Edgar Filing: XEROX CORP

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: June 30, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 001-04471

LOGO

XEROX CORPORATION

(Exact Name of Registrant as specified in its charter)


New York		16-0468020
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

P.O. Box 4505, 45 Glover Avenue Norwalk, Connecticut		06856-4505
(Address of principal executive offices)		(Zip Code)

(203) 968-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x


Class		Outstanding at June 30, 2011
Common Stock, $1 par value		1,403,474,054 shares

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q and any exhibits to this Report may contain "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements. These statements reflect management’s current beliefs, assumptions and expectations and are subject to a number of factors that may cause actual results to differ materially. These factors include but are not limited to: changes in economic conditions, political conditions, trade protection measures, licensing requirements, environmental regulations and tax matters in the United States and in the foreign countries in which we do business; changes in foreign currency exchange rates; the outcome of litigation and regulatory proceedings to which we may be a party; actions of competitors; our ability to expand equipment placements and to drive the expanded use of color in printing and copying; development of new products and services; interest rates, cost of borrowing and access to credit markets; our ability to protect our intellectual property rights; our ability to obtain adequate pricing for our products and services and to maintain and improve cost efficiency of operations, including savings from restructuring actions; the risk that unexpected costs will be incurred; reliance on third parties for manufacturing of products and provision of services; the risk that we may not realize all of the anticipated benefits from the acquisition of Affiliated Computer Services, Inc.; our ability to recover capital investments; the risk that subcontractors, software vendors and utility and network providers will not perform in a timely, quality manner; the risk that multi-year contracts with governmental entities could be terminated prior to the end of the contract term; the risk that individually identifiable information of customers, clients and employees could be inadvertently disclosed or disclosed as a result of a breach of our security; and other risks that are set forth in the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of this Quarterly Report on Form 10-Q, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 and our 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The Company assumes no obligation to update any forward-looking statements as a result of new information or future events or developments, except as required by law.


		2		Xerox 2011 Form 10-Q

XEROX CORPORATION

FORM 10-Q

June 30, 2011

TABLE OF CONTENTS


		Page
Part I — Financial Information			4

Item 1.	Financial Statements (Unaudited)		4

	Condensed Consolidated Statements of Income		4

	Condensed Consolidated Balance Sheets		5

	Condensed Consolidated Statements of Cash Flows		6

	Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27

	Capital Resources and Liquidity		38

	Financial Risk Management		41

	Non-GAAP Financial Measures		41

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		47

Item 4.	Controls and Procedures		47

Part II — Other Information			47

Item 1.	Legal Proceedings		47

Item 1A.	Risk Factors		47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		48

Item 6.	Exhibits		49

Signatures			50

Exhibit Index			51

For additional information about Xerox Corporation and access to our Annual Reports to Shareholders and SEC filings, free of charge, please visit our website at www.xerox.com/investor. Any information on or linked from the website is not incorporated by reference into this Form 10-Q.


		3		Xerox 2011 Form 10-Q

PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

XEROX CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)


	Three Months Ended June 30,					Six Months Ended June 30,
(in millions, except per-share data)	2011			2010		2011			2010
Revenues
Sales	$	1,720		$	1,791	$	3,391		$	3,469
Service, outsourcing and rentals		3,731			3,553		7,363			6,423
Finance income		163			164		325			337

Total Revenues		5,614			5,508		11,079			10,229

Costs and Expenses
Cost of sales		1,139			1,172		2,229			2,254
Cost of service, outsourcing and rentals		2,538			2,359		5,052			4,230
Equipment financing interest		60			61		120			125
Research, development and engineering expenses		175			194		359			399
Selling, administrative and general expenses		1,119			1,163		2,238			2,262
Restructuring and asset impairment charges		(9	)		11		(24	)		206
Acquisition-related costs		—			15		—			63
Amortization of intangible assets		87			85		172			142
Other expenses, net		104			128		182			238

Total Costs and Expenses		5,213			5,188		10,328			9,919

Income before Income Taxes and Equity Income		401			320		751			310
Income tax expense		108			112		203			134
Equity in net income of unconsolidated affiliates		34			28		68			26

Net Income		327			236		616			202
Less: Net income attributable to noncontrolling interests		8			9		16			17

Net Income Attributable to Xerox	$	319		$	227	$	600		$	185

Basic Earnings per Share	$	0.22		$	0.16	$	0.42		$	0.14
Diluted Earnings per Share	$	0.22		$	0.16	$	0.41		$	0.14

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


		4		Xerox 2011 Form 10-Q

XEROX CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)


(in millions, except share data in thousands)	June 30, 2011			December 31, 2010
Assets
Cash and cash equivalents	$	1,098		$	1,211
Accounts receivable, net		2,921			2,826
Billed portion of finance receivables, net		182			198
Finance receivables, net		2,261			2,287
Inventories		1,129			991
Other current assets		1,104			1,126

Total current assets		8,695			8,639
Finance receivables due after one year, net		4,210			4,135
Equipment on operating leases, net		517			530
Land, buildings and equipment, net		1,687			1,671
Investments in affiliates, at equity		1,318			1,291
Intangible assets, net		3,245			3,371
Goodwill		8,830			8,649
Deferred tax assets, long-term		477			540
Other long-term assets		2,116			1,774

Total Assets	$	31,095		$	30,600

Liabilities and Equity
Short-term debt and current portion of long-term debt	$	2,197		$	1,370
Accounts payable		1,693			1,968
Accrued compensation and benefits costs		744			901
Unearned income		355			371
Other current liabilities		1,649			1,807

Total current liabilities		6,638			6,417
Long-term debt		7,113			7,237
Liability to subsidiary trust issuing preferred securities		—			650
Pension and other benefit liabilities		2,103			2,071
Post-retirement medical benefits		913			920
Other long-term liabilities		838			797

Total Liabilities		17,605			18,092

Series A Convertible Preferred Stock		349			349

Common stock		1,403			1,398
Additional paid-in capital		6,670			6,580
Retained earnings		6,482			6,016
Accumulated other comprehensive loss		(1,575	)		(1,988	)

Xerox shareholders’ equity		12,980			12,006
Noncontrolling interests		161			153

Total Equity		13,141			12,159

Total Liabilities and Equity	$	31,095		$	30,600


Shares of common stock issued and outstanding		1,403,474			1,397,578

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


		5		Xerox 2011 Form 10-Q

XEROX CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Three Months Ended June 30,						Six Months Ended June 30,
(in millions)	2011			2010			2011			2010
Cash Flows from Operating Activities:
Net income	$	327		$	236		$	616		$	202
Adjustments required to reconcile net income to cash flows from operating activities:
Depreciation and amortization		298			279			589			520
Provision for receivables		29			43			54			93
Provision for inventory		6			8			19			17
Net (gain) loss on sales of businesses and assets		(7	)		1			(8	)		(1	)
Undistributed equity in net income of unconsolidated affiliates		(7	)		(12	)		(40	)		(9	)
Stock-based compensation		31			30			63			57
Provision for litigation, net		—			36			—			36
Payments for litigation, net		—			(36	)		—			(36	)
Restructuring and asset impairment charges		(9	)		11			(24	)		206
Payments for restructurings		(63	)		(55	)		(120	)		(94	)
Contributions to pension benefit plans		(79	)		(30	)		(123	)		(63	)
(Increase) decrease in accounts receivable and billed portion of finance receivables		(15	)		62			(286	)		(135	)
Collections of deferred proceeds from sales of receivables		95			42			182			42
Increase in inventories		(37	)		(61	)		(137	)		(198	)
Increase in equipment on operating leases		(68	)		(64	)		(129	)		(122	)
Decrease in finance receivables		65			70			160			201
(Increase) decrease in other current and long-term assets		(44	)		(8	)		(123	)		13
(Decrease) increase in accounts payable and accrued compensation		(145	)		18			(378	)		187
Decrease in other current and long-term liabilities		(89	)		(12	)		(175	)		(66	)
Net change in income tax assets and liabilities		47			110			168			107
Net change in derivative assets and liabilities		1			(22	)		24			(4	)
Other operating, net		11			32			(15	)		100

Net cash provided by operating activities		347			678			317			1,053

Cash Flows from Investing Activities:
Cost of additions to land, buildings and equipment		(94	)		(83	)		(165	)		(134	)
Proceeds from sales of land, buildings and equipment		2			6			4			25
Cost of additions to internal use software		(41	)		(44	)		(81	)		(69	)
Acquisitions, net of cash acquired		(94	)		(4	)		(137	)		(1,528	)
Net change in escrow and other restricted investments		(7	)		(9	)		(8	)		6
Other investing, net		19			4			19			4

Net cash used in investing activities		(215	)		(130	)		(368	)		(1,696	)

Cash Flows from Financing Activities:
Net proceeds (payments) on debt		690			(395	)		703			(2,038	)
Payment of liability to subsidiary trust issuing preferred securities		(670	)		—			(670	)		—
Common stock dividends		(59	)		(60	)		(119	)		(97	)
Preferred stock dividends		(6	)		(3	)		(12	)		(3	)
Proceeds from issuances of common stock		12			2			31			117
Excess tax benefits from stock-based compensation		2			6			4			10
Repurchases related to stock-based compensation		(3	)		(2	)		(6	)		(2	)
Other financing		(5	)		(5	)		(12	)		(9	)

Net cash used in financing activities		(39	)		(457	)		(81	)		(2,022	)

Effect of exchange rate changes on cash and cash equivalents		5			(19	)		19			(52	)

Increase (decrease) in cash and cash equivalents		98			72			(113	)		(2,717	)
Cash and cash equivalents at beginning of period		1,000			1,010			1,211			3,799

Cash and Cash Equivalents at End of Period	$	1,098		$	1,082		$	1,098		$	1,082

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


		6		Xerox 2011 Form 10-Q

XEROX CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except per-share data and where otherwise noted)

Note 1 – Basis of Presentation

References herein to “we,” “us,” “our,” the “Company” and “Xerox” refer to Xerox Corporation and its consolidated subsidiaries unless the context specifically requires otherwise.

We have prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with the accounting policies described in our 2010 Annual Report to Shareholders, which is incorporated by reference in our 2010 Annual Report on Form 10-K (“2010 Annual Report”), and the interim reporting requirements of Form 10-Q. Accordingly, certain information and note disclosures normally included in our annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our 2010 Annual Report.

In our opinion, all adjustments which are necessary for a fair statement of financial position, operating results and cash flows for the interim periods presented have been made. Interim results of operations are not necessarily indicative of the results of the full year.

For convenience and ease of reference, we refer to the financial statement caption “Income before Income Taxes and Equity Income” as “pre-tax income.”

Note 2 – Recent Accounting Pronouncements

Presentation of Comprehensive Income: In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income, which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. The items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income were not changed. Additionally, no changes were made to the calculation and presentation of earnings per share. ASU 2011-05 is effective for our fiscal year beginning January 1, 2012 and must be applied retrospectively. We expect to present comprehensive income in two separate but consecutive statements. Other than the change in presentation, we have determined these changes will not have an impact on the Consolidated Financial Statements.

Fair Value Measurement and Disclosure Requirements: In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820) – Fair Value Measurement, to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements, particularly for level 3 fair value measurements. ASU 2011-04 is effective for our fiscal year beginning January 1, 2012 and must be applied prospectively. We are currently evaluating the impact of the adoption of ASU 2011-04 on our consolidated financial statements.

Receivables: In April 2011, the FASB issued ASU 2011-02 to provide additional guidance on a creditor’s determination of whether a restructuring is a troubled debt restructuring. The additional guidance was provided to assist a creditor in determining whether it has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining if a restructuring constitutes a troubled debt restructuring. The update is effective for our third quarter beginning July 1, 2011 and is not expected to have a material effect on our financial condition, results of operations or disclosures.


		7		Xerox 2011 Form 10-Q

Note 3 – Segment Reporting

Our reportable segments are aligned with how we manage the business and view the markets we serve. We report our financial performance based on the following two primary reportable segments – Technology and Services. Our Technology segment includes the sale and support of a broad range of document systems from entry level to high-end. Our Services segment operations involve delivery of a broad range of outsourcing services including document, business processing and IT outsourcing services.

Our Technology segment is centered on strategic product groups, which share common technology, manufacturing and product platforms. This segment includes the sale of document systems and supplies, technical services and product financing. Our products range from:

•

“Entry,” which includes A4 devices and desktop printers; to

•

“Mid-range,” which includes A3 devices that generally serves workgroup environments in mid to large enterprises and includes products that fall into the following market categories: Color 41+ ppm priced at less than $100K and Light Production 91+ ppm priced at less than $100K; to

•

“High-end,” which includes production printing and publishing systems that generally serve the graphic communications marketplace and large enterprises.

The Services segment is comprised of three outsourcing service offerings:

•

Document Outsourcing (which includes Managed Print Services)

•

Business Process Outsourcing

•

Information Technology Outsourcing

Document outsourcing services include service arrangements that allow customers to streamline, simplify and digitize their document-intensive business processes through automation and deployment of software application and tools and the management of their printing needs. Document outsourcing also includes revenues from our partner print services offerings. Business process outsourcing services includes service arrangements where we manage a customer’s business activity or process. Information technology outsourcing services include service arrangements where we manage a customer’s IT-related activities, such as application management and application development, data center operations or testing and quality assurance.

The segment classified as Other includes several units, none of which meet the thresholds for separate segment reporting. This group primarily includes Xerox Supplies Business Group (predominantly paper sales), Wide Format Systems, licensing revenues, GIS network integration solutions and electronic presentation systems and non-allocated Corporate items including non-financing interest, as well as other items included in Other expenses, net.

Operating segment revenues and profitability were as follows:


	Three Months Ended June 30,					Six Months Ended June 30,
	Segment Revenue		Segment Profit (Loss)			Segment Revenue		Segment Profit (Loss)
2011
Technology	$	2,552	$	300		$	5,047	$	566
Services		2,672		322			5,256		588
Other		390		(73	)		776		(139	)

Total	$	5,614	$	549		$	11,079	$	1,015

2010
Technology	$	2,555	$	273		$	5,038	$	506
Services		2,529		319			4,372		522
Other		424		(93	)		819		(197	)

Total	$	5,508	$	499		$	10,229	$	831


		8		Xerox 2011 Form 10-Q


	Three Months Ended June 30,						Six Months Ended June 30,
Reconciliation to Pre-tax Income	2011			2010			2011			2010
Segment Profit	$	549		$	499		$	1,015		$	831
Reconciling items:
Restructuring and asset impairment charges		9			(11	)		24			(206	)
Restructuring charges of Fuji Xerox		(4	)		(5	)		(15	)		(27	)
Acquisition-related costs		—			(15	)		—			(63	)
Amortization of intangible assets		(87	)		(85	)		(172	)		(142	)
Venezuelan devaluation costs		—			—			—			(21	)
ACS shareholders litigation settlement		—			(36	)		—			(36	)
Loss on early extinguishment of liability		(33	)		—			(33	)		—
Equity in net income of unconsolidated affiliates		(34	)		(28	)		(68	)		(26	)
Other		1			1			—			—

Pre-tax Income	$	401		$	320		$	751		$	310

Note 4 – Acquisitions

In February 2011, we acquired Concept Group, Ltd. for $43 net of cash acquired. This acquisition expands our reach into the small and mid-size business market in the U.K. Concept Group has nine locations throughout the U.K. and provides document imaging solutions and technical services to more than 3,000 customers.

In April 2011, we acquired Unamic/HCN B.V., the largest privately-owned customer care provider in the Benelux region, for approximately $55 net of cash acquired. Unamic/HCN’s focus on the Dutch-speaking market will expand ACS’s customer care capabilities in the Netherlands, Belgium, Turkey and Suriname.

In May 2011, we acquired NewField Information Technology, Ltd., a U.K.-based print consultancy and software solution provider, for $17 net of cash acquired. The acquisition expands our market-leading managed print services portfolio that serves workplaces of any size.

GIS acquired four businesses in 2011 for a total of $14 in cash. These acquisitions further GIS’s strategy of creating a nationwide network of office technology suppliers focused on improving document workflow and office efficiency for small and mid-size businesses.

The operating results of the acquisitions described above are not material to our financial statements and are included within our results from the respective acquisition dates. Unamic/HCN and NewField IT are included within our Services segment while Concept Group and the GIS acquisitions are included within our Technology segment. The purchase prices were primarily allocated to intangible assets and goodwill based on third-party valuations and management’s estimates.

ACS Acquisition

In February 2010, we acquired ACS in a cash-and-stock transaction valued at approximately $6.5 billion. In addition, we repaid $1.7 billion of ACS’s debt at acquisition and assumed an additional $0.6 billion of debt. ACS provides business process outsourcing and information technology outsourcing services and solutions to commercial and governmental clients worldwide. The operating results of ACS are included in our Services segment from February 6, 2010.

The unaudited pro-forma results presented below include the effects of the ACS acquisition as if it had been consummated as of January 1, 2010. The pro-forma results include the amortization associated with the acquired intangible assets and interest expense associated with debt used to fund the acquisition, as well as fair value adjustments for unearned revenue, software and land, buildings and equipment. To better reflect the combined operating results, material non-recurring charges directly attributable to the transaction have been excluded. In addition, the pro-forma results do not include any synergies or other expected benefits of the acquisition. Accordingly, the unaudited pro-forma financial information below is not necessarily indicative of either future results of operations or results that might have been achieved had the acquisition been consummated as of January 1, 2010.


		9		Xerox 2011 Form 10-Q


	Six Months Ended June 30, 2010
	Pro-forma		As Reported
Revenue	$	10,848	$	10,229
Net income – Xerox		171		185
Basic earnings per-share		0.12		0.14
Diluted earnings per-share		0.11		0.14

Note 5 – Receivables, Net

Accounts Receivable Sales Arrangements

We have facilities in the U.S., Canada and several countries in Europe that enable us to sell to third-parties, on an on-going basis, certain accounts receivable without recourse. The accounts receivables sold are generally short-term trade receivables with payment due dates of less than 60 days. The agreements involve the sale of entire groups of accounts receivable for cash. In certain instances a portion of the sales proceeds are held back and deferred until collection of the related receivables by the purchaser. Such holdbacks are not considered legal securities nor are they certificated. We report collections on such receivables as operating cash flows in the Condensed Consolidated Statements of Cash Flows, because such receivables are the result of an operating activity and the associated interest rate risk is de minimis due to its short-term nature. These receivables are included in the caption “Other current assets” in the accompanying Condensed Consolidated Balance Sheets and were $106 and $90 at June 30, 2011 and December 31, 2010, respectively. Under most of the agreements, we continue to service the sold accounts receivable. When applicable, a servicing liability is recorded for the estimated fair value of the servicing. The amounts associated with the servicing liability were not material. Accounts receivables sales were as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Accounts receivable sales	$	819	$	535	$	1,549	$	1,012
Deferred proceeds		103		73		197		115
Fees associated with sales		5		3		9		7
Estimated increase (decrease) to operating cash flows⁽¹⁾		29		86		5		(68	)

(1)	Represents the difference between current and prior period receivable sales adjusted for the effects of: (i) the deferred proceeds, (ii) collections prior to the end of the quarter and (iii) currency.

Finance Receivables – Allowance for Credit Losses and Credit Quality

Finance receivables include sales-type leases, direct financing leases and installment loans. Our finance receivable portfolios are primarily in the U.S., Canada and Europe. We generally establish customer credit limits and estimate the allowance for credit losses on a country or geographic basis. Our policy and methodology used to establish our allowance for doubtful accounts has been consistently applied over all periods presented.


		10		Xerox 2011 Form 10-Q

The following table is a rollforward of the allowance for doubtful finance receivables as well as the related investment in finance receivables:


	United States			Canada			Europe			Other⁽³⁾		Total
Allowance for Credit Losses:
Balance December 31, 2010	$	91		$	37		$	81		$	3	$	212
Provision		7			4			11			—		22
Charge-offs		(10	)		(5	)		(8	)		—		(23	)
Recoveries and other⁽¹⁾		(1	)		2			3			—		4

Balance March 31, 2011		87			38			87			3		215
Provision		1			3			14			—		18
Charge-offs		(6	)		(5	)		(11	)		—		(22	)
Recoveries and other⁽¹⁾		(1	)		—			(1	)		—		(2	)

Balance June 30, 2011	$	81		$	36		$	89		$	3	$	209

Finance Receivables as of June 30, 2011 collectively evaluated for impairment⁽²⁾	$	2,979		$	867		$	2,919		$	88	$	6,853
Allowance for Credit Losses:
Balance December 31, 2009	$	99		$	33		$	87		$	3	$	222
Provision		10			6			17			—		33
Charge-offs		(22	)		(6	)		(11	)		—		(39	)
Recoveries and other⁽¹⁾		1			2			(5	)		—		(2	)

Balance March 31, 2010		88			35			88			3		214
Provision		15			6			12			—		33
Charge-offs		(17	)		(8	)		(19	)		—		(44	)
Recoveries and other⁽¹⁾		—			—			(6	)		—		(6	)

Balance June 30, 2010	$	86		$	33		$	75		$	3	$	197

Finance Receivables as of June 30, 2010 collectively evaluated for impairment⁽²⁾	$	3,248		$	835		$	2,447		$	45	$	6,575

(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)	Total Finance Receivables exclude residual values of $9 and $14, and the allowance for credit losses of $209 and $197 at June 30, 2011 and 2010, respectively.

(3)	Includes developing market countries and smaller units.

We evaluate our customers based on the following credit quality indicators:

•

Investment grade: This rating includes accounts with excellent to good business credit, asset quality and the capacity to meet financial obligations. These customers are less susceptible to adverse effects due to shifts in economic conditions or changes in circumstance. The rating generally equates to a Standard & Poors (S&P) rating of BBB- or better. Loss rates in this category are normally minimal at less than 1%.

•

Non-investment grade: This rating includes accounts with average credit risk that are more susceptible to loss in the event of adverse business or economic conditions. This rating generally equates to a BB S&P rating. Although we experience higher loss rates associated with this customer class, we believe the risk is somewhat mitigated by the fact that our leases are fairly well dispersed across a large and diverse customer base. In addition, the higher loss rates are largely offset by the higher rates of return we obtain with such leases. Loss rates in this category are generally in the range of 2% to 4%.

•

Substandard: This rating includes accounts that have marginal credit risk such that the customer’s ability to make repayment is impaired or may likely become impaired. We use numerous strategies to mitigate risk including higher rates of interest, prepayments, personal guarantees and etc. Accounts in this category include customers who were downgraded during the term of the lease from investment and non-investment grade evaluation when the lease was originated. Accordingly there is a distinct possibility for a loss of principal and interest or customer default. The loss rates in this category are around 10%.


		11		Xerox 2011 Form 10-Q

Credit quality indicators are updated at least annually and the credit quality of any given customer can change during the life of the portfolio. Details about our finance receivables portfolio based on industry and credit quality indicators are as follows:


	June 30, 2011
	Investment Grade		Non-investment Grade		Substandard		Total Finance Receivables
Finance and Other Services	$	348	$	381	$	171	$	900
Government and Education		791		21		6		818
Graphic Arts		119		217		147		483
Industrial		199		80		34		313
Healthcare		130		45		25		200
Other		98		104		63		265

Total United States		1,685		848		446		2,979

Finance and Other Services		156		125		51		332
Government and Education		133		10		5		148
Graphic Arts		38		43		41		122
Industrial		60		43		34		137
Other		73		42		13		128

Total Canada		460		263		144		867

France		238		428		81		747
U.K./Ireland		189		193		54		436
Central⁽¹⁾		257		671		52		980
Southern⁽²⁾		217		387		35		639
Nordics⁽³⁾		53		62		2		117

Total Europe		954		1,741		224		2,919

Other		60		17		11		88

Total	$	3,159	$	2,869	$	825	$	6,853


	December 31, 2010
	Investment Grade		Non-investment Grade		Substandard		Total Finance Receivables
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

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

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 and Holland.

(2)	Italy, Greece, Spain and Portugal.

(3)	Sweden, Norway, Denmark and Finland.


		12		Xerox 2011 Form 10-Q

The aging of our billed finance receivables is based upon the number of days an invoice is past due and is as follows:


	June 30, 2011
	Current		31-90 Days Past Due		>90 Days Past Due		Total Billed Finance Receivables		Unbilled Finance Receivables		Total Finance Receivables		Finance Receivables >90 Days and Accruing
Finance and Other Services	$	19	$	3	$	1	$	23	$	877	$	900	$	22
Government and Education		21		3		3		27		791		818		40
Graphic Arts		19		2		1		22		461		483		12
Industrial		9		2		1		12		301		313		11
Healthcare		6		1		1		8		192		200		8
Other		7		1		—		8		257		265		7

Total United States		81		12		7		100		2,879		2,979		100

Canada		5		3		1		9		858		867		25

France		1		2		1		4		743		747		6
U.K./Ireland		7		1		1		9		427		436		6
Central⁽¹⁾		10		4		3		17		963		980		30
Southern⁽²⁾		31		9		14		54		585		639		74
Nordics⁽³⁾		2		—		—		2		115		117		—

Total Europe		51		16		19		86		2,833		2,919		116

Other		2		1		—		3		85		88		—

Total	$	139	$	32	$	27	$	198	$	6,655	$	6,853	$	241


	December 31, 2010
	Current		31-90 Days Past Due		>90 Days Past Due		Total Billed Finance Receivables		Unbilled Finance Receivables		Total Finance Receivables		Finance Receivables >90 Days and Accruing
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

Canada		3		3		1		7		865		872		28

France		1		1		—		2		673		675		5
U.K./Ireland		4		1		1		6		415		421		7
Central⁽¹⁾		9		2		4		15		898		913		39
Southern⁽²⁾		32		10		15		57		524		581		99
Nordics⁽³⁾		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

(1)	Switzerland, Germany, Austria, Belgium and Holland.

(2)	Italy, Greece, Spain and Portugal.

(3)	Sweden, Norway, Denmark and Finland.


		13		Xerox 2011 Form 10-Q

Note 6 – Inventories

The following is a summary of Inventories by major category:


	June 30, 2011		December 31, 2010
Finished goods	$	964	$	858
Work-in-process		67		46
Raw materials		98		87

Total Inventories	$	1,129	$	991

Note 7 – Investment in Affiliates, at Equity

Our equity in net income of our unconsolidated affiliates was as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Fuji Xerox	$	31	$	23	$	62	$	18
Other investments		3		5		6		8

Total Equity in Net Income of Unconsolidated Affiliates	$	34	$	28	$	68	$	26

Fuji Xerox

Equity in net income of Fuji Xerox is affected by certain adjustments to reflect the deferral of profit associated with intercompany sales. These adjustments may result in recorded equity income that is different from that implied by our 25% ownership interest. Equity income for the six months ended June 30, 2011 and 2010 includes after-tax restructuring charges of $15 and $27, respectively, primarily reflecting Fuji Xerox’s continued cost-reduction initiatives.

Condensed financial data of Fuji Xerox was as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Summary of Operations:
Revenues	$	2,852	$	2,609	$	5,944	$	5,466
Costs and expenses		2,645		2,416		5,542		5,239

Income before income taxes		207		193		402		227
Income tax expense		64		78		124		107

Net Income		143		115		278		120
Less: Net income – noncontrolling interests		1		2		2		2

Net Income – Fuji Xerox	$	142	$	113	$	276	$	118

Weighted Average Rate⁽¹⁾		81.59		92.08		81.87		91.34

(1)	Represents Yen/U.S. Dollar exchange rate used to translate.


		14		Xerox 2011 Form 10-Q

Note 8 – Restructuring Programs

Information related to restructuring program activity during the six months ended June 30, 2011 is outlined below:


	Severance and Related Costs			Lease Cancellation and Other Costs			Total
Balance December 31, 2010	$	298		$	25		$	323

Restructuring provision		23			1			24
Reversals of prior accruals		(43	)		(5	)		(48	)

Net current period charges⁽¹⁾		(20	)		(4	)		(24	)
Charges against reserve and currency		(113	)		(7	)		(120	)

Balance June 30, 2011	$	165		$	14		$	179

(1)	Represents net amount recognized within the Condensed Consolidated Statements of Income for the period shown.

Reconciliation to the Condensed Consolidated Statements of Cash Flows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Charges against reserve	$	(67	)	$	(60	)	$	(120	)	$	(83	)
Asset impairment		—			—			—			4
Effects of foreign currency and other non-cash items		4			5			—			(15	)

Cash Payments for Restructurings	$	(63	)	$	(55	)	$	(120	)	$	(94	)


The following table summarizes the total amount of costs incurred in connection with these restructuring programs by segment:
	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Technology	$	(7	)	$	7		$	(19	)	$	136
Services		1			2			—			45
Other		(3	)		2			(5	)		25

Total Net Restructuring Charges	$	(9	)	$	11		$	(24	)	$	206

Note 9 – Debt

Xerox Capital Trust I

In May 2011, Xerox Capital Trust I (“Trust I”), our wholly owned subsidiary, redeemed its 8% Preferred Securities due in 2027 of $650 with funds received from the settlement of our liability to Trust I. The settlement and redemption resulted in a pre-tax loss on extinguishment of debt of $33 ($20 after-tax), representing the call premium of approximately $10 and the write-off of unamortized debt costs and other liability carrying value adjustments of approximately $23.

Senior Notes

In May 2011, we issued $300 of Floating Rate Senior Notes due 2014 (the “2014 Floating Rate Notes”) and $700 of 4.50% Senior Notes due 2021 (the “2021 Senior Notes”). The 2014 Floating Rate Notes were issued at par and the 2021 Senior Notes were issued at 99.246% of par, resulting in aggregate net proceeds for both notes of approximately $995. The 2014 Floating Rate Notes accrue interest at a rate per annum, reset quarterly, equal to the three-month LIBOR plus 0.820% and are payable quarterly. The 2021 Senior Notes accrued interest at a rate of 4.50% per annum and are payable semi-annually. As a result of the discount, they have a weighted average effective interest rate of 4.595%. Proceeds from the offering were used to redeem the $650 Trust I 8% Preferred Securities mentioned above and for general corporate purposes.


		15		Xerox 2011 Form 10-Q

Credit Facility

In the second quarter 2011, two lenders to our Credit Facility agreed to extend the maturity date of their portion of the Facility, such that the entire Credit Facility now has a maturity date of April 30, 2013. Prior to this amendment, 10% of the Credit Facility had a maturity date of April 30, 2012.

Note 10 – Interest Expense and Income

Interest expense and interest income were as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Interest expense⁽¹⁾	$	124	$	153	$	251	$	306
Interest income⁽²⁾		168		168		337		346

(1)	Includes Equipment financing interest, as well as non-financing interest expense that is included in Other expenses, net in the Condensed Consolidated Statements of Income.

(2)	Includes Finance income, as well as other interest income that is included in Other expenses, net in the Condensed Consolidated Statements of Income.

Note 11 – Financial Instruments

Interest Rate Risk Management

We use interest rate swap agreements to manage our interest rate exposure and to achieve a desired proportion of variable and fixed rate debt. These derivatives may be designated as fair value hedges or cash flow hedges depending on the nature of the risk being hedged.

Fair Value Hedges

At June 30, 2011 we did not have any interest rate swaps. At December 31, 2010 pay variable/receive fixed interest rate swaps, with notional amounts of $950 and net asset fair values of $11, were designated and accounted for as a fair value hedges. The swaps were structured to hedge the fair value of related debt by converting them from fixed rate instruments to variable rate instruments. No ineffective portion was recorded to earnings during 2011 or 2010.

Terminated Swaps

During the six months ended June 30, 2011, we terminated early several interest rate swaps that had been designated as fair value hedges of certain debt instruments. The net proceeds from these terminated swaps were $27 and are classified in cash flows from operations in the Statement of Cash Flows. These terminated interest rate swaps had an aggregate notional value of $2,150. The fair value adjustment of $(27) to the debt instruments is being amortized to interest income over the remaining term of the related notes.

Foreign Exchange Risk Management

We are a global company that is exposed to foreign currency exchange rate fluctuations in the normal course of our business. As a part of our foreign exchange risk management strategy, we use derivative instruments, primarily forward contracts and purchase option contracts, to hedge the following foreign currency exposures, thereby reducing volatility of earnings or protecting fair values of assets and liabilities:

•

Foreign currency-denominated assets and liabilities

•

Forecasted purchases and sales in foreign currency

Summary of Foreign Exchange Hedging Positions

At June 30, 2011, we had outstanding forward exchange and purchased option contracts with gross notional values of $3,675, which is reflective of the amounts that are normally outstanding at any point during the year. These contracts generally mature in 12 months or less.


		16		Xerox 2011 Form 10-Q

The following is a summary of the primary hedging positions and corresponding fair values as of June 30, 2011:


Currency Hedged (Buy/Sell)	Gross Notional Value		Fair Value Asset (Liability)⁽¹⁾
Euro/U.K. Pound Sterling	$	811	$	12
U.S. Dollar/Euro		620		(10	)
Japanese Yen/U.S. Dollar		388		6
Japanese Yen/Euro		323		(3	)
Swiss Franc/Euro		228		6
U.K. Pound Sterling/U.S. Dollar		214		—
Canadian Dollar/Euro		155		—
Euro/U.S. Dollar		138		2
U.K. Pound Sterling/Euro		125		(4	)
Swedish Kronor/Euro		98		—
U.K. Pound Sterling/Swiss Franc		79		(3	)
Mexican Peso/U.S. Dollar		67		2
Danish Krone/Euro		61		—
Indian Rupee/U.S. Dollar		58		1
Norwegian Kroner/Euro		52		—
All Other		258		(3	)

Total Foreign Exchange Hedging	$	3,675	$	6

(1)	Represents the net receivable (payable) amount included in the Condensed Consolidated Balance Sheet at June 30, 2011.

Foreign Currency Cash Flow Hedges

We designate a portion of our foreign currency derivative contracts as cash flow hedges of our foreign currency-denominated inventory purchases, sales and expenses. No amount of ineffectiveness was recorded in the Condensed 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. The net asset fair value of these contracts was less than $1 and $18 as of June 30, 2011 and December 31, 2010, respectively.


		17		Xerox 2011 Form 10-Q

Summary of Derivative Instruments Fair Value

The following table provides a summary of the fair value amounts of our derivative instruments:


Designation of Derivatives	Balance Sheet Location	June 30, 2011			December 31, 2010
Derivatives Designated as Hedging Instruments
Foreign exchange contracts – forwards	Other current assets	$	10		$	19
	Other current liabilities		(10	)		(1	)
Interest rate swaps	Other long-term assets		—			11

	Net Designated Asset	$	—		$	29


Derivatives NOT Designated as Hedging Instruments
Foreign exchange contracts – forwards	Other current assets	$	23		$	26
	Other current liabilities		(17	)		(18	)

	Net Undesignated Asset	$	6		$	8


Summary of Derivatives	Total Derivative Assets	$	33		$	56
	Total Derivative Liabilities		(27	)		(19	)

	Net Derivative Asset	$	6		$	37

Summary of Derivative Instruments Gains (Losses)

Derivative gains and (losses) affect the income statement based on whether such derivatives are designated as hedges of underlying exposures. The following is a summary of derivative gains and (losses).

Designated Derivative Instruments Gains (Losses)

The following tables provide a summary of gains (losses) on derivative instruments:


Derivatives in Fair Value Relationships	Location of Gain (Loss) Recognized in Income	Derivative Gain (Loss) Recognized in Income Three Months Ended June 30,				Hedged Item Gain (Loss) Recognized in Income Three Months Ended June 30,
Derivatives in Fair Value Relationships	Location of Gain (Loss) Recognized in Income	2011		2010		2011			2010
Interest rate contracts	Interest expense	$	17	$	55	$	(17	)	$	(55	)

Derivatives in Fair Value Relationships	Location of Gain (Loss) Recognized in Income	Derivative Gain (Loss) Recognized in Income Six Months Ended June 30,				Hedged Item Gain (Loss) Recognized in Income Six Months Ended June 30,
Derivatives in Fair Value Relationships	Location of Gain (Loss) Recognized in Income	2011		2010		2011			2010
Interest rate contracts	Interest expense	$	16	$	77	$	(16	)	$	(77	)


		18		Xerox 2011 Form 10-Q


Derivatives in Cash Flow Hedging Relationships	Derivative Gain (Loss) Recognized in OCI (Effective Portion) Three Months Ended June 30,					Location of Derivative Gain (Loss) Reclassified from AOCI into Income (Effective Portion)	Gain (Loss) Reclassified from AOCI to Income (Effective Portion) Three Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	2011			2010			2011			2010
Foreign exchange contracts – forwards	$	3		$	16	Cost of sales	$	(7	)	$	7

Derivatives in Cash Flow Hedging Relationships	Derivative Gain (Loss) Recognized in OCI (Effective Portion) Six Months Ended June 30,					Location of Derivative Gain (Loss) Reclassified from AOCI into Income (Effective Portion)	Gain (Loss) Reclassified from AOCI to Income (Effective Portion) Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	2011			2010			2011			2010
Foreign exchange contracts – forwards	$	(24	)		25	Cost of sales	$	(4	)		11

No amount of ineffectiveness was recorded in the Condensed 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. In addition, no amount was recorded for an underlying exposure that did not occur or was not expected to occur.

At June 30, 2011, net gains of less than $1 were recorded in accumulated other comprehensive loss associated with our cash flow hedging activity. The entire balance is expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

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 since 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:


Derivatives NOT Designated as Hedging Instruments		Three Months Ended June 30,				Six Months Ended June 30,
Derivatives NOT Designated as Hedging Instruments	Location of Derivative Gain (Loss)	2011		2010		2011			2010
Foreign exchange contracts – forwards	Other expense – Currency gains (losses), net	$	15	$	67	$	(16	)	$	89

During the three months ended June 30, 2011 and 2010, we recorded Currency gains, net of $0 and $2, respectively. During the six months ended June 30, 2011 and 2010, we recorded Currency losses, net of $(1) and $(20), respectively. Currency losses, net includes the mark-to-market adjustments of the derivatives not designated as hedging instruments and the related cost of those derivatives, as well as the re-measurement of foreign currency-denominated assets and liabilities.


		19		Xerox 2011 Form 10-Q

Note 12 – Fair Value of Financial Assets and Liabilities

The following table represents assets and liabilities measured at fair value on a recurring basis. The basis for the measurement at fair value in all cases is Level 2 – Significant Other Observable Inputs.


	June 30, 2011		December 31, 2010
Assets:
Foreign exchange contracts-forwards	$	33	$	45
Interest rate swaps		—		11
Deferred compensation investments in cash surrender life insurance		72		70
Deferred compensation investments in mutual funds		23		22

Total	$	128	$	148

Liabilities:
Foreign exchange contracts-forwards	$	27	$	19
Deferred compensation plan liabilities		100		98

Total	$	127	$	117

We utilize the income approach to measure the fair value for our derivative assets and liabilities. The income approach uses pricing models that rely on market observable inputs such as yield curves, currency exchange rates and forward prices, and therefore are classified as Level 2.

Fair value for our deferred compensation plan investments in Company-owned life insurance is reflected at cash surrender value. Fair value for our deferred compensation plan investments in mutual funds is based on quoted market prices for actively traded investments similar to those held by the plan. Fair value for deferred compensation plan liabilities is based on the fair value of investments corresponding to employees’ investment selections, based on quoted prices for similar assets in actively traded markets.

Summary of Other Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis

The estimated fair values of our other financial assets and liabilities not measured at fair value on a recurring basis were as follows:


	June 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Cash and cash equivalents	$	1,098	$	1,098	$	1,211	$	1,211
Accounts receivable, net		2,921		2,921		2,826		2,826
Short-term debt		2,197		2,238		1,370		1,396
Long-term debt		7,113		7,630		7,237		7,742
Liability to subsidiary trust issuing preferred securities		—		—		650		670

The fair value amounts for Cash and cash equivalents and Accounts receivable, net, approximate carrying amounts due to the short maturities of these instruments. The fair value of Short- and Long-term debt, as well as our Liability to subsidiary trust issuing preferred securities, was estimated based on quoted market prices for publicly traded securities or on the current rates offered to us for debt of similar maturities. The difference between the fair value and the carrying value represents the theoretical net premium or discount we would pay or receive to retire all debt at such date.


		20		Xerox 2011 Form 10-Q

Note 13 – Employee Benefit Plans

The components of Net periodic benefit cost and other changes in plan assets and benefit obligations were as follows:


	Pension Benefits												Retiree Health
	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010			2011			2010			2011			2010
Components of Net Periodic Benefit Costs:
Service cost	$	46		$	42		$	94		$	88		$	2		$	2		$	4		$	4
Interest cost		121			118			239			238			12			14			24			28
Expected return on plan assets		(130	)		(116	)		(257	)		(236	)		—			—			—			—
Recognized net actuarial loss		19			19			36			35			—			—			—			—
Amortization of prior service credit		(6	)		(5	)		(12	)		(10	)		(10	)		(7	)		(20	)		(13	)
Recognized settlement loss		20			15			50			46			—			—			—			—

Net periodic benefit cost		70			73			150			161			4			9			8			19


Other changes in plan assets and benefit obligations recognized in Other Comprehensive Income:
Net actuarial loss (gain) ⁽²⁾		(9	)		—			(9	)		—			—			—			—			—
Amortization of net prior service credit		6			5			12			10			10			7			20			13
Amortization of net actuarial losses		(39	)		(34	)		(86	)		(81	)		—			—			—			—

Total recognized in Other Comprehensive Income⁽¹⁾		(42	)		(29	)		(83	)		(71	)		10			7			20			13

Total recognized in Net Periodic Benefit Cost and Other Comprehensive Income	$	28		$	44		$	67		$	90		$	14		$	16		$	28		$	32

(1)	Amount represents the pre-tax effect included within Other comprehensive income. The amount, net of tax, is included within Note 14, Shareholders’ Equity.

(2)	Represents adjustments for the actual valuation results based on January 1, 2011 plan census data for the U.S.

The following table provides a summary of the components of the Net change in benefit plans included within Other comprehensive income as reported in Note 14, Shareholders’ Equity:


	Three Months Ended June 30,						Six Months Ended June 30,
(Expense)/benefit	2011			2010			2011			2010
Other changes in plan assets and benefit obligations	$	32		$	22		$	63		$	58
Income tax		(11	)		(6	)		(22	)		(20	)
Fuji Xerox changes in defined benefit plans⁽¹⁾		(3	)		(3	)		(21	)		33
Currency, net		(4	)		11			(40	)		53
Other, net		—			(4	)		(2	)		(5	)

Net Change in Benefit Plans	$	14		$	20			$ (22)		$	119

(1)	Represents our share of Fuji Xerox’s changes.

Contributions: During the six months ended June 30, 2011, we made contributions of $123 and $39 to our defined benefit pension plans and our other post-retirement benefit plans, respectively. We presently anticipate contributing an additional $377 to our defined benefit pension plans and $48 to our other post-retirement benefit plans in 2011 for a total of $500 and $87, respectively.


		21		Xerox 2011 Form 10-Q

Note 14 – Shareholders’ Equity


	Common Stock		Additional Paid-in Capital		Retained Earnings			AOCL			Xerox Shareholders’ Equity			Non- controlling Interests			Total Equity
Balance at December 31, 2010	$	1,398	$	6,580	$	6,016		$	(1,988	)	$	12,006		$	153		$	12,159
Net income		—		—		600			—			600			16			616
Translation adjustments		—		—		—			450			450			—			450
Changes in benefit plans⁽¹⁾		—		—		—			(22	)		(22	)		—			(22	)
Other unrealized losses, net		—		—		—			(15	)		(15	)		—			(15	)

Comprehensive Income											$	1,013		$	16		$	1,029

Cash dividends declared-common stock⁽³⁾		—		—		(122	)		—			(122	)		—			(122	)
Cash dividends declared-preferred stock⁽⁴⁾		—		—		(12	)		—			(12	)		—			(12	)
Stock option and incentive plans		5		88		—			—			93			—			93
Tax benefit on stock option and incentive plans, net		—		2		—			—			2			—			2
Distributions to noncontrolling interests		—		—		—			—			—			(10	)		(10	)
Other		—		—		—			—			—			2			2

Balance at June 30, 2011	$	1,403	$	6,670	$	6,482		$	(1,575	)	$	12,980		$	161		$	13,141


	Common Stock		Additional Paid-in Capital		Retained Earnings			AOCL			Xerox Shareholders’ Equity			Non- controlling Interests			Total Equity
Balance at December 31, 2009	$	871	$	2,493	$	5,674		$	(1,988	)	$	7,050		$	141		$	7,191
Net income		—		—		185			—			185			17			202
Translation adjustments		—		—		—			(544	)		(544	)		(1	)		(545	)
Changes in benefit plans⁽¹⁾		—		—		—			119			119			—			119
Other unrealized gains, net		—		—		—			10			10			—			10

Comprehensive (Loss) Income											$	(230	)	$	16		$	(214	)

ACS Acquisition⁽²⁾		490		3,825		—			—			4,315			—			4,315
Cash dividends declared-common stock⁽³⁾		—		—		(121	)		—			(121	)		—			(121	)
Cash dividends declared-preferred stock⁽⁴⁾		—		—		(9	)		—			(9	)		—			(9	)
Stock option and incentive plans		23		150		—			—			173			—			173
Tax benefit on stock option and incentive plans, net		—		7		—			—			7			—			7
Distributions to noncontrolling interests		—		—		—			—			—			(7	)		(7	)

Balance at June 30, 2010	$	1,384	$	6,475	$	5,729		$	(2,403	)	$	11,185		$	150		$	11,335

(1)	Refer to Note 13, Employee Benefit Plans for additional information.

(2)	Refer to Note 4 – Acquisitions for additional information.

(3)	Cash dividends declared on common stock of $0.0425 per share in each quarter of 2011 and 2010.

(4)	Cash dividends declared on preferred stock of $20.00 per share in each quarter of 2011 and 2010 except the first quarter of 2010 which was $12.22 per share.


		22		Xerox 2011 Form 10-Q

Comprehensive Income


	Three Months Ended June 30,					Six Months Ended June 30,
	2011		2010			2011			2010
Net income attributable to Xerox	$	319	$	227		$	600		$	185
Translation adjustments		153		(236	)		450			(544	)
Changes in benefit plans		14		20			(22	)		119
Other unrealized gains (losses), net		6		6			(15	)		10


Comprehensive Income (Loss) – Xerox		492		17			1,013			(230	)
Net income attributable to noncontrolling interests		8		9			16			17
Translation adjustments – noncontrolling interests		—		—			—			(1	)

Comprehensive Income – Noncontrolling Interests		8		9			16			16

Total Comprehensive Income (Loss)	$	500	$	26		$	1,029			$ (214	)

Accumulated Other Comprehensive Loss (“AOCL”)


	June 30, 2011			December 31, 2010
Cumulative translation adjustments	$	(385	)	$	(835	)
Benefit plans net actuarial losses and prior service credits ⁽¹⁾		(1,189	)		(1,167	)
Other unrealized (losses) gains, net		(1	)		14

Total Accumulated Other Comprehensive Loss	$	(1,575	)	$	(1,988	)

(1)	Includes our share of Fuji Xerox – refer to Note 13 for additional information.


		23		Xerox 2011 Form 10-Q

Note 15 – Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share of common stock (shares in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Basic Earnings per Share:
Net income attributable to Xerox	$	319		$	227		$	600		$	185
Accrued dividends on preferred stock		(6	)		(6	)		(12	)		(9	)
Adjusted Net Income Available to Common Shareholders	$	313		$	221		$	588		$	176

Weighted-average common shares outstanding		1,402,206			1,383,283			1,401,065			1,265,080

Basic Earnings per Share	$	0.22		$	0.16		$	0.42		$	0.14


Diluted Earnings per Share:
Net income attributable to Xerox	$	319		$	227		$	600		$	185
Accrued dividends on preferred stock		(6	)		(6	)		(12	)		(9	)
Interest on Convertible Securities, net		—			—			1			—

Adjusted Net Income Available to Common Shareholders	$	313		$	221		$	589		$	176


Weighted-average common shares outstanding		1,402,206			1,383,283			1,401,065			1,265,080
Common shares issuable with respect to:
Stock options		11,698			14,393			12,485			12,439
Restricted stock and performance shares		22,000			18,984			20,903			16,756
Convertible securities		1,992			1,992			1,992			—

Adjusted Weighted Average Common Shares Outstanding		1,437,896			1,418,652			1,436,445			1,294,275

Diluted Earnings per Share	$	0.22		$	0.16		$	0.41		$	0.14

The following securities were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive:

Stock options		53,745			109,790			52,958			111,744
Restricted stock and performance shares		15,892			12,852			16,989			15,080
Convertible preferred stock		26,966			26,966			26,966			26,966
Convertible securities		—			—			—			1,992

		96,603			149,608			96,913			155,782


Dividends per common share	$	0.0425		$	0.0425		$	0.0850		$	0.0850


		24		Xerox 2011 Form 10-Q

Note 16 – Contingencies

Brazil Tax and Labor Contingencies

Our Brazilian operations are involved in various litigation matters and have received or been the subject of numerous governmental assessments related to indirect and other taxes, as well as disputes associated with former employees and contract labor. The tax matters, which comprise a significant portion of the total contingencies, principally relate to claims for taxes on the internal transfer of inventory, municipal service taxes on rentals and gross revenue taxes. We are disputing these tax matters and intend to vigorously defend our position. Based on the opinion of legal counsel and current reserves for those matters deemed probable of loss, we do not believe that the ultimate resolution of these matters will materially impact our results of operations, financial position or cash flows. The labor matters principally relate to claims made by former employees and contract labor for the equivalent payment of all social security and other related labor benefits, as well as consequential tax claims, as if they were regular employees. As of June 30, 2011, the total amounts related to the unreserved portion of the tax and labor contingencies, inclusive of any related interest, amounted to approximately $1,420 with the increase from December 31, 2010 balance of approximately $1,274, primarily related to interest, currency and adjustments to existing cases. With respect to the unreserved balance of $1,420, the majority has been assessed by management as being remote as to the likelihood of ultimately resulting in a loss to the company. In connection with the above proceedings, customary local regulations may require us to make escrow cash deposits or post other security of up to half of the total amount in dispute. As of June 30, 2011 we had $294 of escrow cash deposits for matters we are disputing, and there are liens on certain Brazilian assets with a net book value of $19 and additional letters of credit of approximately $262, which include associated indexation. Generally, any escrowed amounts would be refundable and any liens would be removed to the extent the matters are resolved in our favor. We routinely assess all these matters as to probability of ultimately incurring a liability against our Brazilian operations and record our best estimate of the ultimate loss in situations where we assess the likelihood of an ultimate loss as probable.

Legal Matters

As more fully discussed below, we are involved in a variety of claims, lawsuits, investigations and proceedings concerning securities law, intellectual property law, environmental law, employment law and the Employee Retirement Income Security Act (“ERISA”). We determine whether an estimated loss from a contingency should be accrued by assessing whether a loss is deemed probable and can be reasonably estimated. We assess our potential liability by analyzing our litigation and regulatory matters using available information. We develop our views on estimated losses in consultation with outside counsel handling our defense in these matters, which involves an analysis of potential results, assuming a combination of litigation and settlement strategies. Should developments in any of these matters cause a change in our determination as to an unfavorable outcome and result in the need to recognize a material accrual, or should any of these matters result in a final adverse judgment or be settled for significant amounts, they could have a material adverse effect on our results of operations, cash flows and financial position in the period or periods in which such change in determination, judgment or settlement occurs.


		25		Xerox 2011 Form 10-Q

Litigation Against the Company

In re Xerox Corporation Securities Litigation: A consolidated securities law action (consisting of 17 cases) is pending in the United States District Court for the District of Connecticut. Defendants are the Company, Barry Romeril, Paul Allaire and G. Richard Thoman. The consolidated action is a class action on behalf of all persons and entities who purchased Xerox Corporation common stock during the period October 22, 1998 through October 7, 1999 inclusive (“Class Period”) and who suffered a loss as a result of misrepresentations or omissions by Defendants as alleged by Plaintiffs (the “Class”). The Class alleges that in violation of Section 10(b) and/or 20(a) of the Securities Exchange Act of 1934, as amended (“1934 Act”), and SEC Rule 10b-5 thereunder, each of the defendants is liable as a participant in a fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of the Company’s common stock during the Class Period by disseminating materially false and misleading statements and/or concealing material facts relating to the defendants’ alleged failure to disclose the material negative impact that the April 1998 restructuring had on the Company’s operations and revenues. The complaint further alleges that the alleged scheme: (i) deceived the investing public regarding the economic capabilities, sales proficiencies, growth, operations and the intrinsic value of the Company’s common stock; (ii) allowed several corporate insiders, such as the named individual defendants, to sell shares of privately held common stock of the Company while in possession of materially adverse, non-public information; and (iii) caused the individual plaintiffs and the other members of the purported class to purchase common stock of the Company at inflated prices. The complaint seeks unspecified compensatory damages in favor of the plaintiffs and the other members of the purported class against all defendants, jointly and severally, for all damages sustained as a result of defendants’ alleged wrongdoing, including interest thereon, together with reasonable costs and expenses incurred in the action, including counsel fees and expert fees. In 2001, the Court denied the defendants’ motion for dismissal of the complaint. The plaintiffs’ motion for class certification was denied by the Court in 2006, without prejudice to refiling. In February 2007, the Court granted the motion of the International Brotherhood of Electrical Workers Welfare Fund of Local Union No. 164, Robert W. Roten, Robert Agius (“Agius”) and Georgia Stanley to appoint them as additional lead plaintiffs. In July 2007, the Court denied plaintiffs’ renewed motion for class certification, without prejudice to renewal after the Court holds a pre-filing conference to identify factual disputes the Court will be required to resolve in ruling on the motion. After that conference and Agius’s withdrawal as lead plaintiff and proposed class representative, in February 2008 plaintiffs filed a second renewed motion for class certification. In April 2008, defendants filed their response and motion to disqualify Milberg LLP as a lead counsel. On September 30, 2008, the Court entered an order certifying the class and denying the appointment of Milberg LLP as class counsel. Subsequently, on April 9, 2009, the Court denied defendants’ motion to disqualify Milberg LLP. On November 6, 2008, the defendants filed a motion for summary judgment. Briefing with respect to the motion is complete. The Court has not yet rendered a decision. The parties also filed motions to exclude the testimony of certain expert witnesses. On April 22, 2009, the Court denied plaintiffs’ motions to exclude the testimony of two of defendants’ expert witnesses. On September 30, 2010, the Court denied plaintiffs’ motion to exclude the testimony of another of defendants’ expert witnesses. The Court also granted defendants’ motion to exclude the testimony of one of plaintiffs’ expert witnesses, and granted in part and denied in part defendants’ motion to exclude the testimony of plaintiffs’ two remaining expert witnesses. The individual defendants and we deny any wrongdoing and are vigorously defending the action. At this time, we do not believe it is reasonably possible that we will incur additional material losses in excess of the amount we have already accrued for this matter. In the course of litigation, we periodically engage in discussions with plaintiffs’ counsel for possible resolution of this matter. Should developments cause a change in our determination as to an unfavorable outcome, or result in a final adverse judgment or a settlement for a significant amount, there could be a material adverse effect on our results of operations, cash flows and financial position in the period in which such change in determination, judgment or settlement occurs.

Other Contingencies

We have issued or provided the following guarantees as of June 30, 2011:

•

$429 for letters of credit issued to i) guarantee our performance under certain services contracts; ii) support certain insurance programs; and iii) support our obligations related to the Brazil tax and labor contingencies.

•

$690 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.


		26		Xerox 2011 Form 10-Q

We have service arrangements where we service third party student loans in the Federal Family Education Loan program (“FFEL”) on behalf of various financial institutions. We service these loans for investors under outsourcing arrangements and do not acquire any servicing rights that are transferable by us to a third party. At June 30, 2011, we serviced a FFEL portfolio of approximately 4.2 million loans with an outstanding principal balance of approximately $58.9 billion. Some servicing agreements contain provisions that, under certain circumstances, require us to purchase the loans from the investor if the loan guaranty has been permanently terminated as a result of a loan default caused by our servicing error. If defaults caused by us are cured during an initial period, any obligation we may have to purchase these loans expires. Loans that we purchase may be subsequently cured, the guaranty reinstated and the loans repackaged for sale to third parties. We evaluate our exposure under our purchase obligations on defaulted loans and establish a reserve for potential losses, or default liability reserve, through a charge to the provision for loss on defaulted loans purchased. The reserve is evaluated periodically and adjusted based upon management’s analysis of the historical performance of the defaulted loans. As of June 30, 2011, other current liabilities include reserves which we believe to be adequate.

Note 17 – Subsequent Events

In July 2011, we acquired Education Sales and Marketing, LLC (“ESM”), a leading contact center firm dedicated to school enrollment, for approximately $45 in cash. The acquisition of ESM will enable us to begin offering broader services to assist post-secondary schools in attracting and retaining the most qualified students. We are in the process of determining the purchase price allocation.

ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Xerox Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes.

Throughout this document, references to “we,” “our,” the “Company,” and “Xerox” refer to Xerox Corporation and its subsidiaries. References to “Xerox Corporation” refer to the stand-alone parent company and do not include its subsidiaries.

To understand the trends in the business, we believe that it is helpful to analyze the impact of changes in the translation of foreign currencies into U.S. dollars on revenue and expenses. We refer to this analysis as “currency impact” or “the impact from currency.” This includes translating the most recent financial results of operations using foreign currency of the earliest period presented. Currencies for our developing market countries (Latin America, Brazil, the Middle East, India, Eurasia and Central-Eastern Europe) are reflected at actual exchange rates for all periods presented, since these countries generally have volatile currency and inflationary environments, and our operations in these countries have historically implemented pricing actions to recover the impact of inflation and devaluation. We do not hedge the translation effect of revenues or expenses denominated in currencies where the local currency is the functional currency.

Overview

Results for the three and six months ended June 30, 2011 include revenue growth and operational improvements. Total revenue of $5.6 billion and $11.1 billion for the three and six months ended June 30, 2011, respectively, reflects an increase of 2% and 8%, respectively, from the prior year. Currency had a 3-percentage point and 2-percentage point favorable impact for the three and six months ended June 30, 2011, respectively. In order to provide a clearer comparison of our year-to-date results to the prior year, we are also providing a discussion and analysis on a year-to-date pro-forma basis, where we include ACS’s 2010 estimated results from January 1 through February 5 in our historical 2010 results. On a pro-forma¹ basis, total revenue for the six months ended June 30, 2011 increased 2%, including a 2-percentage point favorable impact from currency. Revenue growth was primarily driven by increased revenues in our Services segment. Technology revenues in the second quarter 2011 were negatively impacted by the supply constraints on products and supplies, particularly color, sourced from Fuji Xerox (“FX”) as a result of the natural disaster in Japan in the first quarter 2011.


		27		Xerox 2011 Form 10-Q

Net income attributable to Xerox for the three and six months ended June 30, 2011 was $319 million and $600 million, respectively, and included $74 million and $127 million, respectively, of after-tax costs related to amortization of intangibles and other discrete items. Net income attributable to Xerox for the three and six months ended June 30, 2010 was $227 million and $185 million, respectively, and included $115 million and $380 million, respectively, of after-tax costs and expenses related to restructuring, amortization of intangibles, acquisition-related costs and other discrete items. The improvement in net income reflects operational cost savings from restructuring and productivity improvements.

Cash flow from operations was $317 million for the six months ended June 30, 2011. Cash used in investing activities of $368 million primarily reflects capital expenditures of $246 million and acquisitions of $137 million. Cash used in financing activities was $81 million primarily reflecting the second quarter 2011 redemption of Xerox Capital Trust’s $650 million preferred securities and the repayment of $300 million of commercial paper partially offset by the issuance of $1.0 billion in Senior Notes.

Financial Review

Revenues


	Three Months Ended June 30,									Six Months Ended June 30,												Six Months Ended June 30,
																						% of Total Revenue
(in millions)	2011			2010			% Change			2011			2010			% Change			Pro-forma⁽¹⁾ % Change			2011			2010
Equipment sales	$	925		$	930			(1	)%	$	1,751		$	1,752			—	%		—	%		16	%		17	%
Annuity revenue		4,689			4,578			2	%		9,328			8,477			10	%		3	%		84	%		83	%

Total Revenue	$	5,614		$	5,508			2	%	$	11,079		$	10,229			8	%		2	%		100	%		100	%


Memo: Color ⁽²⁾	$	1,672		$	1,579			6	%	$	3,281		$	3,106			6	%		6	%		30	%		30	%

Reconciliation to Condensed Consolidated Statements of Income:
Sales	$	1,720		$	1,791					$	3,391		$	3,469
Less: Supplies, paper and other sales		(795	)		(861	)					(1,640	)		(1,717	)

Equipment Sales	$	925		$	930					$	1,751		$	1,752

Service, outsourcing and rentals	$	3,731		$	3,553					$	7,363		$	6,423
Add: Finance income		163			164						325			337
Add: Supplies, paper and other sales		795			861						1,640			1,717

Annuity Revenue	$	4,689		$	4,578					$	9,328		$	8,477


		28		Xerox 2011 Form 10-Q

Second quarter 2011 total revenues increased 2% compared to the second quarter 2010 including a 3-percentage point positive impact from currency. Equipment and supplies revenues in the second quarter 2011 were negatively impacted by the supply constraints on products and supplies, particularly color, sourced from Fuji Xerox (“FX”) as a result of the natural disaster in Japan in the first quarter 2011. Total revenues included the following:

•

2% increase in annuity revenue, including a 3-percentage point positive impact from currency. Annuity revenue is comprised of the following:

Service, outsourcing and rentals revenue of $3,731 million increased 5%, including a 3-percentage point positive impact from currency. The increase was primarily driven by growth in document and business process outsourcing revenue in our Services segment.

Supplies, paper and other sales of $795 million declined 8% including a 2-percentage point positive impact from currency. The decline was driven by a 7% decline in supplies revenue due to a combination of supply constraints on supplies sourced from FX and the impact of the year-over-year timing of price increases.

•

1% decrease in equipment sales revenue, including a 3-percentage point positive impact from currency. Install activity was impacted by supply constraints on products sourced from FX while price declines were in the historical range of 5% to 10%.

•

6% increase in color revenue², including a 5-percentage point positive impact from currency, reflects:

8% increase in color² annuity revenue, including a 5-percentage point positive impact from currency. The increase was driven by higher color page volumes.

1% increase in color² equipment sales revenue, including a 6-percentage point positive impact from currency. Install activity was impacted by supply constraints on products sourced from FX.

Total revenues for the six months ended June 30, 2011 increased 8% compared to the prior year period including a 2-percentage point positive impact from currency. Our 2011 revenues include a full six-months of revenues from ACS, which was acquired on February 5, 2010. On a pro-forma¹ basis, including ACS’s estimated 2010 revenues for the period from January 1 through February 5 in our historical 2010 results, total revenue for the six months ended June 30, 2011 grew 2%, including a 2-percentage point positive impact from currency. Total revenues included the following:

•

Annuity revenue increased 10% or 3% on a pro-forma¹ basis including a 2-percentage point positive impact from currency. Annuity revenue is comprised of the following:

Service, outsourcing and rentals revenue of $7,363 million increased 15% or 5% on a pro-forma¹ basis, including a 2-percentage point positive impact from currency primarily due to growth in business process and document outsourcing revenue in our Services segment partially offset by a decline in digital pages of approximately 4%.

Supplies, paper and other sales of $1,640 million decreased 4% or 6% on a pro-forma¹ basis, with a 1-percentage point positive impact from currency. The decrease was driven by a decline in supplies revenue due to a combination of supply constraints on supplies sourced from FX and the impact of the year-over-year timing of price increases as well as a decline in paper sales.

•

Equipment sales revenue was flat and included a 2-percentage point positive impact from currency. A decline in install activity was driven by supply constraints on products sourced from FX and weakness in entry products, particularly in our developing markets.

•

6% increase in color revenue², including a 3-percentage point positive impact from currency reflecting:

7% increase in color² annuity revenue, with a 1-percentage point negative impact from currency. The increase was driven by higher color page volumes, which increased 8%.

2% increase in color² equipment sales revenue, including a 3-percentage point positive impact from currency. Install activity was impacted by supply chain constraints on products sourced from FX.

(1)	Growth on a pro-forma basis reflects the inclusion of ACS’s adjusted results from January 1 through February 5 in 2010. See the “Non-GAAP Financial Measures” section for an explanation of these non-GAAP financial measures.

(2)	Represents revenues from color devices and is a subset of total revenues and exclude Global Imaging Systems (“GIS”) revenues.

An analysis of the change in revenue for each business segment is included in the “Segment Review” section.


		29		Xerox 2011 Form 10-Q

Costs, Expenses and Other Income

Summary of Key Financial Ratios


	Three Months Ended June 30,								Six Months Ended June 30,								Six Months Ended June 30,
	2011			2010			Change		2011			2010			Change		Pro-forma⁽¹⁾ 2010			Pro-forma⁽¹⁾ Change
Total Gross Margin		33.4	%		34.8	%		(1.4) pts		33.2	%		35.4	%		(2.2) pts		34.3	%		(1.1) pts
RD&E as a % of Revenue		3.1	%		3.5	%		(0.4) pts		3.2	%		3.9	%		(0.7) pts		3.7	%		(0.5) pts
SAG as a % of Revenue		19.9	%		21.1	%		(1.2) pts		20.2	%		22.1	%		(1.9) pts		21.4	%		(1.2) pts
Operating Margin⁽³⁾		10.4	%		10.1	%		0.3 pts		9.8	%		9.4	%		0.4 pts		9.2	%		0.6 pts
Pre-tax Income Margin		7.1	%		5.8	%		1.3 pts		6.8	%		3.0	%		3.8 pts		2.5	%		4.3 pts

The second quarter 2011 operating margin³ of 10.4% increased 0.3-percentage points as compared to the second quarter of 2010. The increase was due primarily to disciplined cost and expense management.

The operating margin³ for the six months ended June 30, 2011 of 9.8% increased 0.4-percentage points, or 0.6-percentage points on a pro-forma¹ basis as compared to the prior year period. The increase was due primarily to disciplined cost and expense management combined with a favorable mix impact from the continued growth in Services revenue.

Note: The acquisition of ACS increased the proportion of our revenue from services, which has a lower gross margin and SAG as a percent of revenue than we historically experienced when Xerox was primarily a technology company. As a result, gross margins and SAG for the six months ended June 30, 2011, are also discussed below on a pro-forma¹ basis, with ACS’s 2010 estimated results from January 1 through February 5 included in our historical 2010 results. See “Non-GAAP Financial Measures” section for a further explanation and discussion of this non-GAAP presentation.

Gross Margin

Gross margin for the second quarter 2011 of 33.4% decreased 1.4-percentage points, as compared to the second quarter of 2010. The decrease was driven by the ramping of new services contracts, the line-of-business mix within the Services segment and the higher mix of Services revenue. Price erosion was offset by the impact of cost productivities and restructuring savings.

Gross margin for six months ended June 30, 2011 of 33.2% decreased 2.2-percentage points, or 1.1-percentage points on a pro-forma¹ basis as compared to the prior year comparable period. The decrease was driven by the ramping of new services contracts, the line of business mix within the Services segment, transaction currency and the higher mix of Services revenue. Price erosion was offset by the impact of cost productivities and restructuring savings.

Technology gross margin for the second quarter of 2011 decreased 1.3-percentage points as compared to the second quarter 2010, due to a lower supplies mix and additional freight and logistics costs related to the equipment and supplies sourced from Japan.

Technology gross margin for the six months ended June 30, 2011 decreased by 1.4-percentage points as compared to the prior year comparable period due to the negative year-over-year impact of transaction currency as well as the supplies mix and additional freight and logistics costs related to equipment and supplies sourced from Japan.

Services gross margin for the second quarter of 2011 decreased 1.1-percentage points as compared to the second quarter 2010. The decrease is due primarily to the ramping of new services contracts and line of business mix.

Services gross margin for the six months ended June 30, 2011 decreased 0.7-percentage points as compared to the prior year comparable period. The decrease is primarily due to the ramping of new services contracts and line of business mix.


		30		Xerox 2011 Form 10-Q

Research, Development and Engineering Expenses (“RD&E”)


	Three Months Ended June 30,							Six Months Ended June 30,
(in millions)	2011		2010		Change			2011		2010		Change
R&D	$	147	$	160	$	(13	)	$	303	$	333	$	(30	)
Sustaining engineering		28		34		(6	)		56		66		(10	)

Total RD&E Expenses	$	175	$	194	$	(19	)	$	359	$	399	$	(40	)

Second quarter 2011 RD&E as a percent of revenue of 3.1% decreased 0.4-percentage points from the second quarter 2010. In addition to lower spending, the decrease was also driven by the positive mix impact of the continued growth in Services revenue.

Second quarter 2011 RD&E of $175 million was $19 million lower than the second quarter 2010, reflecting the impact of restructuring and productivity improvements.

RD&E as a percent of revenue for the six months ended June 30, 2011 of 3.2% decreased 0.7-percentage points. In addition to lower spending, the decrease was also driven by the positive mix impact of the continued growth in Services revenue.

RD&E of $359 million for the six months ended June 30, 2011, was $40 million lower reflecting the impact of restructuring and productivity improvements. Innovation is one of our core strengths and we continue to invest at levels that enhance this core strength, particularly in color, software and services. Xerox R&D is strategically coordinated with Fuji Xerox.

Selling, Administrative and General Expenses (“SAG”)

SAG as a percent of revenue of 19.9%, decreased 1.2-percentage points from the second quarter 2010. In addition to spending reductions including lower compensation, the decrease was also driven by positive mix impact from the continued growth in Services revenue, which historically has a lower SAG percent of revenue.

SAG as a percent of revenue of 20.2%, decreased 1.9-percentage points, or 1.2-percentage points on a pro-forma¹ basis for the six months ended June 30, 2011. In addition to spending reductions and lower compensation, the decrease was also driven by positive mix impact from the continued growth in Services revenue.

SAG expenses of $1,119 million in the second quarter 2011 were $44 million lower than the second quarter 2010, including a $39 million unfavorable impact from currency. SAG expense reflects the following:

•

$5 million decrease in selling expenses, reflecting benefits from restructuring and productivity improvements, partially offset by the impact of acquisitions and increased brand advertising.

•

$22 million decrease in general and administrative expenses, reflecting the benefits from restructuring and operational improvements.

•

$17 million decrease in bad debt expenses to $29 million, reflecting an improving write-off trend. 2011 second quarter bad debt expense continues to remain less than one percent of receivables.

SAG expenses of $2,238 million for the six months ended June 30, 2011 were $24 million lower than the prior year period, or $84 million lower on a pro-forma¹ basis, both including a $44 million unfavorable impact from currency. The pro-forma SAG expense increase reflects the following:

•

$14 million increase in selling expenses reflecting the impact of acquisitions and increased brand advertising partially offset by the benefits from restructuring and productivity improvements.

•

$53 million decrease in general and administrative expenses primarily reflecting the benefits from restructuring and operational improvements.

•

$45 million decrease in bad debt expenses to $61 million, reflecting an improving write-off trend.

Restructuring and Asset Impairment Charges

During the second quarter 2011, we recorded net restructuring and asset impairment credits of $9 million, primarily resulting from net reversals and changes in estimated reserve from prior period initiatives.


		31		Xerox 2011 Form 10-Q

During the six months ended June 30, 2011, we recorded net restructuring and asset impairment credits of $24 million, primarily resulting form net reversals and changes in estimated reserve from prior period initiatives.

During the second quarter 2010, we recorded $11 million of net restructuring and asset impairment charges, which included approximately $16 million of severance costs related to headcount reductions of approximately 300 employees primarily in North America. These costs were partially offset by $6 million of net reversals for changes in estimated reserves from prior period initiatives. We recorded $206 million of net restructuring and asset impairment charges for the six months ended June 30, 2010, which included $199 million of severance costs related to headcount reductions of approximately 2,600 employees, lease termination and asset impairment charges of $19 million and $12 million of net reversals primarily due to changes in estimated reserves from prior year initiatives.

The restructuring reserve balance as of June 30, 2011 for all programs was $179 million, of which approximately $168 million is expected to be spent over the next twelve months. Refer to Note 8, Restructuring Programs, in the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs.

Acquisition Related Costs

Costs of $15 million and $63 million were incurred in the three and six months ended June 30, 2010, respectively, in connection with our acquisition of ACS. These costs include $11 million and $53 million, respectively, of transaction costs which represent external costs directly related to completing the acquisition of ACS. The remainder of the acquisition-related costs represents external incremental costs directly related to the integration of ACS and Xerox.

Amortization of Intangible Assets

During the three and six months ended June 30, 2011, we recorded $87 million and $172 million, respectively, of expense related to the amortization of intangible assets, which is $2 million and $30 million higher than the prior year periods, respectively. The increase for the 2011 year-to-date period primarily reflects the additional month of amortization of intangibles associated with our acquisition of ACS as well as the full year-to-date impact of amortization of intangibles associated with acquisitions from the prior year.

Worldwide Employment

Worldwide employment of 133,500 at June 30, 2011 decreased approximately 3,000 from December 31, 2010, primarily due to restructuring related actions that more than offset the impact of acquisitions.

Other Expenses, Net


	Three Months Ended June 30,				Six Months Ended June 30,
(in millions)	2011		2010		2011	2010
Non-financing interest expense	$	64	$	92	$

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