26 524 Reversals of prior accruals (32) (9) — (41) Net current year charges(2) 438 19 26 483 Charges against reserve and currency (194) (14) (26) (234) Balance December 31, 2010 $ 298 $ 25 $ — $ 323 (1) Charges associated with asset impairments represent the write-down of the related assets to their new cost basis and are recorded concurrently with the recognition of the provision. (2) Represents amount recognized within the Consolidated Statements of Income for the years shown. The following table summarizes the reconciliation to the Consolidated Over the past several years, we have engaged in a series of restructuring Statements of Cash Flows for the three years ended December 31, 2010: programs related to downsizing our employee base, exiting certain 2010 2009 2008 activities, outsourcing certain internal functions and engaging in other actions designed to reduce our cost structure and improve productivity. Charges to reserve $ (234) $ (270) $ (186) These initiatives primarily include severance actions and impact all Asset impairments 26 — 53 major geographies and segments. Management continues to evaluate Effects of foreign currency and our business and, therefore, in future years, there may be additional other non-cash items (5) — 2 provisions for new plan initiatives, as well as changes in estimates to Cash Payments for amounts previously recorded, as payments are made or actions are Restructurings $ (213) $ (270) $ (131) completed. However, we do not expect that there will be significant new restructuring initiatives in 2011. Asset impairment charges were also The following table summarizes the total amount of costs incurred in incurred in connection with these restructuring actions for those assets connection with these restructuring programs by segment for the three made obsolete as a result of these programs. years ended December 31, 2010: 2010 2009 2008 Technology $ 325 $(5) $ 288 Services 104 (2) 85 Other 54 (1) 56 Total Net Restructuring Charges $ 483 $(8) $ 429 78 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. 2010 Activity In addition, related to these activities, we also recorded lease cancellation During 2010, we recorded $483 of net restructuring and asset and other costs of $19 and asset impairment charges of $53. The lease impairment charges, which included the following: termination and asset impairment charges primarily related to: (i) the relocation of certain manufacturing operations including the closing of our • $470 of severance costs related to headcount reductions of toner plant in Oklahoma City and the consolidation of our manufacturing approximately 9,000 employees. The costs associated with these operations in Ireland; and (ii) the exit from certain leased and owned actions applied about equally to North America and Europe, with facilities as a result of the actions noted above. approximately 20% related to our developing market countries. Approximately 50% of the costs were focused on gross margin improvements, 40% on SAG and 10% on the optimization of RD&E Note 10 – Supplementary Financial Information investments and impacted the following functional areas: The components of other current assets and other current liabilities at – Services December 31, 2010 and 2009 were as follows: – Supply chain and manufacturing 2010 2009 – Back-office administration Other Current Assets – Development and engineering costs. Deferred taxes and income taxes receivable $ 345 $ 328 • $28 for lease termination costs primarily reflecting the continued Royalties, license fees and software rationalization and optimization of our worldwide operating locations, maintenance 155 23 particularly in light of our recent acquisition of ACS. Restricted cash 91 31 Prepaid expenses 133 86 • $19 loss associated with the sale of our Venezuelan subsidiary. The Derivative instruments 45 16 loss primarily reflects the write-off of our Venezuelan net assets Deferred purchase price from sale including working capital and long-lived assets. We will continue to of receivables 90 — sell equipment, parts and supplies to the acquiring company through Advances and deposits 23 19 a distribution arrangement but will no longer have any direct or local Other 244 205 operations in Venezuela. The sale of our operations and change in business model follows a decision by management in the fourth Total Other Current Assets $ 1,126 $ 708 quarter of 2010 to reduce the Company’s future exposure and risk Other Current Liabilities associated with operating in this unpredictable economy. Deferred taxes and income taxes payable $ 59 $ 68 Other taxes payable 177 161 The above charges were partially offset by $41 of net reversals for Interest payable 122 114 changes in estimated reserves from prior period initiatives. Restructuring reserves 309 64 The restructuring reserve balance as of December 31, 2010 for all Derivative instruments 19 15 programs was $323, of which approximately $309 is expected to be Product warranties 17 19 spent over the next 12 months. Dividends payable 74 41 Distributor and reseller rebates/commissions 105 127 2009 Activity Other 925 517 Restructuring activity was minimal in 2009 and the related charges primarily reflected changes in estimates in severance costs from Total Other Current Liabilities $ 1,807 $ 1,126 previously recorded actions. 2008 Activity During 2008, we recorded $357 of net restructuring charges predominantly consisting of severance and costs related to the elimination of approximately 4,900 positions primarily in both North America and Europe. Focus areas for the actions include the following: • Improving efficiency and effectiveness of infrastructure including: marketing, finance, human resources and training • Capturing efficiencies in technical services, managed services, and supply chain and manufacturing infrastructure • Optimizing product development and engineering resources. Xerox 2010 Annual Report 79


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The components of other long-term assets and other long-term liabilities Long-term debt at December 31, 2010 and 2009 was as follows: at December 31, 2010 and 2009 were as follows: Weighted Average 2010 2009 Interest Rates at December 31, 2010(2) 2010 2009 Other Long-term Assets Prepaid pension costs $ 92 $ 155 Xerox Corporation Net investment in discontinued operations(1) 224 240 Senior Notes due 2010 —% $ — $ 700 Internal use software, net 468 354 Notes due 2011 0.09% 1 1 Product software, net 145 10 Notes due 2011 —% — 50 Restricted cash 280 258 Senior Notes due 2011 6.59% 750 750 Debt issuance costs, net 42 62 Senior Notes due 2012 5.59% 1,100 1,100 Customer contract costs, net 134 — Senior Notes due 2013 5.65% 400 400 Derivative instruments 11 10 Senior Notes due 2013 —% — 550 Other 378 231 Convertible Notes due 2014 9.00% 19 19 Senior Notes due 2014 8.25% 750 750 Total Other Long-term Assets $ 1,774 $ 1,320 Senior Notes due 2015 4.29% 1,000 1,000 Other Long-term Liabilities Notes due 2016 7.20% 250 250 Deferred and other tax liabilities $ 200 $ 167 Senior Notes due 2016 6.48% 700 700 Derivative instruments — 9 Senior Notes due 2017 6.83% 500 500 Environmental reserves 20 23 Senior Notes due 2018 6.37% 1,000 1,000 Unearned income 36 — Senior Notes due 2019 5.66% 650 650 Restructuring reserves 14 10 Zero Coupon Notes due 2023 5.41% 283 267 Other 527 363 Senior Notes due 2039 6.78% 350 350 Total Other Long-term Liabilities $ 797 $ 572 Subtotal $ 7,753 $ 9,037 (1) At December 31, 2010, our net investment in discontinued operations primarily Xerox Credit Corporation consists of a $245 performance-based instrument relating to the 1997 sale of Notes due 2013 —% — 10 The Resolution Group (“TRG”) net of remaining net liabilities associated with our Notes due 2014 —% — 50 discontinued operations of $21. The recovery of the performance-based instrument is dependent on the sufficiency of TRG’s available cash flows, as guaranteed by TRG’s Subtotal — 60 ultimate parent, which are expected to be recovered in annual cash distributions through 2017. ACS Notes due 2015 4.25% 250 — Borrowings secured by other assets 6.62% 71 — Note 11 – Debt Subtotal 321 — Short-term borrowings at December 31, 2010 and 2009 were as follows: Other U.S. Operations 2010 2009 Borrowings secured by Commercial paper $ 300 $ — finance receivables —% — 2 Current maturities of long-term debt 1,070 988 Borrowings secured by Total Short-term Debt $ 1,370 $ 988 other assets 12.39% 4 5 Subtotal 4 7 The weighted-average interest rate for commercial paper at December Total U.S. Operations 8,078 9,104 31, 2010, including issuance costs, was 1.02% and had maturities International Operations ranging from 18 to 32 days. Other debt due 2011–2013 0.86% 2 18 We classify our debt based on the contractual maturity dates of the Total International Operations 2 18 underlying debt instruments or as of the earliest put date available to Principal Debt Balance 8,080 9,122 the debt holders. We defer costs associated with debt issuance over the Unamortized discount (1) (11) applicable term, or to the first put date in the case of convertible debt or Fair value adjustments(1) 228 153 debt with a put feature. These costs are amortized as interest expense in Less: current maturities (1,070) (988) our Consolidated Statements of Income. Total Long-term Debt $ 7,237 $ 8,276 (1) Fair value adjustments represent changes in the fair value of hedged debt obligations attributable to movements in benchmark interest rates. Hedge accounting requires hedged debt instruments to be reported at an amount equal to the sum of their carrying value (principal value plus/minus premiums/discounts) and any fair value adjustment. (2) Represents weighted average effective interest rate which includes the effect of discounts and premiums on issued debt. 80 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Scheduled principal payments due on our long-term debt for the next The Credit Facility also contains various events of default, the five years and thereafter are as follows: occurrence of which could result in a termination by the lenders and the 2011 2012 2013 2014 2015 Thereafter Total acceleration of all our obligations under the Credit Facility. These events (1) of default include, without limitation: (i) payment defaults, (ii) breaches $1,070 $1,126 $412 $771 $1,251 $3,450 $8,080 of covenants under the Credit Facility (certain of which breaches do not (1) Quarterly total debt maturities for 2011 are $11, $9, $1,041 and $9 for the first, have any grace period), (iii) cross-defaults and acceleration to certain of second, third and fourth quarters, respectively. our other obligations and (iv) a change of control of Xerox. Commercial Paper Capital Market Activity In October 2010, Xerox’s Board of Directors authorized the company During 2010, we redeemed the following Notes prior to their to issue commercial paper (“CP”). Aggregate CP and Credit Facility scheduled maturity: borrowings may not exceed $2 billion outstanding at any time. Under the company’s current private placement CP program, we may issue • 7.625% Senior Notes due in 2013 for $550; CP up to a maximum amount of $1.0 billion outstanding at any time. • 6.00% Medium-term Notes due 2011 for $25; The maturities of the CP Notes will vary, but may not exceed 390 days • 7.41% Medium-term Notes due 2011 for $25; from the date of issue. The CP Notes are sold at a discount from par or, • 6.50% Medium-term Notes due 2013 for $10; alternatively, sold at par and bear interest at market rates. • 6.00% Medium-term Notes due 2014 for $25; and Credit Facility • 6.125% Medium-term Notes due 2014 for $25. The Credit Facility is a $2.0 billion unsecured revolving credit facility including a $300 letter of credit subfacility. At December 31, 2010 we We incurred a loss on extinguishment of approximately $16, had no outstanding borrowings or letters of credit. Approximately $1.8 representing the call premium of approximately $7 on the Senior billion, or 90% of the Credit Facility, has a maturity date of April 30, Notes as well as the write-off of unamortized debt costs of $9. 2013. The remaining portion of the Credit Facility has a maturity date Interest of April 30, 2012. Interest paid on our short-term debt, long-term debt and liability The Credit Facility is available, without sublimit, to certain of our to subsidiary trust issuing preferred securities amounted to $586, qualifying subsidiaries and includes provisions that would allow us $531 and $527 for the years ended December 31, 2010, 2009 and to increase the overall size of the Credit Facility up to an aggregate 2008, respectively. amount of $2.5 billion. Our obligations under the Credit Facility are Interest expense and interest income for the three years ended unsecured and are not currently guaranteed by any of our subsidiaries. December 31, 2010 was as follows: Any domestic subsidiary that guarantees more than $100 of Xerox 2010 2009 2008 Corporation debt must also guaranty our obligations under the Credit Facility. In the event that any of our subsidiaries borrows under the Interest expense(1) $ 592 $ 527 $ 567 Credit Facility, its borrowings thereunder would be guaranteed by us. Interest income(2) 679 734 833 (1) Borrowings under the Credit Facility bear interest at our choice, at either Includes Equipment financing interest expense, as well as non-financing interest expense included in Other expenses, net in the Consolidated Statements of Income. (a) a Base Rate as defined in our Credit Facility agreement, plus an all-in (2) Includes Finance income, as well as other interest income that is included in Other spread that varies between 1.5% and 3.5% depending on our credit expenses, net in the Consolidated Statements of Income. rating at the time of borrowing, or (b) LIBOR plus an all-in spread that varies between 2.5% and 4.5% depending on our credit rating at the Equipment financing interest is determined based on an estimated time of borrowing. Based on our credit rating as of December 31, 2010, cost of funds, applied against the estimated level of debt required to the applicable all-in spreads for the Base Rate and LIBOR borrowing were support our net finance receivables. The estimated cost of funds is 2.5% and 3.5%, respectively. based on our overall corporate cost of borrowing adjusted to reflect a rate that would be paid by a typical BBB rated leasing company. The The Credit Facility contains various conditions to borrowing and estimated level of debt is based on an assumed 7 to 1 leverage ratio affirmative, negative and financial maintenance covenants. Certain of of debt/equity as compared to our average finance receivable balance the more significant covenants are summarized below: during the applicable period. (a) Maximum leverage ratio (a quarterly test that is calculated as principal debt divided by consolidated EBITDA, as defined) of 3.75x (b) Minimum interest coverage ratio (a quarterly test that is calculated as consolidated EBITDA divided by consolidated interest expense) may not be less than 3.00x (c) Limitations on (i) liens of Xerox and certain of our subsidiaries securing debt, (ii) certain fundamental changes to corporate structure, (iii) changes in nature of business and (iv) limitations on debt incurred by certain subsidiaries Xerox 2010 Annual Report 81


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Net (payments) proceeds on debt other than secured borrowings as Note 13 – Financial Instruments shown on the Consolidated Statements of Cash Flows for the three years ended December 31, 2010 was as follows: We are exposed to market risk from changes in foreign currency exchange rates and interest rates, which could affect operating results, 2010 2009 2008 financial position and cash flows. We manage our exposure to these Net proceeds (payments) on market risks through our regular operating and financing activities and, short-term debt $ 300 $ (61) $ (38) when appropriate, through the use of derivative financial instruments. Net payments on Credit Facility — (246) (354) These derivative financial instruments are utilized to hedge economic Net proceeds from issuance of exposures, as well as to reduce earnings and cash flow volatility resulting long-term debt — 2,725 1,650 from shifts in market rates. We enter into limited types of derivative Net payments on long-term debt (3,357) (1,495) (332) contracts, including interest rate swap agreements, foreign currency spot, Net (Payments) Proceeds on forward and swap contracts and net purchased foreign currency options Other Debt $ (3,057) $ 923 $ 926 to manage interest rate and foreign currency exposures. Our primary foreign currency market exposures include the Japanese Yen, Euro and U.K. Pound Sterling. The fair market values of all our derivative contracts Note 12 – Liability to Subsidiary Trust Issuing change with fluctuations in interest rates and/or currency exchange Preferred Securities rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial The Liability to Subsidiary Trust Issuing Preferred Securities included in instruments are held solely as risk management tools and not for trading our Consolidated Balance Sheets of $650 and $649 as of December 31, or speculative purposes. The related cash flow impacts of all of our 2010 and 2009, respectively, reflects our obligations to Xerox Capital derivative activities are reflected as cash flows from operating activities. Trust I (“Trust I”) as a result of their loans to us from proceeds related to their issuance of preferred securities. This subsidiary is not consolidated We do not believe there is significant risk of loss in the event of non- in our financial statements because we are not the primary beneficiary performance by the counterparties associated with our derivative of the trust. instruments because these transactions are executed with a diversified group of major financial institutions. Further, our policy is to deal with In 1997, Trust I issued 650 thousand of 8.0% preferred securities (the counterparties having a minimum investment grade or better credit “Preferred Securities”) to investors for $644 ($650 liquidation value) and rating. Credit risk is managed through the continuous monitoring of 20,103 shares of common securities to us for $20. With the proceeds exposures to such counterparties. from these securities, Trust I purchased $670 principal amount of 8.0% Junior Subordinated Debentures due 2027 of the Company Interest Rate Risk Management (“the Debentures”). The Debentures represent all of the assets of We use interest rate swap agreements to manage our interest rate Trust I. On a consolidated basis, we received net proceeds of $637 exposure and to achieve a desired proportion of variable and fixed rate which was net of fees and discounts of $13. Interest expense, together debt. These derivatives may be designated as fair value hedges or cash with the amortization of debt issuance costs and discounts, was $54 in flow hedges depending on the nature of the risk being hedged. 2010, 2009 and 2008. We have guaranteed, on a subordinated basis, distributions and other payments due on the Preferred Securities. The Fair Value Hedges guarantee, our obligations under the Debentures, the indenture pursuant As of December 31, 2010 and 2009, pay variable/receive fixed interest to which the Debentures were issued and our obligations under the rate swaps with notional amounts of $950 and $2,350 and net asset fair Amended and Restated Declaration of Trust governing the trust, taken value of $11 and $1, respectively, were designated and accounted for as together, provide a full and unconditional guarantee of amounts due fair value hedges. No ineffective portion was recorded to earnings during on the Preferred Securities. The Preferred Securities accrue and pay 2010, 2009 or 2008. cash distributions semiannually at a rate of 8% per year of the stated liquidation amount of one thousand dollars per Preferred Security. The Preferred Securities are mandatorily redeemable upon the maturity of the Debentures on February 1, 2027, or earlier to the extent of any redemption by us of any Debentures. The redemption price in either such case will be one thousand dollars per share plus accrued and unpaid distributions to the date fixed for redemption. 82 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following is a summary of our fair value hedges at December 31, 2010: Year First Weighted Designated Notional Net Fair Average Interest Interest Debt Instrument as Hedge Amount Value Rate Paid Rate Received Basis Maturity Senior Notes due 2013 2010 $ 400 $— 4.71% 5.65% LIBOR 2013 Senior Notes due 2014 2009 450 10 6.19% 8.25% LIBOR 2014 Senior Notes due 2016 2010 100 1 3.96% 6.40% LIBOR 2016 Total Fair Value Hedges $ 950 $11 Terminated Swaps The following is a summary of the primary hedging positions and During the period from 2004 to 2010, we terminated early several corresponding fair values held as of December 31, 2010: interest rate swaps that were designated as fair value hedges of certain Gross Fair Value debt instruments. The associated net fair value adjustments to the debt Notional Asset instruments are being amortized to interest expense over the remaining Currency Hedged (Buy/Sell) Value (Liability)(1) term of the related notes. In 2010, 2009 and 2008, the amortization U.K. Pound Sterling/Euro $ 217 $ (1) of these fair value adjustments reduced interest expense by $28, $17 Euro/U.S. Dollar 370 (3) and $12, respectively, and we expect to record a net decrease in interest U.S. Dollar/Euro 585 9 expense of $199 in future years through 2027. Swedish Kronor/Euro 93 2 Foreign Exchange Risk Management Swiss Franc/Euro 194 8 Japanese Yen/U.S. Dollar 397 8 We are exposed to foreign currency exchange rate fluctuations in Japanese Yen/Euro 367 11 the normal course of business. As a part of our foreign exchange risk Euro/U.K. Pound Sterling 211 1 management strategy, we use derivative instruments, primarily forward U.K. Pound Sterling/Swiss Franc 74 (7) contracts and purchase option contracts, to hedge the following Danish Krone/Euro 57 — foreign currency exposures, thereby reducing volatility of earnings and Mexican Peso/U.S. Dollar 52 — protecting fair values of assets and liabilities: All Other 351 (2) • Foreign currency-denominated assets and liabilities Total Foreign Exchange Hedging $ 2,968 $ 26 • Forecasted purchases and sales in foreign currency (1) Represents the net receivable (payable) amount included in the Consolidated Balance Sheet at December 31, 2010. Summary of Foreign Exchange Hedging Positions At December 31, 2010, we had outstanding forward exchange and Foreign Currency Cash Flow Hedges purchased option contracts with gross notional values of $2,968 which We designate a portion of our foreign currency derivative contracts is reflective of the amounts that are normally outstanding at any point as cash flow hedges of our foreign currency-denominated inventory during the year. These contracts generally mature in 12 months or less. purchases, sales and expenses. No amount of ineffectiveness was recorded in the Consolidated Statements of Income for these designated cash flow hedges and all components of each derivative’s gain or loss was included in the assessment of hedge effectiveness. As of December 31, 2010, the net asset fair value of these contracts was $18. Xerox 2010 Annual Report 83


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Summary of Derivative Instruments Fair Values The following table provides a summary of the fair value amounts of derivative instruments at December 31, 2010 and 2009, respectively. Fair Value Designation of Derivatives Balance Sheet Location 2010 2009 Derivatives Designated as Hedging Instruments Foreign exchange contracts – forwards Other current assets $ 19 $ 4 Other current liabilities (1) (3) Interest rate swaps Other long-term assets 11 10 Other long-term liabilities — (9) Net Designated Assets $ 29 $ 2 Derivatives NOT Designated as Hedging Instruments Foreign exchange contracts – forwards Other current assets $ 26 $ 12 Other current liabilities (18) (12) Net Undesignated Assets $ 8 $— Summary of Derivatives Total Derivative Assets $ 56 $ 26 Total Derivative Liabilities (19) (24) Net Derivative Asset $ 37 $ 2 Summary of Derivative Instruments Gains (Losses) Designated Derivative Instruments Gains (Losses) The following table provides a summary of the gains and losses Derivative gains and losses affect the income statement based on on designated derivative instruments for the three years ended whether such derivatives are designated as hedges of underlying December 31, 2010: exposures. The following is a summary of derivative gains and losses. Derivative Gain (Loss) Hedged Item Gain (Loss) Location of Gain Recognized in Income Recognized in Income Derivatives in Fair Value (Loss) Recognized Hedging Relationships in Income 2010 2009 2008 2010 2009 2008 Interest rate contracts Interest expense $99 $(18) $206 $(99) $18 $(206) Derivative Gain (Loss) Location of Gain (Loss) Derivative Gain (Loss) Recognized in OCI Reclassified from AOCI Reclassified from (Effective Portion) to Income (Effective Portion) Derivatives in Cash Flow AOCI into Income Hedging Relationships 2010 2009 2008 (Effective Portion) 2010 2009 2008 Interest rate contracts $ — $— $ (2) Interest expense $— $— $— Foreign exchange contracts – forwards 46 (1) 4 Cost of sales 28 2 2 Total Cash Flow Hedges $ 46 $ (1) $ 2 $28 $ 2 $ 2 No amount of ineffectiveness was recorded in the Consolidated Statements of Income for these designated cash flow hedges and all components of each derivative’s gain or loss was included in the assessment of hedge effectiveness. 84 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Non-Designated Derivative Instruments Gains (Losses) Non-designated derivative instruments are primarily instruments used to hedge foreign currency-denominated assets and liabilities. They are not designated as hedges because there is a natural offset for the re-measurement of the underlying foreign currency-denominated asset or liability. The following table provides a summary of gains (losses) on non-designated derivative instruments for the three years ended December 31, 2010: Derivatives NOT Designated as Hedging Instruments Location of Derivative Gain (Loss) 2010 2009 2008 Foreign exchange contracts Other expense – Currency losses, net $113 $49 $(147) During the three years ended December 31, 2010, we recorded Accumulated Other Comprehensive Loss (“AOCL”) total Currency losses, net of $11, $26 and $34, respectively. Currency The following table provides a summary of the activity associated losses, net includes the mark-to-market of the derivatives not designated with all of our designated cash flow hedges (interest rate and as hedging instruments and the related cost of those derivatives, as foreign currency) reflected in AOCL for the three years ended well as the re-measurement of foreign currency-denominated assets December 31, 2010: and liabilities. 2010 2009 2008 Beginning cash flow hedges balance, net of tax $ 1 $— $— Changes in fair value gain (loss) 31 (1) 1 Reclass to earnings (18) 2 (1) Ending Cash Flow Hedges Balance, Net of Tax $ 14 $ 1 $— Xerox 2010 Annual Report 85


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 14 – Fair Value of Financial Assets and Liabilities The following table represents our assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009 and the basis for that measurement: Total Quoted Prices in Significant Other Significant Fair Value Active Markets for Observable Unobservable Measurement Identical Asset Inputs Inputs December 31, 2010 (Level 1) (Level 2) (Level 3) Assets: Foreign exchange contracts-forwards $ 45 $— $ 45 $— Interest rate swaps 11 — 11 — Deferred compensation investments in cash surrender life insurance 70 — 70 — Deferred compensation investments in mutual funds 22 — 22 — Total $ 148 $— $ 148 $— Liabilities: Foreign exchange contracts-forwards $ 19 $— $ 19 $— Deferred compensation plan liabilities 98 — 98 — Total $ 117 $— $ 117 $— Total Quoted Prices in Significant Other Significant Fair Value Active Markets for Observable Unobservable Measurement Identical Asset Inputs Inputs December 31, 2009 (Level 1) (Level 2) (Level 3) Assets: Foreign exchange contracts – forwards $ 16 $— $ 16 $— Interest rate swaps 10 — 10 — Total $ 26 $— $ 26 $— Liabilities: Foreign exchange contracts – forwards $ 15 $— $ 15 $— Interest rate swaps 9 — 9 — Total $ 24 $— $ 24 $— We utilized the income approach to measure fair value for our derivative Summary of Other Financial Assets & Liabilities Not Measured assets and liabilities. The income approach uses pricing models that rely at Fair Value on a Recurring Basis on market observable inputs such as yield curves, currency exchange The estimated fair values of our other financial assets and liabilities not rates and forward prices, and therefore are classified as Level 2. measured at fair value on a recurring basis at December 31, 2010 and Fair value for our deferred compensation plan investments in Company- 2009 were as follows: owned life insurance is reflected at cash surrender value. Fair value for 2010 2009 our deferred compensation plan investments in mutual funds is based Carrying Fair Carrying Fair on quoted market prices for actively traded investments similar to those Amount Value Amount Value held by the plan. Fair value for deferred compensation plan liabilities Cash and cash is based on the fair value of investments corresponding to employees’ equivalents $ 1,211 $ 1,211 $ 3,799 $ 3,799 investment selections, based on quoted prices for similar assets in Accounts receivable, actively traded markets. net 2,826 2,826 1,702 1,702 Short-term debt 1,370 1,396 988 1,004 Long-term debt 7,237 7,742 8,276 8,569 Liability to subsidiary trust issuing preferred securities 650 670 649 663 86 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The fair value amounts for Cash and cash equivalents and Accounts Note 15 – Employee Benefit Plans receivable, net approximate carrying amounts due to the short maturities of these instruments. The fair value of Short- and Long- We sponsor numerous pension and other post-retirement benefit plans, term debt, as well as our Liability to subsidiary trust issuing preferred primarily retiree health, in our domestic and international operations. securities, was estimated based on quoted market prices for publicly December 31 is the measurement date for all of our other post- traded securities or on the current rates offered to us for debt of similar retirement benefit plans. maturities. The difference between the fair value and the carrying value represents the theoretical net premium or discount we would pay or receive to retire all debt at such date. Pension Benefits Retiree Health 2010 2009 2010 2009 Change in Benefit Obligation: Benefit obligation, January 1 $ 9,194 $ 8,495 $ 1,102 $ 1,002 Service cost 178 173 8 7 Interest cost 575 508 54 60 Plan participants’ contributions 11 9 26 36 Plan amendments(3) (19) 4 (86) 1 Actuarial loss (gain) 477 209 13 124 Acquisitions(2) 140 1 1 — Currency exchange rate changes (154) 373 6 15 Curtailments (1) — — — Benefits paid/settlements (670) (578) (118) (143) Benefit obligation, December 31 9,731 9,194 1,006 1,102 Change in Plan Assets: Fair value of plan assets, January 1 7,561 6,923 — — Actual return on plan assets 846 720 — — Employer contribution 237 122 92 107 Plan participants’ contributions 11 9 26 36 Acquisitions(3) 107 — — — Currency exchange rate changes (144) 349 — — Benefits paid/settlements (669) (578) (118) (143) Other (9) 16 — — Fair value of plan assets, December 31 7,940 7,561 — — Net funded status at December 31(1) $ (1,791) $ (1,633) $ (1,006) $ (1,102) Amounts recognized in the Consolidated Balance Sheets: Other long-term assets $ 92 $ 155 $ — $ — Accrued compensation and benefit costs (44) (47) (86) (103) Pension and other benefit liabilities (1,839) (1,741) — — Post-retirement medical benefits — — (920) (999) Net Amounts Recognized $ (1,791) $ (1,633) $ (1,006) $ (1,102) (1) Includes under-funded and non-funded plans. (2) Primarily ACS’s acquired balances. (3) Refer to the “Plan Amendment” section for additional information. Xerox 2010 Annual Report 87


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Benefit plans pre-tax amounts recognized in AOCL: Aggregate information for pension plans with an Accumulated benefit Pension Benefits Retiree Health obligation in excess of plan assets is presented below: 2010 2009 2010 2009 2010 2009 Net actuarial loss Projected benefit obligation $ 5,726 $ 5,134 (gain) $ 1,867 $ 1,834 $ 54 $ 40 Accumulated benefit obligation 5,533 4,864 Prior service (credit) Fair value of plan assets 3,883 3,697 cost (167) (169) (200) (144) Our domestic retirement defined benefit plans provide employees Total Pre-tax Loss a benefit, depending on eligibility, at the greater of (i) the benefit (Gain) $ 1,700 $ 1,665 $(146) $ (104) calculated under a highest average pay and years of service formula, (ii) the benefit calculated under a formula that provides for the The Accumulated benefit obligation for all defined benefit pension plans accumulation of salary and interest credits during an employee’s work was $9,256 and $8,337 at December 31, 2010 and 2009, respectively. life, or (iii) the individual account balance from the Company’s prior defined contribution plan (Transitional Retirement Account or TRA). Pension Benefits Retiree Health 2010 2009 2008 2010 2009 2008 Components of Net Periodic Benefit Cost: Service cost $ 178 $ 173 $ 209 $ 8 $ 7 $ 14 Interest cost(1) 575 508 (5) 54 60 84 Expected return on plan assets(2) (570) (523) (80) — — — Recognized net actuarial loss 71 25 36 — — — Amortization of prior service credit (22) (21) (20) (30) (41) (21) Recognized settlement loss 72 70 34 — — — Defined Benefit Plans 304 232 174 32 26 77 Defined contribution plans 51 38 80 — — — Total Net Periodic Benefit Costs 355 270 254 32 26 77 Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income: Net actuarial loss (gain)(3) $ 198 $ 8 $ 1,062 $ 13 $ 126 $ (244) Prior service cost (credit)(4) (19) — 1 (86) 1 (219) Amortization of net actuarial (loss) gain (143) (95) (70) — — — Amortization of prior service (cost) credit 22 21 20 30 41 21 Total Recognized in Other Comprehensive Income 58 (66) 1,013 (43) 168 (442) Total Recognized in Net Periodic Benefit Cost and Other Comprehensive Income $ 413 $ 204 $ 1,267 $ (11) $ 194 $ (365) (1) Interest cost includes interest expense on non-TRA obligations of $381, $390 and $408 and interest expense (income) directly allocated to TRA participant accounts of $194, $118 and $(413) for the years ended December 31, 2010, 2009 and 2008, respectively. (2) Expected return on plan assets includes expected investment income on non-TRA assets of $376, $405 and $493 and actual investment income (expense) on TRA assets of $194, $118 and $(413) for the years ended December 31, 2010, 2009 and 2008, respectively. (3) Includes adjustments as a result of the plan amendments as well as the actual valuation results based on January 1, 2010 plan census data for the U.S. and Canadian defined benefit plans and the U.S. retiree medical plan. Refer to the “Plan Amendment” section for additional information. (4) Refer to “Plan Amendments” for additional information. 88 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following table provides a summary of the components of the Net Plan Amendments change in benefit plans included within Other comprehensive income as In 2010, we amended our domestic retiree health benefit plan to reported in the Consolidated Statement of Shareholders’ Equity. eliminate the use of the Retiree Drug Subsidy that the Company receives (Expense)/Benefit 2010 2009 2008 from Medicare as an offset to retiree contributions. This amendment Other changes in plan assets and is effective January 1, 2011. The Company will instead use this subsidy benefit obligations $ (15) $ (102) $ (571) to reduce its retiree healthcare costs. The amendment resulted in a Income tax (12) 61 183 net decrease of $55 to the retiree medical benefit obligation and a Fuji Xerox changes in defined corresponding $34 after-tax increase to equity. This amendment will benefit plans(1) 28 (36) (75) reduce 2011 expenses by approximately $13. Currency, net(2) 22 (90) 175 In 2010, as a result of a renegotiation of the contract with our Other, net — (2) 2 largest union, we amended our union pension plan for this population Net Change in Benefit Plans $ 23 $ (169) $ (286) to freeze the final average pay formula of the pension plan effective (1) Represents our share of Fuji Xerox’s benefit plan changes. January 1, 2013 and our union retiree health benefits plan to eliminate (2) Represents currency impact on cumulative amount of benefit plan net actuarial losses a portion of the subsidy currently paid to current and future Medicare- and prior service credits included in AOCL. eligible retirees effective January 1, 2011. These amendments are The net actuarial loss and prior service credit for the defined benefit generally consistent with amendments previously made to our salaried pension plans that will be amortized from Accumulated other employee retirement plans. comprehensive loss into net periodic benefit cost over the next fiscal year In 2009, the U.K. Final Salary Pension Plan was amended to close the are $71 and $(24), respectively. The net actuarial loss and prior service plan to future accrual effective January 1, 2014. Benefits earned up to credit for the retiree health benefit plans that will be amortized from January 1, 2014 will not be affected; therefore, the amendment does Accumulated other comprehensive loss into net periodic benefit cost not result in a material change to the projected benefit obligation over the next fiscal year are zero and $(41), respectively. at the re-measurement date, December 31, 2009. The amendment Pension plan assets consist of both defined benefit plan assets and results in substantially all participants becoming inactive; therefore, the assets legally restricted to the TRA accounts. The combined investment amortization period for actuarial gains and losses changes from the results for these plans, along with the results for our other defined benefit average remaining service period of active members (approximately plans, are shown above in the “actual return on plan assets” caption. To 10 years) to the average remaining life expectancy of all members the extent that investment results relate to TRA, such results are charged (approximately 27 years). As of December 31, 2010, the accumulated directly to these accounts as a component of interest cost. actuarial losses for our U.K. plan amounted to $707. In 2008, we amended our domestic retiree health benefit plan to eliminate the subsidy currently paid to current and future Medicare- eligible retirees effective January 1, 2010. The amendment resulted in a net decrease of approximately $225 in the benefit obligation and a corresponding after-tax increase to equity. Xerox 2010 Annual Report 89


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Plan Assets Current Allocation As of the 2010 and 2009 measurement dates, the global pension plan assets were $7.9 billion and $7.6 billion, respectively. These assets were invested among several asset classes. None of the investments includes debt or equity securities of Xerox Corporation. The following table presents the defined benefit plans assets measured at fair value at December 31, 2010 and the basis for that measurement: Valuation Based on: Quoted Prices in Significant Other Significant Total Active Markets for Observable Unobservable Fair Value Identical Asset Inputs Inputs December 31, Asset Class (Level 1) (Level 2) (Level 3) 2010 % of Total Cash and Cash Equivalents $ 640 $ — $ — $ 640 8% Equity Securities: U.S. Large Cap 507 54 — 561 7% U.S. Mid Cap 84 — — 84 1% U.S. Small Cap 60 62 — 122 2% International Developed 1,513 514 — 2,027 26% Emerging Markets 324 — — 324 4% Global Equity 8 25 — 33 —% Total Equity Securities 2,496 655 — 3,151 40% Debt Securities: U.S. Treasury Securities 4 209 — 213 3% Debt Security Issued by Government Agency 75 1,011 — 1,086 14% Corporate Bonds 167 1,412 — 1,579 20% Asset-Backed Securities 2 15 — 17 —% Total Debt Securities 248 2,647 — 2,895 37% Common/Collective Trust 4 69 — 73 1% Derivatives: Interest Rate Contracts — 123 — 123 2% Foreign Exchange Contracts 5 (12) — (7) —% Equity Contracts — 53 — 53 —% Credit Contracts — — — — —% Other Contracts 66 3 — 69 1% Total Derivatives 71 167 — 238 3% Hedge Funds — 2 4 6 —% Real Estate 103 73 275 451 6% Private Equity/Venture Capital — — 308 308 4% Guaranteed Insurance Contracts — — 96 96 1% Other 7 49 (1) 55 —% Total Defined Benefit Plans Assets(1) $ 3,569 $ 3,662 $ 682 $ 7,913 100% (1) Total fair value assets exclude $27 of other net non-financial assets (liabilities) such as due to/from broker, interest receivables and accrued expenses. 90 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following table presents the defined benefit plans assets measured at fair value at December 31, 2009 and the basis for that measurement: Valuation Based on: Quoted Prices in Significant Other Significant Total Active Markets for Observable Unobservable Fair Value Identical Asset Inputs Inputs December 31, Asset Class (Level 1) (Level 2) (Level 3) 2009 % of Total Cash and Cash Equivalents $ 748 $ — $ — $ 748 10% Equity Securities: U.S. Large Cap 768 46 — 814 11% U.S. Mid Cap 31 — — 31 —% U.S. Small Cap 90 70 — 160 2% International Developed 1,292 493 — 1,785 24% Emerging Markets 299 — — 299 4% Global Equity 12 — — 12 —% Total Equity Securities 2,492 609 — 3,101 41% Debt Securities: U.S. Treasury Securities 4 185 — 189 3% Debt Security Issued by Government Agency 114 798 — 912 12% Corporate Bonds 145 1,570 — 1,715 23% Asset-Backed Securities 3 23 — 26 —% Total Debt Securities 266 2,576 — 2,842 38% Common/Collective Trust 2 26 — 28 —% Derivatives: Interest Rate Contracts — 52 — 52 —% Foreign Exchange Contracts 15 (77) — (62) (1)% Equity Contracts — (24) — (24) —% Credit Contracts — (2) — (2) —% Other Contracts — (6) — (6) —% Total Derivatives 15 (57) — (42) (1)% Hedge Funds — — 4 4 —% Real Estate 62 119 237 418 6% Private Equity/Venture Capital — — 286 286 4% Guaranteed Insurance Contracts — — 130 130 2% Other 8 9 — 17 —% Total Defined Benefit Plans Assets(1) $ 3,593 $ 3,282 $ 657 $ 7,532 100% (1) Total fair value assets exclude $29 of other net non-financial assets (liabilities) such as due to/from broker, interest receivables and accrued expenses. Xerox 2010 Annual Report 91


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following table represents a roll-forward of the defined benefit plans assets measured using significant unobservable inputs (Level 3 assets): Fair Value Measurement Using Significant Unobservable Inputs (Level 3) Private Guaranteed Equity/Venture Insurance Hedge Funds Real Estate Capital Contracts Other Total December 31, 2008 $ 3 $ 279 $ 331 $ 104 $— $ 717 Net payments, purchases and sales 1 5 16 1 — 23 Net transfers in (out) — — — 16 — 16 Realized gains (losses) — — 8 3 (1) 10 Unrealized gains (losses) — (66) (69) 2 1 (132) Currency translation — 19 — 4 — 23 December 31, 2009 4 237 286 130 — 657 Net payments, purchases and sales — 7 (8) (12) — (13) Net transfers in (out) — — — 1 — 1 Realized gains (losses) — 5 28 (2) — 31 Unrealized gains (losses) — 22 — (2) — 20 Currency translation — (6) — (9) — (15) Other — 10 1 (9) (1) 1 December 31, 2010 $ 4 $ 275 $307 $ 97 $ (1) $ 682 Our pension plan assets and benefit obligations at December 31, 2010 We employ a total return investment approach whereby a mix of were as follows: equities and fixed income investments are used to maximize the long- Fair Value of Pension Funded term return of plan assets for a prudent level of risk. The intent of this Pension Plan Benefit Status strategy is to minimize plan expenses by exceeding the interest growth (in billions) Assets Obligations Status in long-term plan liabilities. Risk tolerance is established through careful U.S. $ 3.2 $ 4.4 $ (1.2) consideration of plan liabilities, plan funded status and corporate U.K. 2.9 2.9 — financial condition. This consideration involves the use of long-term Canada 0.6 0.8 (0.2) measures that address both return and risk. The investment portfolio Other 1.2 1.6 (0.4) contains a diversified blend of equity and fixed income investments. Furthermore, equity investments are diversified across U.S. and non- Total $ 7.9 $ 9.7 $ (1.8) U.S. stocks, as well as growth, value and small and large capitalizations. Other assets such as real estate, private equity and hedge funds are Investment Strategy used to improve portfolio diversification. Derivatives may be used to The target asset allocations for our worldwide plans for 2010 and 2009 hedge market exposure in an efficient and timely manner; however, were: derivatives may not be used to leverage the portfolio beyond the market 2010 2009 value of the underlying investments. Investment risks and returns are Equity investments 42% 41% measured and monitored on an ongoing basis through annual liability Fixed income investments 45% 45% measurements and quarterly investment portfolio reviews. Real estate 7% 7% Expected Long-term Rate of Return Private equity 4% 4% We employ a “building block” approach in determining the long-term Other 2% 3% rate of return for plan assets. Historical markets are studied and long- Total Investment Strategy 100% 100% term relationships between equities and fixed income are assessed. Current market factors such as inflation and interest rates are evaluated before long-term capital market assumptions are determined. The long- term portfolio return is established giving consideration to investment diversification and rebalancing. Peer data and historical returns are reviewed periodically to assess reasonableness and appropriateness. 92 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Contributions Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as 2010 contributions for our defined benefit pension plans were $237 and appropriate, are expected to be paid during the following years: $92 for our retiree health plans. In 2011 we expect, based on current actuarial calculations, to make contributions of approximately $500 to Pension Retiree Benefits Health our defined benefit pension plans and approximately $90 to our retiree health benefit plans. 2011 $ 749 $ 87 2012 647 86 2013 644 85 2014 653 85 2015 668 84 Years 2016–2020 3,473 396 Assumptions Weighted-average assumptions used to determine benefit obligations at the plan measurement dates: Pension Benefits Retiree Health 2010 2009 2008 2010 2009 2008 Discount rate 5.2% 5.7% 6.3% 4.9% 5.4% 6.3% Rate of compensation increase 3.1% 3.6% 3.9% —(1) —(1) —(1) (1) Rate of compensation increase is not applicable to the retiree health benefits, as compensation levels do not impact earned benefits. Weighted-average assumptions used to determine net periodic benefit cost for years ended December 31: Pension Benefits Retiree Health 2011 2010 2009 2008 2011 2010 2009 2008 Discount rate 5.2% 5.7% 6.3% 5.9% 4.9% 5.4% 6.3% 6.2% Expected return on plan assets 7.2% 7.3% 7.4% 7.6% —(1) —(1) —(1) —(1) Rate of compensation increase 3.1% 3.6% 3.9% 4.1% —(2) —(2) —(2) —(2) (1) Expected return on plan assets is not applicable to retiree health benefits, as these plans are not funded. (2) Rate of compensation increase is not applicable to retiree health benefits, as compensation levels do not impact earned benefits. Assumed healthcare cost trend rates at December 31, Assumed healthcare cost trend rates have a significant effect on 2010 2009 the amounts reported for the healthcare plans. A 1-percentage- point change in assumed health care cost trend rates would have the Healthcare cost trend rate assumed for next year 9.0% 9.8% following effects: Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 4.9% 4.9% 1% increase 1% decrease Year that the rate reaches the ultimate trend rate 2017 2017 Effect on total service and interest cost components $ 6 $ (5) Effect on post-retirement benefit obligation 82 (68) Xerox 2010 Annual Report 93


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Note 16 – Income and Other Taxes On a consolidated basis, we paid a total of $49, $78 and $194 in income taxes to federal, foreign and state jurisdictions during the three years Income (loss) before income taxes for the three years ended December ended December 31, 2010, 2009 and 2008, respectively. 31, 2010 was as follows: Total income tax expense (benefit) for the three years ended December 2010 2009 2008 31, 2010 was allocated as follows: Domestic income (loss) $ 433 $ 45 $ (622) 2010 2009 2008 Foreign income 382 582 543 Pre-tax income $ 256 $ 152 $ (231) Income (Loss) Before Common shareholders’ equity: Income Taxes $ 815 $ 627 $ (79) Changes in defined benefit plans 12 (61) (183) Stock option and incentive Provisions (benefits) for income taxes for the three years ended plans, net (6) 21 (2) December 31, 2010 was as follows: Translation adjustments 2010 2009 2008 and other 11 (13) 10 Federal income taxes Total Income Tax Expense Current $ 153 $ (50) $ (26) (Benefit) $ 273 $ 99 $ (406) Deferred (17) 109 (285) Foreign income taxes Unrecognized Tax Benefits and Audit Resolutions Current 59 84 118 Due to the extensive geographical scope of our operations, we are Deferred 8 11 4 subject to ongoing tax examinations in numerous jurisdictions. State income taxes Accordingly, we may record incremental tax expense based upon Current 46 (2) 1 the more-likely-than-not outcomes of any uncertain tax positions. Deferred 7 — (43) In addition, when applicable, we adjust the previously recorded tax Total Provision (Benefits) $ 256 $ 152 $ (231) expense to reflect examination results when the position is effectively settled. Our ongoing assessments of the more-likely-than-not outcomes A reconciliation of the U.S. federal statutory income tax rate to the of the examinations and related tax positions require judgment and consolidated effective income tax rate for the three years ended can increase or decrease our effective tax rate, as well as impact our December 31, 2010 was as follows: operating results. The specific timing of when the resolution of each 2010 2009 2008 tax position will be reached is uncertain. As of December 31, 2010, we do not believe that there are any positions for which it is reasonably U.S. federal statutory income possible that the total amount of unrecognized tax benefits will tax rate 35.0% 35.0% 35.0% significantly increase or decrease within the next 12 months. Nondeductible expenses 6.3 3.2 (19.5) Effect of tax law changes (0.2) — 16.1 A reconciliation of the beginning and ending amount of unrecognized Change in valuation allowance tax benefits is as follows: for deferred tax assets 2.6 (1.7) (21.0) 2010 2009 2008 State taxes, net of federal benefit 2.0 (0.2) 36.7 Balance at January 1 $ 148 $ 170 $ 303 Audit and other tax return Additions from acquisitions 46 — — adjustments (4.2) (8.7) 84.4 Additions related to current year 38 6 12 Tax-exempt income (0.4) (0.5) 8.5 Additions related to prior Other foreign, including earnings years positions 24 27 13 taxed at different rates (8.1) (3.7) 148.9 Reductions related to prior Other (1.6) 0.8 3.3 years positions (16) (33) (65) Effective Income Tax Rate 31.4% 24.2% 292.4% Settlements with taxing authorities(1) (19) (7) (28) Reductions related to lapse of statute of limitations (35) (29) (45) Currency — 14 (20) Balance at December 31 $ 186 $ 148 $ 170 (1) Majority of settlements did not result in the utilization of cash. 94 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Included in the balances at December 31, 2010, 2009 and 2008 are The tax effects of temporary differences that give rise to significant $39, $67 and $67, respectively, of tax positions that are highly certain of portions of the deferred taxes at December 31, 2010 and 2009 were realizability but for which there is uncertainty about the timing or may as follows: be reduced through an indirect benefit from other taxing jurisdictions. 2010 2009 Because of the impact of deferred tax accounting, other than for the Deferred Tax Assets: possible incurrence of interest and penalties, the disallowance of these Research and development $ 855 $ 752 positions would not affect the annual effective tax rate. Post-retirement medical benefits 373 421 We have filed claims in certain jurisdictions to assert our position should Depreciation 200 246 the law be clarified by judicial means. At this point in time, we believe Net operating losses 634 576 it is unlikely that we will receive any benefit from these types of claims Other operating reserves 172 261 but we will continue to analyze as the issues develop. Accordingly, we Tax credit carryforwards 409 525 have not included any benefit for these types of claims in the amount of Deferred compensation 340 233 unrecognized tax benefits. Allowance for doubtful accounts 97 93 Restructuring reserves 78 16 We recognized interest and penalties accrued on unrecognized tax Pension 437 403 benefits, as well as interest received from favorable settlements within Other 156 132 income tax expense. We had $31, $13 and $22 accrued for the payment of interest and penalties associated with unrecognized tax benefits at Subtotal 3,751 3,658 December 31, 2010, 2009 and 2008, respectively. Valuation allowance (735) (672) We file income tax returns in the U.S. federal jurisdiction and various Total $ 3,016 $ 2,986 foreign jurisdictions. In the U.S., with the exception of ACS, we are no Deferred Tax Liabilities: longer subject to U.S. federal income tax examinations for years before Unearned income and installment sales $ (1,025) $ (996) 2007. ACS is no longer subject to such examinations for years before Intangibles and goodwill (1,207) (154) 2004. With respect to our major foreign jurisdictions, we are no longer Other (54) (38) subject to tax examinations by tax authorities for years before 2000. Total $ (2,286) $ (1,188) Deferred Income Taxes Total Deferred Taxes, Net $ 730 $ 1,798 In substantially all instances, deferred income taxes have not been provided on the undistributed earnings of foreign subsidiaries and other The above amounts are classified as current or long-term in the foreign investments carried at equity. The amount of such earnings at Consolidated Balance Sheets in accordance with the asset or liability to December 31, 2010 was approximately $7 billion. These earnings have which they relate or, when applicable, based on the expected timing of been indefinitely reinvested and we currently do not plan to initiate any the reversal. Current deferred tax assets at December 31, 2010 and 2009 action that would precipitate the payment of income taxes thereon. It is amounted to $298 and $290, respectively. not practicable to estimate the amount of additional tax that might be The deferred tax assets for the respective periods were assessed for payable on the foreign earnings. Our 2001 sale of half of our ownership recoverability and, where applicable, a valuation allowance was recorded interest in Fuji Xerox resulted in our investment no longer qualifying as a to reduce the total deferred tax asset to an amount that will, more likely foreign corporate joint venture. Accordingly, deferred taxes are required than not, be realized in the future. The net change in the total valuation to be provided on the undistributed earnings of Fuji Xerox, arising allowance for the years ended December 31, 2010 and 2009 was an subsequent to such date, as we no longer have the ability to ensure increase of $63 and a increase of $44, respectively. The valuation indefinite reinvestment. allowance relates primarily to certain net operating loss carryforwards, tax credit carryforwards and deductible temporary differences for which we have concluded it is more likely than not that these items will not be realized in the ordinary course of operations. Although realization is not assured, we have concluded that it is more likely than not that the deferred tax assets, for which a valuation allowance was determined to be unnecessary, will be realized in the ordinary course of operations based on the available positive and negative evidence, including scheduling of deferred tax liabilities and projected income from operating activities. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if actual future income or income tax rates are lower than estimated, or if there are differences in the timing or amount of future reversals of existing taxable or deductible temporary differences. Xerox 2010 Annual Report 95


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. At December 31, 2010, we had tax credit carryforwards of $409 Legal Matters available to offset future income taxes, of which $109 are available As more fully discussed below, we are involved in a variety of claims, to carry forward indefinitely, while the remaining $300 will expire lawsuits, investigations and proceedings concerning securities law, 2011 through 2027 if not utilized. We also had net operating loss intellectual property law, environmental law, employment law and the carryforwards for income tax purposes of $1,236 that will expire 2011 Employee Retirement Income Security Act (“ERISA”). We determine through 2029, if not utilized, and $2,478 billion available to offset whether an estimated loss from a contingency should be accrued by future taxable income indefinitely. assessing whether a loss is deemed probable and can be reasonably estimated. We assess our potential liability by analyzing our litigation Note 17 – Contingencies and regulatory matters using available information. We develop our Brazil Tax and Labor Contingencies views on estimated losses in consultation with outside counsel handling our defense in these matters, which involves an analysis of potential Our Brazilian operations are involved in various litigation matters results, assuming a combination of litigation and settlement strategies. and have received or been the subject of numerous governmental Should developments in any of these matters cause a change in our assessments related to indirect and other taxes, as well as disputes determination as to an unfavorable outcome and result in the need to associated with former employees and contract labor. The tax matters, recognize a material accrual, or should any of these matters result in a which comprise a significant portion of the total contingencies, final adverse judgment or be settled for significant amounts, they could principally relate to claims for taxes on the internal transfer of inventory, have a material adverse effect on our results of operations, cash flows municipal service taxes on rentals and gross revenue taxes. We are and financial position in the period or periods in which such change in disputing these tax matters and intend to vigorously defend our determination, judgment or settlement occurs. positions. Based on the opinion of legal counsel and current reserves for those matters deemed probable of loss, we do not believe that the Litigation Against the Company ultimate resolution of these matters will materially impact our results In re Xerox Corporation Securities Litigation: A consolidated securities of operations, financial position or cash flows. The labor matters law action (consisting of 17 cases) is pending in the United States principally relate to claims made by former employees and contract District Court for the District of Connecticut. Defendants are the labor for the equivalent payment of all social security and other related Company, Barry Romeril, Paul Allaire and G. Richard Thoman. The labor benefits, as well as consequential tax claims, as if they were consolidated action is a class action on behalf of all persons and entities regular employees. As of December 31, 2010, the total amounts related who purchased Xerox Corporation common stock during the period to the unreserved portion of the tax and labor contingencies, inclusive October 22, 1998 through October 7, 1999 inclusive (“Class Period”) and of any related interest, amounted to approximately $1,274, with the who suffered a loss as a result of misrepresentations or omissions by increase from December 31, 2009 balance of approximately $1,225 Defendants as alleged by Plaintiffs (the “Class”). The Class alleges that primarily related to currency and current year interest indexation in violation of Section 10(b) and/or 20(a) of the Securities Exchange Act partially offset by matters that have been closed. With respect to the of 1934, as amended (“1934 Act”), and SEC Rule 10b-5 thereunder, each unreserved balance of $1,274, the majority has been assessed by of the defendants is liable as a participant in a fraudulent scheme and management as being remote as to the likelihood of ultimately resulting course of business that operated as a fraud or deceit on purchasers of in a loss to the Company. In connection with the above proceedings, the Company’s common stock during the Class Period by disseminating customary local regulations may require us to make escrow cash deposits materially false and misleading statements and/or concealing material or post other security of up to half of the total amount in dispute. As of facts relating to the defendants’ alleged failure to disclose the material December 31, 2010 we had $276 of escrow cash deposits for matters negative impact that the April 1998 restructuring had on the Company’s we are disputing and there are liens on certain Brazilian assets with a operations and revenues. The complaint further alleges that the alleged net book value of $19 and additional letters of credit of approximately scheme: (i) deceived the investing public regarding the economic $160. Generally, any escrowed amounts would be refundable and any capabilities, sales proficiencies, growth, operations and the intrinsic liens would be removed to the extent the matters are resolved in our value of the Company’s common stock; (ii) allowed several corporate favor. We routinely assess all these matters as to probability of ultimately insiders, such as the named individual defendants, to sell shares of incurring a liability against our Brazilian operations and record our best privately held common stock of the Company while in possession of estimate of the ultimate loss in situations where we assess the likelihood materially adverse, non-public information; and (iii) caused the individual of an ultimate loss as probable. plaintiffs and the other members of the purported class to purchase common stock of the Company at inflated prices. The complaint seeks unspecified compensatory damages in favor of the plaintiffs and the other members of the purported class against all defendants, jointly and severally, for all damages sustained as a result of defendants’ alleged wrongdoing, including interest thereon, together with reasonable costs and expenses incurred in the action, including counsel fees and expert fees. In 2001, the Court denied the defendants’ motion for dismissal of 96 Xerox 2010 Annual Report


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    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. the complaint. The plaintiffs’ motion for class certification was denied The plaintiffs in the Delaware action alleged, among other things, by the Court in 2006, without prejudice to refiling. In February 2007, the that (i) the Individual Defendants breached their fiduciary duties to Court granted the motion of the International Brotherhood of Electrical ACS and its shareholders by authorizing the sale of ACS to Xerox for Workers Welfare Fund of Local Union No. 164, Robert W. Roten, Robert what plaintiffs deemed was inadequate consideration and pursuant Agius (“Agius”) and Georgia Stanley to appoint them as additional lead to inadequate process, and the Xerox Defendants aided and abetted plaintiffs. In July 2007, the Court denied plaintiffs’ renewed motion for those alleged breaches; (ii) the Individual Defendants breached their class certification, without prejudice to renewal after the Court holds fiduciary duties to ACS and its shareholders by agreeing to the provisions a pre-filing conference to identify factual disputes the Court will be of the merger agreement relating to the consideration to be paid to the required to resolve in ruling on the motion. After that conference and holders of Class B shares which the Delaware plaintiffs alleged violated Agius’s withdrawal as lead plaintiff and proposed class representative, the ACS certificate of incorporation and was, therefore, void, and the in February 2008 plaintiffs filed a second renewed motion for class Xerox Defendants aided and abetted those alleged breaches; and (iii) certification. In April 2008, defendants filed their response and motion the Individual Defendants breached their fiduciary duties by failing to to disqualify Milberg LLP as a lead counsel. On September 30, 2008, the disclose material facts in the October 23, 2009 Form S-4 filed with the Court entered an order certifying the class and denying the appointment SEC in connection with the merger. The plaintiffs sought, among other of Milberg LLP as class counsel. Subsequently, on April 9, 2009, the Court things, to enjoin the defendants from consummating the merger on the denied defendants’ motion to disqualify Milberg LLP. On November 6, agreed-upon terms, and unspecified compensatory damages, together 2008, the defendants filed a motion for summary judgment. Briefing with the costs and disbursements of the action. with respect to the motion is complete. The Court has not yet rendered On May 19, 2010, the parties in the Delaware and Texas Actions entered a decision. The parties also filed motions to exclude the testimony of into a Stipulation and Agreement of Compromise and Settlement certain expert witnesses. On April 22, 2009, the Court denied plaintiffs’ (“Settlement”) resolving all claims by ACS shareholders arising out of motions to exclude the testimony of two of defendants’ expert Xerox’s acquisition of ACS, including all claims in the Delaware and witnesses. On September 30, 2010, the Court denied plaintiffs’ motion Texas Actions. The defendants in the Delaware and Texas Actions did not to exclude the testimony of another of defendants’ expert witnesses. admit to any wrongdoing as part of the Settlement, which provided for The Court also granted defendants’ motion to exclude the testimony an aggregate payment of $69 on behalf of all defendants, including a of one of plaintiffs’ expert witnesses, and granted in part and denied payment of approximately $36 by Xerox, net of insurance proceeds. The in part defendants’ motion to exclude the testimony of plaintiffs’ two Delaware court approved the Settlement at a hearing held on August remaining expert witnesses. The individual defendants and we deny any 24, 2010. In light of the Delaware court’s approval of the Settlement, on wrongdoing and are vigorously defending the action. In the course of October 13, 2010, the Texas court signed an order dismissing the Texas litigation, we periodically engage in discussions with plaintiffs’ counsel action. for possible resolution of this matter. Should developments cause a change in our determination as to an unfavorable outcome, or result Other Contingencies in a final adverse judgment or a settlement for a significant amount, Guarantees, Indemnifications and Warranty Liabilities there could be a material adverse effect on our results of operations, Guarantees and claims arise during the ordinary course of business cash flows and financial position in the period in which such change in from relationships with suppliers, customers and nonconsolidated determination, judgment or settlement occurs. affiliates when the Company undertakes an obligation to guarantee Merger Agreement Between Xerox and Affiliated Computer Services, the performance of others if specified triggering events occur. Inc.: In late September and early October 2009, nine purported class Nonperformance under a contract could trigger an obligation of the action complaints were filed by ACS shareholders challenging ACS’s Company. These potential claims include actions based upon alleged proposed merger with Xerox. Two actions were filed in the Delaware exposures to products, real estate, intellectual property such as patents, Court of Chancery which subsequently were consolidated into environmental matters, and other indemnifications. The ultimate one action. Seven actions were filed in state courts in Texas, which effect on future financial results is not subject to reasonable estimation subsequently were consolidated into one action in the Dallas County because considerable uncertainty exists as to the final outcome of these Court at Law No. 3. The operative complaints in the Delaware and Texas claims. However, while the ultimate liabilities resulting from such claims actions named as defendants ACS and/or the members of ACS’s board may be significant to results of operations in the period recognized, of directors (the “Individual Defendants”) and Xerox Corporation and/or management does not anticipate they will have a material adverse Boulder Acquisition Corp., a wholly owned subsidiary of Xerox (“Boulder”) effect on the Company’s consolidated financial position or liquidity. As (ACS, the Individual Defendants, Xerox Corporation and Boulder, of December 31, 2010, we have accrued our estimate of liability incurred collectively, the “Xerox Defendants”). A class of ACS shareholders was under our indemnification arrangements and guarantees. certified in the Delaware action. Pursuant to a stipulation entered into by all parties in the Delaware and Texas actions prosecution of the Texas action was stayed and further prosecution of the Delaware and Texas actions would proceed in the Delaware action. Xerox 2010 Annual Report 97


  • Page 45

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. Indemnifications Provided as Part of Contracts and Agreements Indemnification of Officers and Directors We are a party to the following types of agreements pursuant to Our corporate by-laws require that, except to the extent expressly which we may be obligated to indemnify the other party with respect prohibited by law, we must indemnify Xerox Corporation’s officers to certain matters: and directors against judgments, fines, penalties and amounts paid in settlement, including legal fees and all appeals, incurred in • Contracts that we entered into for the sale or purchase of businesses or connection with civil or criminal action or proceedings, as it relates real estate assets, under which we customarily agree to hold the other to their services to Xerox Corporation and our subsidiaries. Although party harmless against losses arising from a breach of representations the by-laws provide no limit on the amount of indemnification, we and covenants, including obligations to pay rent. Typically, these relate may have recourse against our insurance carriers for certain payments to such matters as adequate title to assets sold, intellectual property made by us. However, certain indemnification payments may not rights, specified environmental matters and certain income taxes be covered under our directors’ and officers’ insurance coverage. In arising prior to the date of acquisition. addition, we indemnify certain fiduciaries of our employee benefit plans • Guarantees on behalf of our subsidiaries with respect to real estate for liabilities incurred in their service as fiduciary whether or not they leases. These lease guarantees may remain in effect subsequent to are officers of the Company. the sale of the subsidiary. • Agreements to indemnify various service providers, trustees and bank Product Warranty Liabilities In connection with our normal sales of equipment, including those agents from any third-party claims related to their performance on our under sales-type leases, we generally do not issue product warranties. behalf, with the exception of claims that result from third party’s own Our arrangements typically involve a separate full service maintenance willful misconduct or gross negligence. agreement with the customer. The agreements generally extend over a • Guarantees of our performance in certain sales and services contracts period equivalent to the lease term or the expected useful life under a to our customers and indirectly the performance of third parties cash sale. The service agreements involve the payment of fees in return with whom we have subcontracted for their services. This includes for our performance of repairs and maintenance. As a consequence, indemnifications to customers for losses that may be sustained as a we do not have any significant product warranty obligations including result of the use of our equipment at a customer’s location. any obligations under customer satisfaction programs. In a few In each of these circumstances, our payment is conditioned on the circumstances, particularly in certain cash sales, we may issue a limited other party making a claim pursuant to the procedures specified in the product warranty if negotiated by the customer. We also issue warranties particular contract, which procedures typically allow us to challenge for certain of our entry level products, where full service maintenance the other party’s claims. In the case of lease guarantees, we may contest agreements are not available. In these instances, we record warranty the liabilities asserted under the lease. Further, our obligations under obligations at the time of the sale. Aggregate product warranty liability these agreements and guarantees may be limited in terms of time expenses for the three years ended December 31, 2010 were $33, $34 and/or amount, and in some instances, we may have recourse against and $39, respectively. Total product warranty liabilities as of December third parties for certain payments we made. 31, 2010 and 2009 were $18 and $20, respectively. Patent Indemnifications Other Contingencies In most sales transactions to resellers of our products, we indemnify We have issued or provided the following guarantees as of against possible claims of patent infringement caused by our products December 31, 2010: or solutions. In addition, we indemnify certain software providers against claims that may arise as a result of our use or our subsidiaries’, • $270 for letters of credit issued i) to guarantee our performance under customers’ or resellers’ use of their software in our products and certain services contracts; ii) to support certain insurance programs; solutions. These indemnifications usually do not include limits on the and iii) to support our obligations related to the Brazil tax and labor claims, provided the claim is made pursuant to the procedures required contingencies. in the sales contract. • $666 for outstanding surety bonds. Certain contracts, primarily those involving public sector customers, require us to provide a surety bond as a guarantee of our performance of contractual obligations. In general, we would only be liable for the amount of these guarantees in the event of default in our performance of our obligations under each contract; the probability of which we believe is remote. We believe that our capacity in the surety markets, as well as under various credit arrangements (including our Credit Facility), is sufficient to allow us to respond to future requests for proposals that require such credit support. 98 Xerox 2010 Annual Report


  • Page 46

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. We have service arrangements where we service third-party student over the 7-trading day period ended on September 14, 2009 and loans in the Federal Family Education Loan program (“FFEL”) on behalf the number used for calculating the conversion price in the ACS of various financial institutions. We service these loans for investors merger agreement), subject to customary anti-dilution adjustments. under outsourcing arrangements and do not acquire any servicing On or after the fifth anniversary of the issue date, we have the right rights that are transferable by us to a third party. At December 31, to cause, under certain circumstances, any or all of the convertible 2010, we serviced a FFEL portfolio of approximately 3.6 million loans preferred stock to be converted into shares of common stock at the with an outstanding principal balance of approximately $51.4 billion. then applicable conversion rate. The convertible preferred stock is also Some servicing agreements contain provisions that, under certain convertible, at the option of the holder, upon a change in control, at circumstances, require us to purchase the loans from the investor if the the applicable conversion rate plus an additional number of shares loan guaranty has been permanently terminated as a result of a loan determined by reference to the price paid for our common stock upon default caused by our servicing error. If defaults caused by us are cured such change in control. In addition, upon the occurrence of certain during an initial period, any obligation we may have to purchase these fundamental change events, including a change in control or the loans expires. Loans that we purchase may be subsequently cured, delisting of Xerox’s common stock, the holder of convertible preferred the guaranty reinstated and the loans repackaged for sale to third stock has the right to require us to redeem any or all of the convertible parties. We evaluate our exposure under our purchase obligations on preferred stock in cash at a redemption price per share equal to the defaulted loans and establish a reserve for potential losses, or default liquidation preference and any accrued and unpaid dividends to, but liability reserve, through a charge to the provision for loss on defaulted not including the redemption date. The convertible preferred stock is loans purchased. The reserve is evaluated periodically and adjusted classified as temporary equity (i.e., apart from permanent equity) as based upon management’s analysis of the historical performance of a result of the contingent redemption feature. the defaulted loans. As of December 31, 2010, other current liabilities include reserves of less than $1 for losses on defaulted loans purchased. Note 19 – Shareholders’ Equity In connection with the acquisition of ACS, the Company agreed Preferred Stock to provide certain tax and prior employment agreement-related As of December 31, 2010 we had one class of preferred stock indemnities to former officers and directors of ACS. Management does outstanding. See Note 18 – Preferred Stock for further information. not anticipate any potential claims under these indemnities would have We are authorized to issue approximately 22 million shares of a material adverse effect on the Company’s financial statements taken cumulative preferred stock, $1.00 par value per share. as a whole and accordingly no value has been assigned for financial reporting purposes. Common Stock We have 1.75 billion authorized shares of common stock, $1 par value per share. At December 31, 2010, 167 million shares were reserved for Note 18 – Preferred Stock issuance under our incentive compensation plans, 48 million shares were Series A Convertible Preferred Stock reserved for debt to equity exchanges, 27 million shares were reserved In connection with the acquisition of ACS in February 2010 (see Note for conversion of the Series A convertible preferred stock and two million 3 – Acquisitions for additional information), we issued 300,000 shares shares were reserved for the conversion of convertible debt. of Series A convertible perpetual preferred stock with an aggregate In connection with the acquisition of ACS in February 2010 (see Note 3 – liquidation preference of $300 and a fair value of $349 as of the Acquisitions for further information), we issued 489,802 thousand shares acquisition date to the holder of ACS Class B common stock. The of common stock to holders of ACS Class A and Class B common stock. convertible preferred stock pays quarterly cash dividends at a rate of 8% per year and has a liquidation preference of $1,000 per share. Treasury Stock Each share of convertible preferred stock is convertible at any time, at Our Board of Directors has authorized programs for repurchase of the the option of the holder, into 89.8876 shares of common stock for a Company’s common stock. During the year ended December 31, 2010, total of 26,966 thousand shares (reflecting an initial conversion price we did not purchase any common stock. of approximately $11.125 per share of common stock and is a 25% The following provides cumulative information relating to our share premium over $8.90, the average closing price of Xerox common stock repurchase programs from their inception in October 2005 through December 31, 2010 (shares in thousands): Authorized share repurchase $ 4,500 Share repurchases $ 2,941 Share repurchase fees $ 4 Number of shares repurchased 194,093 Xerox 2010 Annual Report 99


  • Page 47

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. The following table reflects the changes in Common and We grant PSs and RSUs in order to continue to attract and retain employees Treasury stock shares for the three years ended December 31, 2010 and to better align employees’ interests with those of our shareholders. (shares in thousand): Each of these awards is subject to settlement with newly issued shares of Common Stock Shares Treasury Stock Shares our common stock. At December 31, 2010 and 2009, 30 million and 15 million shares, respectively, were available for grant of awards. Balance at December 31, 2007 919,013 (1,836) Stock option and incentive plans, net 4,442 — Stock-based compensation expense for the three years ended December Acquisition of Treasury stock — (56,842) 31, 2010 was as follows: Cancellation of Treasury stock (58,678) 58,678 2010 2009 2008 Balance at December 31, 2008 864,777 — Stock-based compensation Stock option and incentive plans, net 4,604 — expense, pre-tax $ 123 $ 85 $ 85 Balance at December 31, 2009 869,381 — Income tax benefit recognized ACS acquisition(1) 489,802 — in earnings 47 33 33 Stock option and incentive plans, net 38,395 — Restricted stock units: Compensation expense is based upon the grant Balance at December 31, 2010 1,397,578 — date market price for most awards and a Monte Carlo simulation pricing (1) Refer to Note 3 – Acquisitions for additional information. model for a grant in 2009 that included a market condition; the expense is recorded over the vesting period, which ranges from three to five Stock-Based Compensation years from the date of grant. A summary of the activity for RSUs as of We have a long-term incentive plan whereby eligible employees may be December 31, 2010, 2009 and 2008, and changes during the years then granted restricted stock units (“RSUs”), performance shares (“PSs”) and ended, is presented below (shares in thousands): non-qualified stock options. 2010 2009 2008 Weighted Weighted Weighted Average Grant Average Grant Average Grant Nonvested Restricted Stock Units Shares Date Fair Value Shares Date Fair Value Shares Date Fair Value Outstanding at January 1 25,127 $ 10.18 14,037 $ 15.43 11,696 $ 16.78 Granted 11,845 8.56 15,268 6.69 5,923 13.63 Vested (3,671) 18.22 (3,764) 15.17 (3,350) 16.92 Cancelled (870) 10.36 (414) 13.94 (232) 15.98 Outstanding at December 31 32,431 8.68 25,127 10.18 14,037 15.43 At December 31, 2010, the aggregate intrinsic value of RSUs Performance shares: We grant officers and selected executives PSs that outstanding was $374. The total intrinsic value and actual tax benefit vest contingent upon meeting pre-determined Earnings per Share (“EPS”) realized for the tax deductions for vested RSUs for the three years ended and Cash Flow from Operations targets. These shares entitle the holder December 31, 2010 were as follows: to one share of common stock, payable after a three-year period and Vested Restricted Stock Units 2010 2009 2008 the attainment of the stated goals. If the cumulative three-year actual results for EPS and Cash Flow from Operations exceed the stated targets, Total intrinsic value of then the plan participants have the potential to earn additional shares vested RSUs $ 31 $ 19 $ 54 of common stock. This overachievement can not exceed 50% for officers Tax benefit realized for and 25% for non-officers of the original grant. vested RSUs tax deductions 10 6 18 In connection with the ACS acquisition, selected ACS executives received a At December 31, 2010, there was $135 of total unrecognized special one-time grant of PSs that vest over a three-year period contingent compensation cost related to nonvested RSUs, which is expected to be upon ACS meeting pre-determined annual earnings targets. These shares recognized ratably over a remaining weighted-average contractual term entitle the holder to one share of common stock, payable after the three- of 1.7 years. year period and the attainment of the targets. The aggregate number of shares that may be delivered based on achievement of the targets was determined on the date of grant and ranges in value as follows: 50% of base salary (threshold); 100% of base salary (target); and 200% of base 100 Xerox 2010 Annual Report salary plus 50% of the value of the August 2009 options (maximum).


  • Page 48

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. A summary of the activity for PSs as of December 31, 2010, 2009 and 2008, and changes during the years then ended, is presented below (shares in thousands): 2010 2009 2008 Weighted Weighted Weighted Average Grant Average Grant Average Grant Nonvested Restricted Stock Units Shares Date Fair Value Shares Date Fair Value Shares Date Fair Value Outstanding at January 1 4,874 $ 15.49 7,378 $ 15.39 6,585 $ 16.16 Granted 5,364 8.10 718 15.17 3,696 13.67 Vested (1,566) 18.48 (3,075) 15.17 (2,734) 14.87 Cancelled (901) 15.51 (147) 15.52 (169) 16.05 Outstanding at December 31 7,771 9.78 4,874 15.49 7,378 15.39 At December 31, 2010, the aggregate intrinsic value of PSs outstanding ACS Acquisition: In connection with the acquisition of ACS (see Note was $90. The total intrinsic value of PSs and the actual tax benefit 3 – Acquisitions for further information), outstanding ACS options were realized for the tax deductions for vested PSs for the three years ended converted into 96,662 thousand Xerox options. The Xerox options have a December 31, 2010 was as follows: weighted average exercise price of $6.79 per option. The estimated fair Vested Performance Shares 2010 2009 2008 value associated with the options issued was approximately $222 based on a Black-Scholes valuation model utilizing the assumptions stated Total intrinsic value of vested PSs $ 12 $ 15 $ 41 below. Approximately $168 of the estimated fair value is associated with Tax benefit realized for vested PSs ACS options issued prior to August 2009, which became fully vested and tax deductions 5 6 13 exercisable upon the acquisition in accordance with pre-existing change- We account for PSs using fair value determined as of the grant date. in-control provisions, was recorded as part of the acquisition fair value. If the stated targets are not met, any recognized compensation cost The remaining $54 is associated with ACS options issued in August 2009 would be reversed. As of December 31, 2010, there was $45 of total which continue to vest according to their original terms and, therefore, is unrecognized compensation cost related to nonvested PSs; this cost is being expensed as compensation cost over the remaining vesting period. expected to be recognized ratably over a remaining weighted-average The options generally expire 10 years from date of grant. contractual term of 1.8 years. Pre-August 2009 August 2009 Assumptions Options Options Stock options Strike price $ 6.89 $ 6.33 Employee stock options: With the exception of the stock options issued Expected volatility 37.90% 38.05% in connection with the ACS acquisition (see below), we have not issued Risk-free interest rate 0.23% 1.96% any new stock options associated with our employee long-term incentive Dividend yield 1.97% 1.97% plan since 2004. All stock options previously issued under our employee Expected term 0.75 years 4.2 years long-term incentive plan and currently outstanding are fully vested and exercisable and generally expire between eight and 10 years from the The following table provides information relating to the status of, and date of grant. changes in, outstanding stock options for each of the three years ended December 31, 2010 (stock options in thousands): 2010 2009 2008 Weighted Weighted Weighted Stock Average Stock Average Stock Average Employee Stock Options Options Option Price Options Option Price Options Option Price Outstanding at January 1 28,363 $10.13 45,185 $15.49 52,424 $19.73 Granted – ACS acquisition 96,662 6.79 — — — — Cancelled/Expired (2,735) 7.33 (16,676) 24.68 (6,559) 50.08 Exercised (51,252) 6.92 (146) 5.88 (680) 8.89 Outstanding at December 31 71,038 8.00 28,363 10.13 45,185 15.49 Exercisable at December 31 57,985 8.38 28,363 10.13 45,185 15.49 Xerox 2010 Annual Report 101


  • Page 49

    Notes to the Consolidated Financial Statements Dollars in millions, except per-share data and unless otherwise indicated. As of December 31, 2010, there was $35 of total unrecognized The following table provides information relating to stock option compensation cost related to nonvested stock options. This cost is exercises for the three years ended December 31, 2010: expected to be recognized ratably over a remaining weighted-average 2010 2009 2008 vesting period of three years. Total intrinsic value of Information relating to options outstanding and exercisable at stock options $ 155 $ — $ 4 December 31, 2010 was as follows: Cash received 183 1 6 Options Outstanding Options Exercisable Tax benefit realized for stock option tax deductions 56 — 2 Aggregate intrinsic value $267 $199 Weighted-average remaining contractual life in years 4.42 3.46 Note 20 – Earnings per Share The following table sets forth the computation of basic and diluted earnings per share of common stock for the three years ended December 31, 2010 (shares in thousands): 2010 2009 2008 Basic Earnings per Share: Net income attributable to Xerox $ 606 $ 485 $ 230 Accrued dividends on preferred stock (21) — — Adjusted Net Income Available to Common Shareholders $ 585 $ 485 $ 230 Weighted average common shares outstanding 1,323,431 869,979 885,471 Basic Earnings per Share $ 0.44 $ 0.56 $ 0.26 Diluted Earnings per Share: Net income attributable to Xerox $ 606 $ 485 $ 230 Accrued dividends on Preferred stock (21) — — Interest on Convertible securities, net — 1 — Adjusted Net Income Available to Common Shareholders $ 585 $ 486 $ 230 Weighted-average common shares outstanding 1,323,431 869,979 885,471 Common shares issuable with respect to: Stock options 13,497 462 3,885 Restricted stock and performance shares 13,800 7,087 6,186 Convertible securities — 1,992 — Adjusted Weighted Average Shares Outstanding 1,350,728 879,520 895,542 Diluted Earnings per Share $ 0.43 $ 0.55 $ 0.26 The following represents shares not included in the computation of diluted earnings per share, because to do so would have been anti-dilutive (shares in thousands): Stock options 57,541 27,901 41,300 Restricted stock and performance shares 25,983 22,574 14,969 Convertible preferred stock 26,966 — — Convertible securities 1,992 — 1,992 112,482 50,475 58,261 Dividends Declared per Common Share $0.17 $0.17 $0.17 102 Xerox 2010 Annual Report


  • Page 50

    Reports of Management Management’s Responsibility for Management’s Report on Internal Control Financial Statements Over Financial Reporting Our management is responsible for the integrity and objectivity Our management is responsible for establishing and of all information presented in this annual report. The consolidated maintaining adequate internal control over financial reporting, financial statements were prepared in conformity with accounting as such term is defined in the rules promulgated under the principles generally accepted in the United States of America Securities Exchange Act of 1934. Under the supervision and with and include amounts based on management’s best estimates the participation of our management, including our principal and judgments. Management believes the consolidated financial executive, financial and accounting officers, we have conducted statements fairly reflect the form and substance of transactions an evaluation of the effectiveness of our internal control over and that the financial statements fairly represent the Company’s financial reporting based on the framework in “Internal Control – financial position and results of operations. Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Audit Committee of the Board of Directors, which is composed solely of independent directors, meets regularly with Based on the above evaluation, management has concluded the independent auditors, PricewaterhouseCoopers LLP, the that our internal control over financial reporting was effective as internal auditors and representatives of management to review of December 31, 2010. accounting, financial reporting, internal control and audit matters, as well as the nature and extent of the audit effort. The Audit Committee is responsible for the engagement of the independent auditors. The independent auditors and internal auditors have free access to the Audit Committee. Ursula M. Burns Luca Maestri Gary R. Kabureck Chief Executive Officer Chief Financial Officer Chief Accounting Officer Xerox 2010 Annual Report 103

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