Xerox Reports Second-Quarter Earnings of 26 Cents Per Share

-- Total revenue up 1 percent

-- Post-sale revenue up 2 percent

-- Gross margins improve to 41.1 percent

-- Operating cash flow of $220 million; debt down $1 billion YOY

-- Increasing stock buyback program by $500 million

Xerox Corporation (NYSE: XRX) announced today second-quarter 2006earnings per share of 26 cents and total revenue of $4 billion.

Total revenue grew 1 percent in the second quarter. Post-sale andfinancing revenue, which represents about 75 percent of Xerox's totalrevenue, increased 2 percent, largely driven by 4 percent post-salegrowth from digital systems. Currency had a negligible impact on totaland post-sale revenue.

Xerox's strategy to boost revenue through annuity from colorproducts and services contracts also contributed to post-sale growthwith a 16 percent increase in color post-sale revenue and 5 percentpost-sale growth from global services. Signings for documentmanagement services were up more than 15 percent in the quarter.

"Our second-quarter performance reflects the positive track Xeroxis on to grow revenue while remaining cost-effective and competitive,"said Anne M. Mulcahy, Xerox chairman and chief executive officer."Revenue is up - the benefit of increasing install rates of Xeroxdigital and color systems as well as continued demand for our documentmanagement services, all of which fuels our healthy annuity stream.Through a disciplined focus on costs and operational improvements, weincreased gross margins and delivered solid bottom-line results.

"During the second quarter, we also announced the acquisition ofAmici LLC, an e-discovery company whose offerings strengthen ourservices portfolio. And, we repurchased $225 million more in Xeroxstock, nearly completing the $1 billion program. Our financialstrength allows us now to increase the buyback program by another $500million.

"This all adds up to consistent, steadily improving progress thatdelivers profitable returns and value for our shareholders," addedMulcahy.

Revenue from Xerox's industry-leading color systems grew 14percent in the second quarter and now represents 34 percent of totalrevenue. "The number of pages printed on Xerox color systems grew 40percent in the quarter. Pages are the power of the annuity stream asthe increasing volume of color pages flows through to post-salerevenue," said Mulcahy, noting that 44 percent of Xerox's equipmentsales now come from color products, a 10 point increase from two yearsago. The company recently expanded its color offerings with five newsystems including the DocuColor(R) 5000 mid-level digital productioncolor press as well as a color printer, digital copiers andmultifunction products aimed at offices small to large.

Equipment sale revenue was flat in the quarter and down 1 percentin constant currency. Installs of key products like production colorpresses and WorkCentre(R) multifunction systems drove up activity inthe company's production and office businesses.

Xerox's production business provides commercial printers anddocument-intensive industries with high-speed digital printing andservices that enable on-demand, personalized printing. Totalproduction revenue increased 1 percent in the second quarter and wasflat in constant currency. Installs of production black-and-whitesystems increased 9 percent, reflecting the continued success of theXerox 4110 light production system. Production color installs grew 96percent as strong demand continued for the DocuColor 240/250multifunction device, Xerox's entry production color system thatprints, copies and scans.

Xerox's office business provides document technology and servicesfor businesses of any size. Total office revenue was up 1 percent andflat in constant currency. Installs of office black-and-white systemswere down 4 percent with 12 percent growth from mid-range systems,which generate higher page volumes, only partially offsetting declinesin desktop devices. In office color, installs of multifunction systemswere up 13 percent driven by the continued success of the officeversion of the DocuColor 240/250 system.

The company also cited continued improvement in its developingmarkets operations. Total revenue grew 7 percent in DMO.

Gross margins were 41.1 percent, a year-over-year increase of 0.7points and a nearly 1 point improvement from the first quarter of thisyear. The company's selling, administrative and general expenses were25.6 percent of revenue, a year-over-year decline of 1.1 points.

In the second quarter, Xerox generated operating cash flow of $220million after contributing $226 million to its U.S. pension plans. Thecompany closed the quarter with $1.2 billion in cash and short-terminvestments. Debt declined $1 billion year over year and about $600million from the first quarter of this year.

Through the first half of 2006, Xerox repurchased $895 million ofits stock since launching the buyback program in October 2005. Thecompany's board recently authorized the repurchase of another $500million.

Xerox expects third-quarter 2006 earnings in the range of 20-22cents per share.

NOTE TO EDITORS: This release contains "forward-lookingstatements" as defined in the Private Securities Litigation Reform Actof 1995. These statements reflect management's current beliefs andexpectations, and are subject to a number of factors that may causeactual results to differ materially. These factors include but are notlimited to the outcome of litigation and regulatory proceedings towhich we may be a party; actions of competitors; changes anddevelopments affecting our industry; quarterly or cyclical variationsin financial results; development of new products and services;interest rates and cost of borrowing; our ability to maintain andimprove cost efficiency of operations; changes in foreign currencyexchange rates; changes in economic conditions, political conditions,trade protection measures, licensing requirements and tax matters inthe foreign countries in which we do business; reliance on thirdparties for manufacturing of products and provision of services; andother risks that are set forth in the "Risk Factors" section, the"Legal Proceedings" section, the "Management's Discussion and Analysisof Results of Operations and Financial Condition" section and othersections of our 2005 Form 10-K and first-quarter 2006 Form 10-Q filedwith the SEC. Additional information concerning these and otherfactors is included in the company's 2005 Form 10-K and first-quarter2006 Form 10-Q filed with the SEC. The company assumes no obligationto update any forward-looking statements as a result of newinformation or future events or developments, except as required bylaw.

NON-GAAP FINANCIAL MEASURES

Constant Currency: To understand the trends in the business, Xeroxbelieves that it is helpful to adjust revenue to exclude the impact ofchanges in the translation of foreign currencies into U.S. dollars.Xerox refers to this adjusted growth as "constant currency."Developing Market currencies are shown at actual exchange rates forboth actual and constant growth rates since these countries generallyhave volatile currency and inflationary environments. The company'soperations in these countries have historically implemented pricingactions to recover the impact of inflation and devaluation. Managementbelieves this measure gives investors an additional perspective ofrevenue trends. The currency impact can be determined as thedifference between actual growth rates and constant currency growthrates.

For the company's second-quarter 2006 management discussion andanalysis, presentation slides and more information about Xerox, visitwww.xerox.com/investor. To receive its RSS news feed, visitwww.xerox.com/news. XEROX(R) and WorkCentre(R) are trademarks of XEROXCORPORATION. DocuColor(R) is used under license.
Xerox Corporation
Condensed Consolidated Statements of Income (Unaudited)

Three Months Ended Six Months Ended
June 30, June 30,
(in millions,
except per-share
data) 2006 2005 % Change 2006 2005 % Change
------------------ ------------------------- -------------------------

Revenues
Sales $1,882 $1,827 3% $3,548 $3,521 1%
Service,
outsourcing and
rentals 1,884 1,874 1% 3,700 3,723 (1%)
Finance income 211 220 (4%) 424 448 (5%)
--------------- ---------------
Total Revenues 3,977 3,921 1% 7,672 7,692 -

Costs and Expenses
Cost of sales 1,200 1,170 3% 2,275 2,217 3%
Cost of service,
outsourcing and
rentals 1,068 1,083 (1%) 2,128 2,145 (1%)
Equipment
financing
interest 76 83 (8%) 152 169 (10%)
Research,
development and
engineering
expenses 230 242 (5%) 455 467 (3%)
Selling,
administrative
and general
expenses 1,020 1,046 (2%) 2,003 2,055 (3%)
Restructuring * *
and asset
impairment
charges 36 194 36 279
Other expenses * *
(income), net 82 (14) 150 (46)
------------------ --------------- ---------------
Total Costs and
Expenses 3,712 3,804 (2%) 7,199 7,286 (1%)
------------------ --------------- ---------------

Income from
Continuing
Operations before
Income Taxes,
Equity Income and
Discontinued
Operations** 265 117 126% 473 406 17%
Income tax * *
expenses
(benefits) 22 (233) 69 (117)
Equity in net
income of
unconsolidated
affiliates 17 20 (15%) 56 57 (2%)
------------------ --------------- ---------------

Income from
Continuing
Operations before
Discontinued
Operations 260 370 (30%) 460 580 (21%)

Income from * *
Discontinued
Operations, net
of tax - 53 - 53
------------------ --------------- ---------------

Net Income $260 $423 (39%) $460 $633 (27%)
Less: Preferred
stock
dividends, net (15) (15) - (29) (29) -
------------------ --------------- ---------------

Income Available
to Common
Shareholders $245 $408 (40%) $431 $604 (29%)
================== =============== ===============

Basic Earnings per
share
Earnings from
Continuing
Operations $0.27 $0.37 (27%) $0.47 $0.57 (18%)
Earnings from * *
Discontinued
Operations - 0.06 - 0.06
--------------- ---------------
Basic Earnings
per Share $0.27 $0.43 (37%) $0.47 $0.63 (25%)
=============== ===============

Diluted Earnings
per share
Earnings from
Continuing
Operations $0.26 $0.35 (26%) $0.46 $0.55 (16%)
Earnings from * *
Discontinued
Operations - 0.05 - 0.05
--------------- ---------------
Diluted Earnings
per Share $0.26 $0.40 (35%) $0.46 $0.60 (23%)
=============== ===============

Note: Certain reclassifications of prior year amounts have been made
to these financial statements to conform to the current year
presentation.

* Percent not meaningful.

** Referred to as "pre-tax income" throughout the remainder of this
document.



Xerox Corporation
Condensed Consolidated Balance Sheets (Unaudited)

(in millions, except share data in June 30, December 31,
thousands) 2006 2005
------------------------------------------- ------------ ------------
Assets
Cash and cash equivalents $982 $1,322
Short-term investments 199 244
------------ ------------
Total cash, cash equivalents and short-
term investments 1,181 1,566
Accounts receivable, net 2,218 2,037
Billed portion of finance receivables, net 287 296
Finance receivables, net 2,610 2,604
Inventories 1,332 1,201
Other current assets 1,098 1,032
------------ ------------
Total current assets 8,726 8,736
Finance receivables due after one year, net 4,874 4,949
Equipment on operating leases, net 439 431
Land, buildings and equipment, net 1,600 1,627
Investments in affiliates, at equity 845 782
Intangible assets, net 270 289
Goodwill 1,748 1,671
Deferred tax assets, long-term 1,535 1,547
Other long-term assets 1,844 1,921
------------ ------------
Total Assets $21,881 $21,953
============ ============

Liabilities and Equity
Short-term debt and current portion of
long-term debt $1,273 $1,139
Accounts payable 1,076 1,043
Accrued compensation and benefits costs 533 621
Unearned income 190 191
Other current liabilities 1,158 1,352
------------ ------------
Total current liabilities 4,230 4,346
Long-term debt 5,846 6,139
Liabilities to subsidiary trusts issuing
preferred securities 604 626
Pension and other benefit liabilities 1,059 1,151
Post-retirement medical benefits 1,207 1,188
Other long-term liabilities 1,384 1,295
------------ ------------
Total liabilities 14,330 14,745
Series C mandatory convertible preferred
stock 889 889
Common stock, including additional paid-in-
capital 4,365 4,741
Treasury stock, at cost (225) (203)
Retained earnings 3,452 3,021
Accumulated other comprehensive loss (930) (1,240)
------------ ------------
Total Liabilities and Equity $21,881 $21,953
============ ============

Shares of common stock issued 919,304 945,106
Treasury stock (15,886) (13,917)
------------ ------------
Shares of common stock outstanding 903,418 931,189
============ ============



Xerox Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
(in millions) 2006 2005 2006 2005
----------------------------------------- -------- ------- -------

Cash Flows from Operating
Activities:
Net
income $260 $423 $460 $633
Adjustments required to
reconcile net income to cash
flows from operating
activities:
Depreciation and amortization 163 167 318 326
Provisions for receivables
and inventory 32 18 66 45
Net gain on sales of
businesses and assets (10) (4) (12) (102)
Distributed (undistributed)
equity in net income of
unconsolidated affiliates 3 2 (34) (33)
Income from discontinued
operations - (53) - (53)
Stock-based compensation 17 10 28 20
Restructuring and other
charges 36 194 36 279
Cash payments for
restructurings (62) (27) (142) (63)
Contributions to pension
benefit plans (248) (255) (280) (279)
Increase in inventories (85) (21) (152) (137)
Increase in equipment on
operating leases (58) (61) (113) (113)
Decrease in finance
receivables 80 95 235 274
Increase in accounts
receivable and billed
portion of finance
receivables (101) (41) (112) (49)
Decrease in other current and
long-term assets 29 80 29 99
Increase in accounts payable
and accrued compensation 103 158 30 157
Net change in income tax
assets and liabilities (10) (346) 2 (273)
Net change in derivative
assets and liabilities (10) (24) 6 51
Increase (decrease) in other
current and long-term
liabilities 61 (9) (7) (107)
Other, net 20 (16) 9 (48)
-------- -------- ------- -------
Net cash provided by
operating activities $220 $290 $367 $627
-------- -------- ------- -------

Cash Flows from Investing
Activities:
Purchases of short-term
investments (54) (196) (99) (196)
Proceeds from sales of short-
term investments 51 6 144 6
Cost of additions to land,
buildings and equipment (46) (43) (77) (76)
Proceeds from sales of land,
buildings and equipment 1 - 3 2
Cost of additions to internal
use software (18) (14) (31) (26)
Proceeds from divestitures
and investments, net 12 - 150 105
Net change in escrow and
other restricted investments 66 11 (22) 42
Other - (1) - (1)
-------- -------- ------- -------
Net cash provided by
(used in) investing
activities 12 (237) 68 (144)
-------- -------- ------- -------

Cash Flows from Financing
Activities:
Cash proceeds from new
secured financings 25 38 74 285
Debt payments on secured
financings (771) (484) (1,105) (952)
Net cash proceeds (payments)
on other debt 119 (958) 791 (1,070)
Payment of liability to
subsidiary trusts issuing
preferred securities - - (100) -
Preferred stock dividends (15) (15) (29) (29)
Proceeds from issuances of
common stock 6 10 28 24
Excess tax benefits from
stock-based compensation 3 - 10 -
Payments to acquire treasury
stock (225) - (463) -
Other (1) (1) (3) 8
-------- -------- ------- -------
Net cash used in
financing activities (859) (1,410) (797) (1,734)
-------- -------- ------- -------
Effect of exchange rate changes
on cash and cash equivalents 11 (29) 22 (55)
-------- -------- ------- -------

Decrease in cash and cash
equivalents (616) (1,386) (340) (1,306)
Cash and cash equivalents at
beginning of period 1,598 3,298 1,322 3,218
-------- -------- ------- -------
Cash and cash equivalents at end
of period $982 $1,912 $982 $1,912
======== ======== ======= =======



Xerox Corporation
Segment Revenues and Segment Operating Profit

Three Months Ended
June 30,
(in millions, except operating margin) 2006 2005 Change
-------------------------------------- -------------------------------

Revenues
Production $1,134 $1,125 1%
Office 1,927 1,914 1%
Developing Markets Operations (DMO) 469 440 7%
Other 447 442 1%
--------------------------
Total Revenues $3,977 $3,921 1%
==========================

Memo: Color* $1,364 $1,200 14%

Operating Profit
Production $88 $79 $9
Office 213 173 40
DMO 34 19 15
Other (13) 66 (79)
--------------------------
Total Operating Profit $322 $337 $(15)
==========================

Operating Margin
Production 7.8% 7.0% 0.8 pts
Office 11.1% 9.0% 2.1 pts
DMO 7.2% 4.3% 2.9 pts
Other (2.9%) 14.9% (17.8) pts
-------------------------------
Total Operating Margin 8.1% 8.6% (0.5) pts
===============================


----------------------------------------------------------------------


Reconciliation to pre-tax income: Three Months Ended
June 30,
------------------
2006 2005
-------- --------
Total segment profit $322 $337
Reconciling items:
Restructuring and asset
impairment charges (36) (194)
Other expenses (4) (6)
Equity in net income of
unconsolidated affiliates (17) (20)
------------------

Pre-tax income: $265 $117
==================


* Color revenues represent a subset of total revenues.

Our reportable segments are consistent with how we manage the business
and view the markets we serve. Our reportable segments are Production,
Office, Developing Markets Operations ("DMO") and Other. The
Production and Office segments are centered around strategic product
groups, which share common technology, manufacturing and product
platforms, as well as classes of customers.

Production: Monochrome 91+ pages per minute (ppm), Color 41+ ppm
excluding 50 ppm with embedded controller; North America &
Europe

Office: Monochrome up to 90 ppm; Color up to 40 ppm as well as 50
ppm with embedded controller; North America & Europe

DMO: Operations in Latin America, Central-Eastern Europe,
Middle East, India, Eurasia, Russia and Africa

Other: Xerox Supplies Business Group (predominantly paper), Wide
Format Systems, Xerox Technology Enterprises ("XTE"),
value added services, royalty and licensing, equity income
and non-allocated corporate items



Financial Review

Summary
Three Months Ended
June 30,
(in millions) 2006 2005 Change
---------------------------------------------- -----------------------

Equipment sales $1,109 $1,109 -%
Post sale and other revenue 2,657 2,592 3%
Finance income 211 220 (4%)
----------------
Total Revenues $3,977 $3,921 1%
================

Reconciliation to Condensed Consolidated Statements of Income

Sales $1,882 $1,827
Less: Supplies, paper and other sales (773) (718)
----------------
Equipment sales $1,109 $1,109

Service, outsourcing and rentals $1,884 $1,874
Add: Supplies, paper and other sales 773 718
----------------
Post sale and other revenue $2,657 $2,592
================

Revenues

Second quarter 2006 total revenues grew 1% compared to the secondquarter 2005. Currency had a negligible impact on total revenues inthe quarter. Total revenues included the following:

-- Equipment sales were flat compared to second quarter 2005, including a 1-percentage point benefit from currency, and primarily reflected growth from Office multifunction color and Production color products as well as growth in DMO, which were offset by revenue declines in black and white products and color printers.

-- 3% increase in Post sale and other revenue, including a 1-percentage point benefit from currency, reflected growth in color products and DMO which more than offset declines in light lens products.

-- 14% growth in color revenue. Color revenue of $1,364 million comprised 34% of total revenue in the second quarter 2006 compared to 31% in the second quarter 2005.

-- 4% decline in Finance income included a 1-percentage benefit from currency and reflected lower finance receivables.

Net Income

Second quarter 2006 net income of $260 million, or $0.26 perdiluted share, included a $46 million tax benefit resulting from theresolution of certain tax matters associated with foreign tax audits,as well as after-tax restructuring charges of $25 million ($36 millionpre-tax) and a $9 million after-tax charge ($13 million pre-tax) fromthe write-off of remaining unamortized deferred debt issuance costs asa result of the termination of our 2003 Credit Facility.

Second quarter 2005 net income of $423 million or $0.40 perdiluted share included a $343 million after-tax benefit related tofinalization of the 1996-1998 IRS audit, as well as after-taxrestructuring charges of $130 million ($194 million pre-tax).

The calculations of basic and diluted earnings per share areenclosed as Appendix I.
Operations Review
Three Months ended June 30,
------------------------------------------
(in millions) Production Office DMO Other Total
--------------------------- ------------------------------------------

2006
Equipment sales $333 $598 $140 $38 $1,109
Post sale and other
revenue 720 1,204 327 406 2,657
Finance income 81 125 2 3 211
------------------------------------------
Total Revenues $1,134 $1,927 $469 $447 $3,977
==========================================

2005
Equipment sales $328 $610 $133 $38 $1,109
Post sale and other
revenue 712 1,175 304 401 2,592
Finance income 85 129 3 3 220
------------------------------------------
Total Revenues $1,125 $1,914 $440 $442 $3,921
==========================================

Equipment Sales

Equipment sales reflect the results of our technology investmentsand the associated product launches as more than two-thirds of thesecond quarter 2006 equipment sales were generated from productslaunched in the past 24 months.

In the second quarter 2006 equipment sales of $1,109 million wereunchanged from the second quarter 2005 reflecting:

-- Currency benefit of 1-percentage point.

-- Growth in Office color multifunction products, Production color products and in DMO offset by declines in revenue from black and white equipment and color printers.

-- Strong install activity in entry production color, light production, and office multifunction color products offset by overall price declines of 7% and lower installs of low end office black and white equipment.

-- Growth in color equipment sales of 9%. The pace of color equipment sales growth was impacted by lower color printer sales. Color sales represented approximately 44% of total equipment sales in the second quarter 2006 versus 40% in the second quarter 2005.

Production

Production second quarter 2006 equipment sales grew approximately2% reflecting strong install activity partially offset by pricedeclines of 5% and product mix. Production system install activityincluded:

-- 96% growth in installs of production color products driven by strong DocuColor(R) 240/250 activity and increases in DocuColor 7000/8000 and iGen3 installs.

-- 9% growth in installs of production black and white systems included 24% growth in installs of black and white light production systems reflecting the continued success of the 4110 light production system which was partially offset by a decline in installs of mid-volume black and white production systems.

Office

Office second quarter 2006 equipment sales revenue declined 2%,including a 1-percentage point benefit from currency. Price declinesof approximately 8% more than offset the impact of install growth inSegment 3-5 and Office color multifunction products. Office productinstall activity included:

-- 13% install growth in color multifunction devices driven by strong sales of the office version of the DocuColor 240/250.

-- 4% decline in black and white copiers and multifunction devices as 12% install growth in Segment 3-5 products (31-90 ppm) was more than offset by an 8% decline in installs of Segment 1&2 products (11-30 ppm).

-- 1% decline in color printers compared to 155% growth in the second quarter 2005. Second quarter 2005 growth was primarily a result of higher OEM sales, which have leveled in 2006.

DMO

DMO equipment sales consist of office and production products,including a large proportion of sales of Segment 1&2 office devicesand printers. Equipment sales in the second quarter 2006 grew 5%reflecting strong sales of Segment 1&2 devices as well as installgrowth in light production black and white and production colorsystems.

Post Sale and Other Revenue

Post sale revenue is largely a function of the equipment placed atcustomer locations, the volume of prints and copies that our customersmake on that equipment, the mix of color pages, as well as associatedservices.

The second quarter 2006 post sale and other revenue of $2,657million increased 3% compared to the second quarter 2005 reflecting:

-- Currency benefit of 1-percentage point.

-- 5% growth in office and production digital products and 8% growth in DMO, which were partially offset by a 40% decline in analog light lens products.

-- 17% growth in color post sale and other revenue. Color represented 31% of post sale and other revenue in the second quarter 2006 versus 27% in the second quarter 2005.

-- Approximately 9% of total pages were printed on color devices and color pages generate around five times more revenue and gross profit dollars than black and white pages.

Within post sale and other revenue, service, outsourcing, andrental revenue of $1,884 million increased approximately 1% reflectinggrowth in outsourcing revenue partially offset by a decline in revenuefrom service and rentals. Supplies, paper, and other sales of $773million grew 8% year-over-year.

Production

Production second quarter 2006 post sale and other revenue grew 1%and reflected growth in color products which was partially offset bydeclines in revenue from high-end black and white digital products andolder light lens technology.

Office

Office second quarter 2006 post sale and other revenue increasedapproximately 2% from second quarter 2005 and reflected growth inrevenue from color multifunction devices and color printers.

DMO

DMO second quarter 2006 post sale and other revenue growth ofapproximately 8% was driven by growth in revenue from color productsand services.

Other

Post sale and other revenue within the Other segment increased 1%in the second quarter 2006 primarily driven by increased paper sales.Paper and other supplies revenue comprised approximately two-thirds ofsecond quarter 2006 Other segment post sale and other revenue.
Key Ratios and Expenses
Three Months Ended
June 30,
-------- -------- ----------
2006 2005 Change
-------- -------- ----------
Gross Margin
Sales 36.2 % 36.0 % 0.2 pts.
Service, outsourcing and rentals 43.3 42.2 1.1
Financing Income 64.0 62.3 1.7
Total 41.1 40.4 0.7

R,D&E % Revenue 5.8 6.2 (0.4)
SAG % Revenue 25.6 26.7 (1.1)

Gross Margin

Second quarter 2006 total gross margin of 41.1% increased0.7-percentage points compared to second quarter 2005 as costimprovements and other variances of 2.6-percentage points more thanoffset the unfavorable impact of price declines and activity mix of1.9-percentage points.

Sales gross margin increased 0.2-percentage points as costimprovements, favorable mix of equipment and other variances of2.2-percentage points more than offset the impact of price declines of2.0-percentage points. Cost improvements reflect manufacturingproductivity while price declines were equipment-related and in linewith historical levels.

Service, outsourcing and rentals margin increased 1.1-percentagepoints as year-over-year cost improvements and other variances of3.7-percentage points more than offset the impacts of price declinesand unfavorable activity mix of 2.6-percentage points. Costimprovements were driven by service labor productivity.

Research, Development and Engineering ("R,D&E")

R,D&E of $230 million in the second quarter 2006 was approximately$12 million lower than the second quarter 2005. R&D of $186 milliondecreased by $2 million and sustaining engineering costs of $44million decreased by $10 million. The decrease in sustainingengineering was primarily in the Production segment and reflectedlower spending related to environmental compliance activities andmaturing product platforms.

We invest in technological development, particularly in color, andbelieve our R&D spending is sufficient to remain technologicallycompetitive. Xerox R&D remains strategically coordinated with FujiXerox.

Selling, Administrative and General Expenses ("SAG")

SAG expenses of $1,020 million in the second quarter 2006 were $26million lower than the second quarter 2005. The decrease in SAGexpenses reflected the following:

-- $17 million reduction in selling expenses compared to second quarter 2005 included savings from restructuring initiatives and the absence of a one-time special compensation payment related to the 2005 annual merit increase process.

-- $15 million reduction in general and administrative ("G&A") expenses as a result of continued expense management initiatives.

-- $21 million in bad debt expense was $6 million higher than second quarter 2005, but was comparable to first quarter 2006. This level of bad debt expense continues to reflect the favorable trend in write-offs, receivables aging and collections.

Restructuring Charges

During the second quarter 2006, we recorded restructuring chargesof $36 million primarily related to headcount reductions ofapproximately 500 employees primarily in North American serviceorganizations. The remaining reserve balance as of June 30, 2006, forall programs was $135 million, of which approximately $42 million isexpected to be spent over the remainder of 2006.

Worldwide Employment

Worldwide employment of 55,100 at June 30, 2006, declinedapproximately 100 from year-end 2005 reflecting activity from ongoingrestructuring programs and hiring in strategic business areas.
Other Expenses (Income), Net
Three Months Ended
June 30,
(in millions) 2006 2005
------------------------------------------------- ------------------


Non-financing interest expense $60 $62
Interest income (16) (88)
Gains on sales of businesses and assets (10) (4)
Currency losses (gains), net 10 (6)
Amortization of intangible assets 10 10
Legal matters and other expenses, net 28 12
------------------
Total $82 $(14)
==================

Non-Financing Interest Expense

Second quarter 2006 non-financing interest expense of $60 millionwas $2 million lower than the second quarter 2005. The decline isprimarily due to lower average debt balances, partially offset byhigher interest rates.

Interest Income

Second quarter 2006 interest income of $16 million decreased $72million compared to second quarter 2005. The second quarter 2005interest income included $57 million in interest associated with asettlement of the 1996-1998 IRS audit. Excluding this item interestincome decreased $15 million, primarily reflecting lower average cashbalances.

Gains on Sales of Businesses and Assets

Second quarter 2006 gains of $10 million reflect the receipt fromescrow of additional proceeds from our sale of Integic in the firstquarter 2005. The proceeds were placed in escrow upon the sale ofIntegic pending completion of an indemnification period which ended inMay 2006.

Currency Losses, Net

Currency gains and losses netted a loss of $10 million in thesecond quarter 2006 compared to a gain of $6 million in the secondquarter 2005. Net second quarter 2006 currency losses reflected thefollowing offsetting impacts:

-- Losses related to the mark-to-market of derivative contracts, due to the strengthening Euro and Sterling, which are economically hedging the cost of anticipated foreign currency denominated inventory purchases and other payments in Europe.

-- Gains related to the mark-to-market of derivative contracts, due to the strengthening Japanese Yen, economically hedging the cost of anticipated foreign currency denominated inventory purchases in the United States.

Legal Matters and Other Expenses, Net

Legal and other expenses of $28 million in the second quarter 2006included $13 million of unamortized deferred debt issuance costsassociated with the termination of the 2003 Credit Facility. Legalmatters of $10 million primarily included charges of $19 millionassociated with probable losses from various legal matters partiallyoffset by $12 million of proceeds from the previously disclosed Palmlitigation matter. The remaining proceeds from the Palm litigationmatter of $10.5 million are associated with a license and are recordedin Sales as licensing revenue.

Income Tax Expense

In the second quarter 2006, we recorded income tax expense of $22million compared with income tax benefit of $(233) million in thesecond quarter 2005. The effective tax rate for the second quarter2006 was 8.3% versus (199.1)% in the second quarter 2005.

The 2006 second quarter effective tax rate of 8.3% was lower thanthe U.S. statutory tax rate of 35% primarily reflecting tax benefitsof $46 million from the resolution of certain tax issues associatedwith foreign tax audits, $11 million from the reversal of a valuationallowance on deferred tax assets associated with foreign net operatingloss carryforwards, the geographical mix of income and the relatedeffective tax rates in those jurisdictions and a tax law change.

The 2005 second quarter effective tax rate of (199.1)% was lowerthan the U.S. statutory tax rate of 35% primarily due to a tax benefitof $253 million associated with the finalization of the 1996-1998Internal Revenue Service audit. The finalization of this audit yieldedbenefits associated with a change in tax law that allowed us torecognize a tax benefit for capital losses associated with thedisposition of our insurance group operations, as well as favorableresolution of other tax matters. Also contributing to this lowereffective tax rate was a $33 million tax benefit from the reversal ofa valuation allowance on deferred tax assets associated with foreignnet operating loss carryforwards. This reversal followed are-evaluation of their future realization resulting from a refinancingof a foreign operation.

Our effective tax rate is based on recurring factors including thegeographical mix of income before taxes and the related tax rates inthose jurisdictions, as well as available foreign tax credits. Inaddition, our effective tax rate will change based on discrete orother nonrecurring events (such as audit settlements) that may not bepredictable. We anticipate that our effective tax rate for theremainder of the year will approximate 33%, excluding the effects ofany future discrete events, and we expect our full year tax rate to beapproximately 26%.
Segment Operating Profit
Three Months Ended
June 30,
(in millions, except operating margin) 2006 2005 Change
------------------------------------------- ---------------------- ---

Revenues
Production $1,134 $1,125 1%
Office 1,927 1,914 1%
Developing Markets Operations (DMO) 469 440 7%
Other 447 442 1%
----------------------
Total Revenues $3,977 $3,921 1%
======================

Memo: Color $1,364 $1,200 14%

Operating Profit
Production $88 $79 $9
Office 213 173 40
DMO 34 19 15
Other (13) 66 (79)
----------------------
Total Operating Profit $322 $337 $(15)
======================

Operating Margin
Production 7.8% 7.0% 0.8 pts
Office 11.1% 9.0% 2.1 pts
DMO 7.2% 4.3% 2.9 pts
Other (2.9%) 14.9% (17.8) pts
--------------------------
Total Operating Margin 8.1% 8.6% (0.5) pts
==========================

Total segment operating profit of $322 million in the secondquarter 2006 was $15 million lower than the second quarter 2005. Thesecond quarter 2006 operating margin declined 0.5-percentage pointsyear-over-year. The Other segment profit in the second quarter 2005included a $57 million interest income benefit associated with thefinalization of the 1996-1998 IRS audit. Excluding this benefit,operating margin improved by approximately 1-percentage point.

Production

Second quarter 2006 Production profit of $88 million increased $9million from 2005. Operating profit margin improved 0.8-percentagepoints in the second quarter. The increase in operating profitreflected higher year-over-year gross profit, which was favorablyimpacted by growth in color post sale revenues.

Office

Second quarter 2006 Office profit of $213 million increased $40million from 2005. Operating profit margin improved by 2.1-percentagepoints in the second quarter reflecting higher gross profit and lowerexpenses.

DMO

Second quarter 2006 DMO profit of $34 million increased $15million from 2005. Operating profit margin improved 2.9-percentagepoints in the second quarter. The $15 million increase in profitreflects higher gross profit and lower SAG expenses.

Other

Second quarter 2006 Other operating loss of $13 million declined$79 million from second quarter 2005 primarily due to a $57 millioninterest income benefit associated with the finalization of the1996-1998 Internal Revenue Service tax audit.

Capital Resources and Liquidity

The following table summarizes our cash, cash equivalents andshort-term investments for the three months ended June 30, 2006 and2005:
Three Months Ended
June 30,
------------------------
Amount
(in millions) 2006 2005 Change
--------------------------------------------- ------- ------- --------

Net Cash provided by operating activities $220 $290 $(70)
Net Cash provided by (used in) investing
activities 12 (237) 249
Net Cash used in financing activities (859) (1,410) 551
Effect of exchange rate changes on cash and
cash equivalents 11 (29) 40
------- ------- --------
Decrease in cash and cash equivalents (616) (1,386) 770
Cash and cash equivalents at beginning of
period 1,598 3,298 (1,700)
------- ------- --------
Cash and cash equivalents at end of period $982 $1,912 $(930)
======= ======= ========

Cash, cash equivalents and Short-term investments reported in our
Consolidated Financial Statements were as follows:

2006 2005
------- -------
Cash and cash equivalents $982 $1,912
Short-term investments 199 190
------- -------
Total Cash, cash equivalents and Short-term
investments $1,181 $2,102
======= =======

Cash Flows from Operating Activities

Net cash provided by operating activities of $220 million in thesecond quarter 2006 decreased $70 million from second quarter 2005.The changes in operating cash flows included the following:

-- $148 million increase in pre-tax income.

-- $61 million decrease due to higher year-over-year growth in inventory and equipment on operating leases primarily associated with new product launches.

-- $60 million decrease due to higher accounts receivable resulting from increased revenue and timing of billings.

-- $55 million decrease due to a year-over-year reduction in accounts payable and accrued compensation primarily due to lower year-over-year purchases.

-- $35 million decrease resulting from higher restructuring payments.

Cash Flows from Investing Activities

Net cash provided by investing activities of $12 million in thesecond quarter 2006 increased $249 million from second quarter 2005reflecting the following:

-- $187 million increase as a result of lower net purchases of short-term investments. The second quarter 2005 was the initial quarter of our short-term investments program.

-- $55 million increase as a result of lower escrow and other restricted investments balances associated with our secured borrowing programs.

Cash Flows from Financing Activities

Net cash used in financing activities of $859 million in thesecond quarter 2006 decreased $551 million from second quarter 2005reflecting the following:

-- $1,077 million lower primarily resulting from the 2005 net repayments on term and other unsecured debt, including scheduled bond maturities.

-- $287 million higher repayments on secured borrowings.

-- $225 million used in second quarter 2006 in connection with the company's share repurchase program.

Customer Financing Activities and Debt

The following table compares finance receivables tofinancing-related debt as of June 30, 2006:

Finance Secured Debt
Receivables, Net
---------------- ------------
Finance Receivables Encumbered by
Loans (1)
GE Secured Loans:
United States $1,375 $1,198
Canada 184 130
United Kingdom 640 618
------------------------------
Total GE encumbered finance
receivables, net 2,199 1,946

Merrill Lynch Loan - France 452 394
DLL - Netherlands 217 177
---------------- ------------
Total encumbered finance
receivables, net 2,868 $2,517
============
Unencumbered finance receivables, net 4,903
----------------
Total finance receivables, net(2) $7,771
Equipment on operating leases, net 439
----------------
Total Finance Assets, net(3) $8,210
================

(1)Encumbered finance receivables represent the book value of finance
receivables that secure each of the indicated loans.

(2)Includes (i) billed portion of finance receivables, net (ii)
finance receivables, net and (iii) finance receivables due after one
year, net as included in the Condensed Consolidated Balance Sheets as
of June 30, 2006.

(3) includes (i) finance receivables, net and (ii) equipment on
operating leases, net to reflect the total assets associated with our
lease or finance business. Management expects to leverage or fund
these assets at a 7 to 1 debt-to-equity ratio.

As of June 30, 2006, 37% of total finance receivables wereencumbered as compared to 44% at December 31, 2005. Also as of June30, 2006, approximately 36% of total debt was secured by financereceivables and other assets compared to 49% at December 31, 2005.Consistent with our objective to rebalance the ratio of secured andunsecured debt, we expect payments on secured loans will continue toexceed proceeds from new secured loans for the balance of 2006. Weexpect the level of secured debt as a percent of total debt toapproximate 35% by the end of 2006. Our debt maturities are asfollows:
Debt Secured Other
Unsecured by Finance Secured
Debt Receivables Debt Total Debt
--------------------------------------------


Third Quarter $155 $256 $3 $414
Fourth Quarter 14 216 3 233
--------------------------------------------
2006 169 472 6 647

First Quarter 6 183 3 192
Second Quarter 263 168 3 434
Third Quarter - 609 2 611
Fourth Quarter - 228 2 230
--------------------------------------------
2007 269 1,188 10 1,467

2008 29 700 6 735

2009 897 109 6 1,012

2010 677 43 2 722

Thereafter 2,497 5 34 2,536

--------------------------------------------
Total $4,538 $2,517 $64 $7,119
============================================

Recent Events

On June 14, 2006, Xerox announced it would expand its documentmanagement services business by agreeing to acquire privately-heldAmici LLC for $174 million. Amici is a leading provider ofelectronic-discovery (e-discovery) services, primarily supportinglitigation and regulatory compliance. The acquisition of Amici wascompleted on July 21, 2006.

On July 3, 2006, 9.2 million shares of 6.25% Series C MandatoryConvertible Preferred Stock were automatically converted into 74.8million common shares. As a result of the automatic conversion, thereare no remaining outstanding shares of our Series C MandatoryConvertible Preferred Stock. The issuance of Xerox shares uponautomatic conversion had no impact on diluted earnings per share asthey were previously included in our diluted EPS calculation inaccordance with the "if converted" accounting methodology.

The board of directors has approved an additional authorization torepurchase up to $500 million of the company's common stock. Thecompany expects the stock to be repurchased over the next 6-12 months,primarily through open-market purchases. Open-market repurchases willbe made in compliance with the Securities and Exchange Commission'sRule 10b-18, and are subject to market conditions as well asapplicable legal and other considerations.

Other Items

Reference has been made in this press release to "signings fordocument management services." Services signings representsmanagement's estimate of the total contract life value of managedservices and value-added services contracts signed within the period.This estimate includes new contracts, renewals, extensions, andamendments to existing contracts. The total contract life value isdefined as the average monthly commitment minimum multiplied by thenumber of months in the contract, plus an estimate of any otherrevenue related to the contract, but not included in the minimum. If acontract does not have a monthly commitment minimum, managementdevelops an estimate based on historical and expected usage patternsand other relevant information. Our contracts have terms thatgenerally range from 3 to 5 years.

Forward-Looking Statements

This release contains "forward-looking statements" as defined inthe Private Securities Litigation Reform Act of 1995. These statementsreflect management's current beliefs and expectations, and are subjectto a number of factors that may cause actual results to differmaterially. These factors include but are not limited to the outcomeof litigation and regulatory proceedings to which we may be a party;actions of competitors; changes and developments affecting ourindustry; quarterly or cyclical variations in financial results;development of new products and services; interest rates and cost ofborrowing; our ability to maintain and improve cost efficiency ofoperations; changes in foreign currency exchange rates; changes ineconomic conditions, political conditions, trade protection measures,licensing requirements and tax matters in the foreign countries inwhich we do business; reliance on third parties for manufacturing ofproducts and provision of services; and other risks that are set forthin the "Risk Factors" section, the "Legal Proceedings" section, the"Management's Discussion and Analysis of Results of Operations andFinancial Condition" section and other sections of our 2005 Form 10-Kand first-quarter 2006 Form 10-Q filed with the SEC. Additionalinformation concerning these and other factors is included in thecompany's 2005 Form 10-K and first-quarter 2006 Form 10-Q filed withthe SEC. The company assumes no obligation to update anyforward-looking statements as a result of new information or futureevents or developments, except as required by law.
APPENDIX I

Xerox Corporation
Earnings per Common Share

(Dollars in millions, except per share data.
Shares in thousands)

Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------

Basic Earnings per
Share:

Income from continuing
operations 260 370 460 580
Accrued dividends on
Series C Mandatory
Convertible Preferred
Stock (15) (15) (29) (29)
---------- ---------- ---------- ----------
Adjusted income from
continuing operations 245 355 431 551
Income from
discontinued
operations, net of tax - 53 - 53
---------- ---------- ---------- ----------
Adjusted net income
available to common
shareholders 245 408 431 604
========== ========== ========== ==========

Weighted Average Common
Shares Outstanding 913,503 960,450 920,422 959,631
========== ========== ========== ==========

Basic Earnings per
Share
Earnings from
continuing
operations 0.27 0.37 0.47 0.57
Earnings from
discontinued
operations - 0.06 - 0.06
---------- ---------- ---------- ----------
Basic Earnings per
Share 0.27 0.43 0.47 0.63
========== ========== ========== ==========


Diluted Earnings per
Share:

Income from continuing
operations 260 370 460 580
Interest on Convertible
Securities, net - - 1 1
---------- ---------- ---------- ----------
Adjusted income from
continuing operations 260 370 461 581
Income from
discontinued
operations, net of tax - 53 - 53
---------- ---------- ---------- ----------
Adjusted net income
available to common
shareholders 260 423 461 634
========== ========== ========== ==========

Weighted Average Common
Shares Outstanding 913,503 960,450 920,422 959,631
Common shares issuable
with respect to:
Stock options 8,459 10,024 8,884 11,434
Restricted stock and
performance shares 3,054 1,170 3,035 253
Series C Mandatory
Convertible
Preferred Stock 74,797 74,797 74,797 74,797
Convertible
securities 1,992 1,992 1,992 1,992
---------- ---------- ---------- ----------
Adjusted Weighted
Average Common Shares
Outstanding 1,001,805 1,048,433 1,009,130 1,048,107
========== ========== ========== ==========

Diluted Earnings per
Share
Earnings from
continuing
operations 0.26 0.35 0.46 0.55
Earnings from
discontinued
operations - 0.05 - 0.05
---------- ---------- ---------- ----------
Diluted Earnings per
Share 0.26 0.40 0.46 0.60
========== ========== ========== ==========