By Trevor Shackelford January 31, 2006 – Xerox Corporation (NYSE: XRX) announced their fourth quarter and fiscal year 2005 results last week. Total revenue of Xerox’s fourth quarter was $4.25 billion, down 2% from $4.33 billion reported for the same period in 2004. This decline is made up of a 2% decline in equipment sales, a 1% decline in post sale and other revenue and a 9% decline in finance income offset by 17% growth in color revenue. Currency had a negative impact of 3% on total revenue. Net income for the fourth quarter was $282 million, or $0.27 per diluted share, up 18% from $240 million, or $0.24 per diluted share reported for the same period in 2004. Total revenue for the full fiscal year 2005 was $15.7 billion, which remains unchanged from 2004. Net income for the full fiscal year 2005 was $978 million, or $0.94 per diluted share, up 9% from $859 million, or $0.86 per diluted share reported for the fiscal year 2004. Contents of this Summary * Quarter Highlights * Segment Performance * Guidance * Raine Radar * Q & A Quarter Highlights • Xerox saw a 17% growth in color revenue. Color revenue for the quarter was $1,348 million, represents 32% of total revenue, compared to 27% of total revenue in the fourth quarter of 2004. • Xerox announced plans to repurchase an additional $500 million of the company’s common stock over the next 6 to 12 months, primarily through open market purchases. • Q4 gross margin was 41.4% increased approximately 0.5% from previous year, reflecting cost improvements, partially offset by change in product mix and price declines. • SG&A expenses decreased $37 million year over year and were 24.6% of revenues in the fourth quarter. • The company generated operating cash flow of $631 for the quarter and $1.4 billion for the full year. • Xerox closed the year with $1.6 billion in cash and short-term investments. • During the fourth quarter, the company used $433 million of cash towards repurchase of its common stock. • Debt was down $2.8 billion year over year and declined by about $200 million from the third quarter of this year. Debt balance at the end of year was $7.3 billion, a reduction of $2.8 billion from year-end 2004. • Effective tax rate for the quarter was 23.9% as compared to 36.6% reported for the same period in 2004. • Worldwide employment of 55,200 declined approximately 1,100 from the third quarter 2005, primarily due to on-going restructuring programs. Segment Performance Production Segment Q4 revenues for the segment were $1.285 billion, down 2% from the same period last year. Production equipment sales declined 1% including a 3% negative impact from currency reflecting strong install growth, which was offset by the product mix. Post sale and other revenue declined 3%, including 3% negative impact from currency and reflecting declines in revenue from black and white digital products and older light lens technology, which were partially offset by growth in color products. Operating profit for the segment was $174 million, declined $28 million from 2004, reflecting reduced gross margins impacted by mix. Color production operating margin continues to improve reflecting the scaling of product platforms. Office Segment Q4 revenues for the segment were $2.027 billion, down 3% from the same period last year. Office equipment sales declined 4% including a 3% negative impact from currency reflecting strong install growth, which was offset by a price decline of approximately 10% as well as the product mix. Post sale and other revenue was unchanged from the fourth quarter of 2004, including the 2% negative impact from currency, reflecting growth in color printing and color multifunction products partially offset by declines in black and white digital and light lens products. Operating profit for the segment was $265 million, up $24 million from 2004. Developing Markets Operations (DMO) Segment Q4 revenues for the segment were $514 million, up 11% from the same period reported in the last year. Equipment sales in the fourth quarter grew 16% reflecting strong growth in Eurasia and Central and Eastern Europe. Post sale and other revenue growth of approximately 8% were primarily driven by strong growth in Eurasia and Central and Eastern Europe. Operating profit for the segment was $17 million, up $11 million from 2004. Other Segment Q4 revenues for the segment were $424 million, down 10% from $473 million reported for the same period last year. Post sale and other revenue in the other segment declined 8% due to declines in paper and other supplies (including SOHO supplies), which comprised approximately two-thirds of segment revenues, were partially offset by growth in value added services. Operating loss for the segment was $10 million improved $57 million from 2004, primarily reflecting a $42 million improvement in currency gains and losses, lower non-financing interest expense of $40 million and lower equity income of $14 million. Guidance Xerox expects first-quarter 2006 earnings in the range of $0.20 - $0.23 per share. The company also reiterated its full-year 2006 guidance of $1.00 - $1.07 per share. Anne M. Mulcahy, Xerox chairman and chief executive officer indicated that she now expects the company will deliver full-year earnings in the high end of this range. The board of directors of Xerox authorized the repurchase of up to $500 million of the company’s common stock over the next 6 to 12 months primarily through open-market purchases. Raine Radar Xerox would be a nice turn-around story, if only they could get a little more traction. The company emphasized the growth of color, but the 18% increase in profits seemed to come more from the company’s stock buy-back program and a lower tax rate than anything, and it still wasn’t as high as most analysts had predicted. Where are the new revenue drivers for the company? More color is great, but where is the impact on either the top or bottom lines? The company simply isn’t seeing it yet. Q & A 1. Cash flow for the first quarter was not particularly high and it’s a low mark for the full year. The company doesn’t see any significant inventory or AR improvements helping to change this during the first quarter. 2. There is no dramatic change in the pension contribution. 3. Color growth and services contract will have positive impact on post sales growth. 4. Xerox expressed confidence about the 3% revenue growth in constant currency for the fiscal year 2006, despite lower equipment sales in the Q4 2005. The company expects strong growth in post sales and in DMO. 5. The company said that growth in color has already offset the weakness in the post sale part of the business. 6. Xerox stated that the growth in developing markets comes primarily from the indirect distribution part of the business, which is low-end printers and low-end multifunction. The strength of that business applies pressure on the overall operating margin of the DMO segment. The company believes the operating margin of DMO will improve during fiscal 2006, with Latin America operations continuing to lead the charge. 7. The company commented that the OEM business provided no real growth year-over-year. 8. Xerox believes that it can deliver growth by the strength of activity and the leveraging of the color business, intended to work with and clearly optimize the industry strengths going forward. 9. The company expects more impact in 2006 from equipment sales.