UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No.               )

 

 

Xerox Corporation
800 Long Ridge Road
P.O. Box 1600
Stamford, Connecticut 06904

April 10, 2006

Dear Shareholders:

You are cordially invited to attend the Annual Meeting of Shareholders of Xerox Corporation to be held on Wednesday, May 24, 2006, at the Xerox Corporation Corporate Headquarters, 800 Long Ridge Road, Stamford, Connecticut. Your Board of Directors and Management look forward to greeting in person those shareholders able to attend.

At the Annual Meeting you will be asked to vote upon the election of eleven directors and to ratify the selection of PricewaterhouseCoopers LLP, as the Company’s independent registered public accounting firm for 2006. The Board of Directors unanimously recommends that you vote in favor of each of these proposals.

The Company has been advised that two shareholder proposals are intended to be submitted for shareholder vote. Your Board believes that these shareholder proposals are not in the best interest of the Company and its shareholders, and unanimously recommends a vote against these proposals.

You will note that Mary Agnes Wilderotter, Chairman and Chief Executive Officer, Citizens Communications, has been added to the slate of directors proposed for election at the Annual Meeting. She will bring the benefit of a strong operational background and 25 years of business experience to our Board. In addition, Stephen Robert has chosen not to stand for reelection due to an increase in time required for his other responsibilities. We are grateful for his contributions to the Company. Considering these changes, the proposed slate of directors includes 10 independent directors and one employee director.

It is important that your shares be represented and voted at the Annual Meeting, regardless of whether or not you plan to attend in person. Therefore, you are urged to vote your shares using one of the methods described in the following pages. Voting instructions are detailed in the accompanying voting instruction and proxy card.

For the Board of Directors,

Anne M. Mulcahy
Chairman and Chief Executive Officer

Notice of Annual Shareholders’ Meeting

Date and Time:	Wednesday, May 24, 2006, at 10:00 a.m.
Location:	Xerox Corporation Corporate Headquarters, 800 Long Ridge Road, Stamford, Connecticut
Purpose:	(1) Election of 11 directors (2) Ratification of the selection of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2006 (3) Vote on shareholder proposal relating to director election by majority vote (4) Vote on shareholder proposal relating to senior executive bonuses (5) Consider such other business as may properly come before the meeting
Record Date:	March 24, 2006 — You are eligible to vote if you were a shareholder of record on this date.
Proxy Voting:	(1) Telephone (2) Internet (3) Proxy Card Please review the accompanying proxy card for voting instructions.
Importance of Vote:	Whether or not you plan to attend, please submit a proxy as soon as possible to insure that your shares are represented.

 

By order of the Board of Directors,

 

J. Michael Farren

Secretary

April 10, 2006

 

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TABLE OF CONTENTS

 

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PROXY STATEMENT

GENERAL

The Meeting

The Board of Directors of Xerox Corporation is requesting your proxy for the Annual Meeting of Shareholders on May 24, 2006, beginning at 10:00 a.m., and any adjournments thereof. The meeting will be held at the Xerox Corporation Corporate Headquarters, 800 Long Ridge Road, Stamford, Connecticut.

Shares Entitled to Vote

Holders of record of the Company’s Common Stock, par value $1 per share (Common Stock), as of the close of business on March 24, 2006, are entitled to vote. On that date there were 918,430,232 shares of Common Stock outstanding. At the meeting each share of Common Stock is entitled to one vote on each proposal.

Proxy Voting and Quorum

Shareholders of record may vote their proxies by telephone, Internet or mail. By using your proxy to vote in one of these ways, you authorize the three directors whose names are listed on the front of the proxy card accompanying this Proxy Statement to represent you and vote your shares. Holders of a majority of the shares entitled to vote at the meeting must be present in person or represented by proxy to constitute a quorum.

Of course, if you attend the meeting, you may vote by ballot. If you are not present, your shares can be voted only when represented by a properly submitted proxy.

You may revoke or change your proxy at any time before it is exercised, either in writing to the Secretary of the Company, through the Internet or by telephone voting.

Choices in Voting

You have several choices in completing your voting:

·       You may vote on each proposal, in which case your shares will be voted in accordance with your choices.

·       In voting on directors, you can either vote FOR all the directors or withhold your vote on all or certain of the directors.

·       You may indicate a preference to abstain on any other proposal, in which case no vote will be recorded.

·       You may submit a proxy without indicating your voting preferences, in which case the proxies will vote your shares:

·        for election of the directors nominated by the Board of Directors,

·        for ratification of the selection of PricewaterhouseCoopers LLP (PwC) as the Company’s independent registered public accounting firm for 2006,

·        against the shareholder proposal relating to director election by majority vote and

·        against the shareholder proposal relating to senior executive bonuses.

ESOP Voting Instruction

Beneficial owners of the shares of Common Stock held in their accounts in the Company’s Employee Stock Ownership Plan (ESOP) can instruct State Street Bank and Trust Company, as ESOP Trustee (ESOP Trustee), by telephone, Internet or mail, how to vote. No matter which method is used, the instructions are confidential and will not be disclosed to the Company. By using the voting instruction in one of these ways, you instruct the ESOP Trustee to vote the shares allocated to your ESOP account. You also authorize the ESOP Trustee to vote a proportion of the shares of Common Stock held in the ESOP trust for which no instructions have been received.

Required Vote

A plurality of the votes cast is required for the election of directors. Pursuant to the law of the State of New York, the Company’s state of incorporation, only votes cast “for” the election of directors will be counted in determining whether a nominee for director has been elected. However, in February, the Board of Directors adopted a policy that provides that in an uncontested election any nominee for director who receives a greater number of votes

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“withheld” for his or her election than votes “for” such election shall tender his or her resignation promptly after such election. The independent directors shall then evaluate and determine, based on the relevant facts and circumstances, whether to accept or reject the resignation. Any director who so tenders a resignation shall not participate in the decision of the Board of Directors. Within 90 days following certification of the results of the election, the Board of Directors will promptly disclose its decision and the basis for that decision in a filing with the Securities and Exchange Commission.

The affirmative vote of a majority of the votes cast is required to ratify the selection of PricewaterhouseCoopers LLP (PwC) as the Company’s independent registered public accounting firm for 2006 and to approve the shareholder proposals. Under the law of New York, only votes cast “for” or “against” the selection of PwC and each shareholder proposal will be counted in determining whether the selection of PwC has been ratified or such shareholder proposal has been approved. Abstentions, broker non-votes and votes withheld are not treated as votes cast at the meeting for such purposes.

PROPOSAL 1 — ELECTION OF DIRECTORS

Shareholders annually elect directors to serve for one year and until their successors have been elected and shall have qualified. The eleven persons whose biographies appear on pages 10 through 13 have been proposed by the Board of Directors based on a recommendation by the Corporate Governance Committee.

All eleven nominees bring to us valuable experience from a variety of fields. The Board of Directors has determined that each of the nominees (other than Anne M. Mulcahy, Chairman and CEO of the Company) to be independent under the New York Stock Exchange Corporate Governance Rules and under the Company’s more stringent independence standards.

If for any reason, which the Board of Directors does not expect, a nominee is unable to serve, the proxies may use their discretion to vote for a substitute proposed by the Board of Directors.

Corporate Governance

Xerox is committed to the highest standards of business integrity and corporate governance. All our directors, executives and employees must act ethically. In addition, our directors must act in accordance with our Code of Business Conduct and Ethics for members of the Board of Directors; our principal executive officer, principal financial officer and principal accounting officer, among others, must act in accordance with our Finance Code of Conduct; and all our executives and employees must act in accordance with our Employee Code of Conduct. Each of these codes of conduct, as well as our Corporate Governance Guidelines, and the charters of our Corporate Governance, Audit, Compensation and Finance Committees can be found on our website at http://www.xerox.com/investor and then clicking on Corporate Governance. They are also available to any shareholder who requests them by writing to Xerox Corporation, 800 Long Ridge Road, Stamford, Connecticut 06904, Attention: Corporate Secretary. Copies of our Corporate Governance Guidelines and the charters of our Audit, Compensation, and Corporate Governance Committees are also attached to this Proxy Statement as Exhibits I, II, III and IV.

The Board and each of the Committees of the Board periodically review and reassess the adequacy of our overall corporate governance, the Corporate Governance Guidelines and the Committee charters. The board has adopted categorical standards to assist its determination, and the Corporate Governance Committee’s recommendation, as to each director’s independence. Under these categorical standards, a director will be presumed not to have a material relationship with the Company if:

(1)         he or she meets all the bright-line independence and other applicable requirements under the listing standards of the New York Stock Exchange (NYSE) and all other applicable laws, rules and regulations regarding director independence, in each case from time to time in effect;

(2)         he or she is not a current employee (and none of his or her “immediate family members”, as defined by the NYSE Corporate Governance Rules, is employed as an “executive officer”, as defined by the NYSE Corporate Governance Rules) of a company that has made payments to, or received payments from, the

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Company or any of its consolidated subsidiaries for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or one percent of such other company’s consolidated gross revenues; and

(3)         in the event that he or she serves as an executive officer or director of a charitable organization, the Company and its consolidated subsidiaries donated less than five percent of that organization’s charitable receipts (provided that if within the preceding three years the Company and its consolidated subsidiaries donated annual aggregate contributions in excess of $1 million or two percent of the annual consolidated gross revenue of the charitable organization, such contributions must be disclosed in the Company’s proxy statement).

Our Board has determined that all of the nominees for election as directors have satisfied the foregoing categorical standards and are independent under the NYSE Corporate Governance Rules, with the exception of Anne M. Mulcahy, our Chairman and Chief Executive Officer. As a result, 91% of the proposed members of our Board are independent.

Under our Corporate Governance Guidelines, each regularly scheduled Board meeting includes an executive session of all directors with the CEO and a separate executive session of just the independent directors. The Chairmen of the Corporate Governance Committee and the Compensation Committee rotate responsibility to preside over non-management executive sessions and are responsible for providing appropriate feedback to the CEO.

Set forth below is a list of the Committees of our Board, the number of meetings held and a summary of the responsibilities of each Committee and its membership.

Committee Functions, Membership and Meetings

Our Board of Directors has four standing committees: Audit, Corporate Governance, Compensation and Finance. Here is a description of each committee, the number of meetings held during 2005 and its membership:

Audit Committee   (12 meetings)

Reference is made to a complete copy of the charter of the revised Audit Committee which is attached to this Proxy Statement as Exhibit II and posted on the Company’s website as described above.

Responsibility:

·       oversight of the integrity of the Company’s financial statements,

·       Company’s compliance with legal and regulatory requirements,

·       independent auditors’ qualifications and independence,

·       performance of the Company’s independent auditors and the internal audit function, and

·       Company’s code of business conduct and ethics.

The Committee is also responsible for the preparation of the audit committee report to be included in the Company’s annual proxy statement. The Audit Committee’s report appears on page 30 of this Proxy Statement.

Members: Glenn A. Britt, Richard J. Harrington, William Curt Hunter and Robert A. McDonald.

Chairman: Mr. Harrington

The Board of Directors has determined that all of the members of the Audit Committee are independent under the Company’s Corporate Governance Guidelines and under the applicable SEC and NYSE Corporate Governance Rules. In addition, the Board of Directors has determined that the following members of the Audit Committee are “audit committee financial experts”, as defined in the applicable SEC rules, and are financially literate: Glenn A. Britt, Richard J. Harrington, William Curt Hunter, and Robert A. McDonald. The SEC has determined that the designation or identification of a person as an audit committee financial expert does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the Audit Committee and the Board of Directors in the absence of such identification.

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Compensation Committee   (5 meetings)

Reference is made to a complete copy of the charter of the Compensation Committee which is attached to this Proxy Statement as Exhibit III and posted on the Company’s website as described above.

Responsibility:

·       recommend to the Board of Directors the remuneration arrangements for senior management of the Company including the adoption of compensation plans in which senior management is eligible to participate and the granting of benefits under any such plans,

·       consult with the Chief Executive Officer and advise the Board with respect to senior management succession planning,

·       review and approve performance goals and objectives with respect to the compensation of the Chief Executive Officer and all other officers consistent with approved compensation plans, and

·       oversee the performance evaluation of the Chief Executive Officer and all other officers against approved goals and objectives.

The Committee is also responsible for the preparation of an annual report on executive compensation to be included in the Company’s annual proxy statement. The Compensation Committee report appears on pages 15-19 of this Proxy Statement.

Members: Vernon E. Jordan, Jr., Hilmar Kopper, Ralph S. Larsen and N. J. Nicholas, Jr.

Chairman: Mr. Larsen

The Board of Directors has determined that all of the members of the Compensation Committee are independent under the Company’s Corporate Governance Guidelines and the NYSE Corporate Governance Rules.

Corporate Governance Committee   (4 meetings)

Reference is made to a complete copy of the charter of the Corporate Governance Committee which is attached to this Proxy Statement as Exhibit IV and posted on the Company’s website as described above.

Responsibility:

·       identify and recommend to the Board individuals to serve as directors of the Company and on committees of the Board,

·       advise the Board regarding composition, procedures and committees,

·       develop and recommend to the Board and annually review a set of corporate governance principles applicable to the Company,

·       evaluate and recommend director compensation to the Board, and

·       oversee the annual Board and Committee evaluation processes.

The Committee recommends to the Board of Directors nominees for election as directors of the Company and considers the performance of incumbent directors in determining whether to recommend their nomination.

Members: Glenn A. Britt, William Curt Hunter, Vernon E. Jordan, Jr., Ralph S. Larsen and Ann N. Reese.

Chairman: Mr. Jordan

The Board of Directors has determined that all of the members of the Corporate Governance Committee are independent under the Company’s Corporate Governance Guidelines and the NYSE Corporate Governance Rules.

Finance Committee   (4 meetings)

Reference is made to a complete copy of the charter of the Finance Committee which is posted on the Company’s website as described above.

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Responsibility:

·       oversee the investment management of the Company’s employee savings and retirement plans, and

·       review the Company’s asset mix, capital structure and strategies, financing strategies, insurance coverage and dividend policy.

Members: Hilmar Kopper, N. J. Nicholas, Jr., Ann N. Reese and Stephen Robert, all non-employee directors.

Chairman: Mr. Nicholas

The Board of Directors has determined that all of the members of the Finance Committee are independent under the Company’s Corporate Governance Guidelines and the NYSE Corporate Governance Rules.

Attendance and Compensation of Directors

Attendance:   6 meetings of the Board of Directors and 25 meetings of the Board committees were held in 2005. All incumbent directors attended at least 75 percent of the total number of meetings of the Board of Directors and Board committees on which they served. The Company’s policy generally is for all members of the Board of Directors to attend the Annual Meeting of Shareholders. All nominees for director, except one, attended the 2005 Annual Meeting of Shareholders.

We believe that attendance at meetings is only one means by which directors may contribute to the effective management of the Company and that the contributions of all directors have been substantial and are highly valued.

Summary of Director Annual Compensation

Compensation for our directors during fiscal year 2005 was determined by the Corporate Governance Committee, as consistent with a plan recommended to it by independent consultant Frederic W. Cook & Co., Inc., and approved by the Board of Directors. Directors receive a retainer payable semi-annually in advance for service on the Board of Directors, with additional retainers for serving on the Audit Committee or for serving as a committee chairman. All retainers are paid 50% in cash and 50% in the form of Deferred Stock Units (DSUs). For the cash portion of their compensation, directors have the option to either receive cash on a current basis, defer receipt under the existing Deferred Compensation Plan for Directors, or receive additional DSUs in lieu of cash. DSUs are a bookkeeping entry that represents the right to receive one share of the Company’s Common Stock at a future date, currently at the earlier of one year after termination of Board service or the date of death. DSUs include the right to receive dividend equivalents, which are credited in the form of additional DSUs, at the same time and in the same amounts that an equivalent number of shares of Common Stock would be entitled to receive dividends. The DSUs are issued under the 2004 Equity Compensation Plan for Non-Employee Directors (2004 Director Plan), a plan that was approved by the Xerox shareholders at the 2004 Annual Meeting.

During fiscal year 2005, the annual retainer for all of our directors was $130,000; Audit Committee members received an additional $10,000; the chairman of the Audit Committee received an additional $30,000; the chairman of the Compensation Committee received an additional $20,000; and the chairmen of the Corporate Governance and the Finance Committees received an additional $15,000. Directors who join the Board at a time other than at the annual meeting of shareholders receive pro-rated retainers in the form of both cash and DSUs, and directors who do not serve for a complete fiscal year receive a pro-rated portion of any retainer awarded in the form of DSUs and any cash retainers already awarded. Directors also receive reimbursement for out-of-pocket expenses incurred in connection with their service on the Board.

Each non-employee director is required to maintain a meaningful ownership requirement in the Company, equivalent to five times the annual cash fees that such director receives for service on the Board of Directors, other than committee related fees. Newly appointed directors have up to five years to reach this ownership threshold. Directors who are our employees receive no compensation for service as a director.

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Individually, the compensation for each director during fiscal year 2005 was as follows:

(1)             Directors:  Mr. McDonald was elected at the 2005 Annual Meeting. Mr. Pepper did not stand for reelection at the 2005 Annual Meeting.

(2)             Cash:  Cash compensation deferred under the Deferred Compensation Plan for Directors is reflected in the “All Other Compensation” column of this table. Cash compensation elected in the form of DSUs under the 2004 Director Plan is  reflected in the “Stock Awards” column of this table.

(3)             DSUs:  Compensation awarded in the form of DSUs or DSUs elected in lieu of cash compensation are reflected in this column. Each of Mr. Britt, Mr. Hunter, Mr. Larsen, Ms. Reese and Mr. Robert, elected to take their 2005 cash compensation in the form of DSUs under the 2004 Director Plan.

The total number and value of all DSUs held by each director as of the end of 2005 (based on the year-end closing market price of our Common Stock of $14.65) is as follows: Mr. Britt, 13,139 ($192,486); Mr. Harrington, 10,276 ($150,543); Mr. Hunter, 14,634 ($214,388); Mr. Jordan, 10,265 ($150,382); Mr. Kopper, 9,392 ($137,593); Mr. Larsen, 15,680 ($229,712); Mr. McDonald, 2,548 ($37,328); Mr. Nicholas, 10,974 ($160,769); Mr. Pepper, 8,001 ($117,215); Ms. Reese 13,589 ($199,079); and Mr. Robert, 13,589 ($199,079).

(4)             Deferred Compensation: Mr. Nicholas deferred his cash compensation for 2005 under the Deferred Compensation Plan for Directors. Amounts deferred under the Deferred Compensation Plan for Directors are assumed to be invested, without charge, in a stock fund established under the Xerox Corporation Savings Plan or a prime rate fixed income return investment fund. The value of each of these deferred accounts reflect all gains, losses and rates of return from such hypothetical investments. The value of each of these deferred accounts is generally determined on each business day. Amounts deemed invested in the prime rate fixed income return investment fund would have accrued interest at rates ranging from 5.25% to 7.00% per annum in fiscal year 2005.

Terms Used in Biographies

To help you consider the nominees, we provide summary biographical information. Certain terms used in the biographies may be unfamiliar to you, so we are defining them here.

Xerox securities owned means the Company’s Common Stock, including restricted shares of Common Stock issued under the Restricted Stock Plan For Directors, which was terminated upon shareholder approval of the 2004 Directors Plan at the 2004 Annual Meeting, DSUs issued under the 2004 Directors Plan and Common Stock owned through the individual’s ESOP account. None of the nominees owns any of the Company’s other securities.

Immediate family means the spouse, the minor children and any relatives sharing the same home as the nominee.

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Unless otherwise noted, all Xerox securities held are owned beneficially by the nominee. This means he or she has or shares voting power and/or investment power with respect to the securities, even though another name — that of a broker, for example — appears in the Company’s records. All ownership figures are as of March 15, 2006.

For information on compensation for officers, see the Executive Compensation section starting on page 15.

 

Other Background:   Joined Time Inc. in 1972. Elected Vice President of Time Inc. in 1986, Treasurer in 1986 and Vice President-Finance of Time Inc. in 1988. Became Senior Vice President and Treasurer of Time Warner Inc. and then President and CEO of Time Warner Cable Ventures. Appointed President of Time Warner Cable in 1999, Chairman and CEO in 2001, President and CEO in 2006. Member of the Audit and Corporate Governance Committees of Xerox.

 

Other Background:   Joined Thomson in 1982 and held a number of leadership positions including President and CEO of Thomson Newspapers: President and CEO of Thomson Professional Publishing; President and CEO of Mitchell International and President of Thomson & Thomson. Employed as a Certified Public Accountant for Arthur Young & Co for six years prior to joining Thomson. Chairman of the Audit Committee of Xerox.

 

Other Background:   Joined the Federal Reserve Bank of Chicago in 1995 and most recently held the position of Senior Vice President and Director of Research. Member of the Bank’s management committee, served as the Bank’s chief economic advisor and oversaw the Statistical Reports and Consumer and Community Affairs units. Also served as Associate Economist on the Federal Open Market Committee, the Federal Reserve System’s primary monetary policy group. US Treasury advisor to the Bulgarian National Bank. Held faculty positions at University of Georgia, Atlanta University, Emory University, Chicago State University and Northwestern University. Member of the Audit and the Corporate Governance Committees of Xerox.

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Other Background:   Joined Lazard Freres & Co. LLC in January 2000. Became a partner in the law firm of Akin, Gump, Strauss, Hauer & Feld in 1982, following ten years as President of the National Urban League, Inc. Member of the Bar of Arkansas, Georgia and the District of Columbia as well as the U.S. Supreme Court Bar. Member of the Council on Foreign Relations, The American Law Institute, the American Bar Association, the National Bar Association and the Bilderberg Meetings. Chairman of the Corporate Governance Committee and member of the Compensation Committee of Xerox.

 

Other Background:   Apprenticeship with Rheinisch-Westfalischen Bank AG in Cologne, 1954. Management trainee at J. Henry Schroder Banking Corporation, New York. Foreign Department, Deutsche Bank’s Central Office in Dusseldorf and Manager, Leverkusen branch, 1969. Appointed to the Board of Managing Directors of Deutsche Bank subsidiary European Asian Bank AG in Hamburg, 1972. Executive Vice President, Deutsche Bank AG, 1975; and Member of the Board of Managing Directors, Deutsche Bank AG, 1977. Spokesman of the Board of Managing Directors, December 1989 to May 1997. Member of the Compensation and Finance Committees of Xerox.

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Other Background:   Joined Johnson & Johnson in 1962, named Vice President of Marketing, McNeil Consumer Products Company in 1980. President of Becton Dickinson’s Consumer Products Division, 1981 to 1983. Returned to Johnson & Johnson as President of its Chicopee subsidiary in 1983. Named a company Group Chairman in 1986, and Chairman of the Board and Chief Executive Officer in 1989. Retired in 2002. Served two years in the U.S. Navy. Member of the Nominating and  Corporate Governance and Management Development and Compensation Committees and the presiding director of General Electric. Chairman of the Compensation Committee and member of the Corporate Governance Committee of Xerox.

 

Other Background:   Joined Procter & Gamble in 1980. Named Vice President and General Manager — Philippines, Asia/Pacific-South, Procter & Gamble Far East in 1994; Regional Vice President — Japan, Procter & Gamble Asia in 1996; President, Northeast Asia in 1999; President, Global Fabric & Home Care in 2001; and Vice Chairman Global Operations in 2004. He is a non-voting member of the Board of Directors of The Procter & Gamble Company. Member of the Audit Committee.

 

Other Background:   Joined Xerox in 1976 as a sales representative and held various sales and senior management positions. Named Vice President for Human Resources in 1992; Senior Vice President in 1998; and Executive Vice President in 1999. Elected President and Chief Operating Officer in May 2000, Chief Executive Officer in August 2001, and assumed the additional role of Chairman on January 1, 2002.

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Other Background:   President of Time, Inc. from 1986 to 1990 and President and Co-Chief Executive Officer, Time-Warner Inc. from 1990 to 1992. Former member of the President’s Advisory Committee on Trade Policy and Negotiations and the President’s Commission on Environmental Quality. Trustee Chairman of Environmental Defense. Chairman of the Finance Committee and member of the Compensation Committee of Xerox.

 

Other Background:   Co-founded the Center for Adoption Policy Studies in 2001. Principal, Clayton, Dubilier & Rice, 1999 — 2000. Executive Vice President and Chief Financial Officer, ITT Corporation, 1995 — 1998; Treasurer, ITT Corporation, 1992 — 1995; Assistant Treasurer, ITT Corporation, 1987 — 1992. Member of the Finance and Governance Committees of Xerox.

 

Other Background:   Joined Citizens Communications in 2004 as President and Chief Executive Officer, named Chairman in 2006. Senior Vice President of Worldwide Public Sector, Microsoft, 2002-2004; President and Chief Executive Officer, Wink Communications Inc., 1996-2002; Executive Vice President, National Operations, AT&T Wireless and Chief Executive Officer Aviation Communication Division 1995-1996; Senior Vice President, McCaw Cellular Communications Inc., 1990-1995.

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Ownership of Company Securities

We do not know of any person who, or group which, owns beneficially more than 5% of any class of the Company’s equity securities as of December 31, 2005, except as set forth below(1).

(1)             The words “group” and “beneficial” are as defined in regulations issued by the SEC. Beneficial ownership under such definition means possession of sole voting power, shared voting power, sole dispositive power or shared dispositive power. The information provided in this table is based solely upon the information contained in the Form 13G filed by the named entity with the SEC. All of the firms named in the table, other than State Street Bank and Trust Company, are registered investment advisers under the Investment Advisers Act of 1940, as amended.

(2)             Within the total reported, as to certain of the shares, Dodge & Cox has sole voting power for 115,518,083 shares, shared voting power for 1,222,500 shares, sole dispositive power for 123,035,083 shares and no shared dispositive power for any of the shares.

(3)             Within this total as to certain of the shares, State Street Bank and Trust Company has sole voting power for 29,180,743 shares, shared voting power for 44,558,527 shares, shared dispositive power for 73,739,270 shares and no sole dispositive power for any of the shares. State Street Bank and Trust Company holds 24,740,828 of the total reported shares as ESOP Trustee under the Xerox ESOP. Each ESOP participant may direct the ESOP Trustee as to the manner in which shares allocated to his or her ESOP account shall be voted. The ESOP Trust Agreement provides that the ESOP Trustee shall vote any shares allocated to participants’ ESOP accounts as to which it has not received voting instructions in the same proportions as shares in participants’ ESOP accounts as to which voting instructions are received. Shares which have not been allocated are voted in the same proportion. The power to dispose of shares is governed by the terms of the ESOP Plan and elections made by ESOP participants.

(4)             Brandes Investment Partners, L.P. and its affiliate companies and partners own these shares in aggregate and have shared voting power for 45,052,313 shares and shared dispositive power for 55,001,395 shares, and have no sole voting or dispositive power for any of the shares.

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Shares of Common Stock of the Company owned beneficially by its directors and nominees for director, each of the current executive officers named in the Summary Compensation Table below and directors and all current executive officers as a group, as of March 15, 2006, were as follows: 

 

Percent Owned by Directors and Executive Officers:   Less than 1% of the aggregate number of shares of Common Stock outstanding at March 15, 2006 is owned by any director or executive officer. The amount beneficially owned by all directors and executive officers as a group amounted to approximately 1%.

Amount Beneficially Owned:   The numbers shown are the shares of Common Stock considered beneficially owned by the directors and executive officers in accordance with SEC rules. Shares of Common Stock which executive officers and directors had a right, within 60 days, to acquire upon the exercise of options or rights are included. Shares held in a GRAT or by family members, shares held in the Xerox Corporation Employee Stock Ownership Plan accounts, and vested restricted shares the receipt of which has been deferred under one or more equity compensation plans (which plans have been superseded by the Xerox Corporation 2004 Performance Incentive Plan approved by the shareholders at the 2004 Annual Meeting) are also included. All these are counted as outstanding for purposes of computing the percentage of Common Stock outstanding and beneficially owned.

Total Stock Interest:   The numbers shown include the amount shown in the Amount Beneficially Owned column plus options held by directors and executive officers not exercisable within 60 days, incentive stock units, deferred stock units, performance shares and restricted shares. The numbers also include the interests of executive officers and directors in the Xerox Stock Fund under the Xerox Corporation Savings Plan and the Deferred Compensation Plans.

Executive Compensation

Report of the Compensation Committee of the Board of Directors

The Board of Directors created the Compensation Committee (the “Committee”) to fulfill the Board’s responsibilities relating to compensation of the Company’s officers. Specific Committee responsibilities include reviewing and approving performance goals of the Chief Executive Officer and all other officers, overseeing the performance evaluation of all officers, reviewing and approving executive compensation plans, setting the compensation for the Chief Executive Officer and all other officers, and consulting with the Chief Executive Officer and the Board on management succession. The Committee Charter can be found attached to this proxy

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statement as Exhibit III, or by visiting our website at http://www.xerox.com/investor and then clicking on Corporate Governance, and is also available to any shareholder who requests it by writing to Xerox Corporation, 800 Long Ridge Road, Stamford, Connecticut 06904, Attention: Corporate Secretary.

The Committee is comprised of four independent directors.

Actions Taken by the Committee

The Company’s executive compensation policies, plans and programs provide opportunities for competitive levels of compensation that align pay with the Company’s annual and long-term performance objectives. They include incentives necessary to reward contributions and leadership to increase profitability, revenue and operating cash flow of the Company, enhancing confidence in the financial stewardship of the Company, creating and maintaining the high morale and commitment of the Company’s employees and furthering the Company’s values as a responsible corporate citizen. The Company seeks to be recognized as a leader in corporate social responsibility. These leadership goals are encompassed within our environmental, diversity, and ethics programs and are supported by the Company’s corporate governance process and extensive community outreach. They also support the Company objectives of attracting, motivating and retaining high-performing executives and allowing for recognition of superior corporate and individual achievement.

Our pay policy is to target compensation levels for officers at the midpoint of a range determined from the median compensation levels paid by other companies for comparable positions.

In connection with our duties, the Committee met five times during 2005.

To meet compensation policy objectives, we reviewed Xerox executive officer compensation and compared it to relevant external data. The Committee reviewed the reported compensation data of firms that were part of the Business Week Computers and Peripherals Industry Group. The Committee also reviewed a broader group of organizations with which the Company is likely to compete for executive expertise as well as companies of similar size and scope. The latter group includes global companies in technology, office equipment and other related industries. During 2005, the Committee, following an extensive review, revised this grouping of companies. The new grouping is slightly larger in median total revenues and slightly better performing as measured by total shareholder return when compared to the former grouping. The revised grouping also has a greater representation of services companies. Taken as a whole, we believe the new grouping to be a more relevant group to compare performance and executive compensation.

The Committee sets base salaries based on competitive data and each executive’s performance. In addition, a substantial portion of each executive officer’s total compensation, generally two-thirds or more, is at risk and variable from year to year.

During 2005, the Company generated significant positive operating cash flow, increased sales of new equipment and services as measured on a constant currency basis, and continued its disciplined cost and expense management, which resulted in positive growth in earnings per share. During 2005, total shareholder return was -13.9% for the calendar year. This compares against total shareholder return of over 23% in 2004. Based on the 2005 performance, the Company ranked below the median in total shareholder return in 2005 and in the upper quartile over the past three years when compared to the latter group mentioned above.

Goals for the Company in 2005 focused on Financial and Leadership Effectiveness. Financial goals emphasized improved earnings per share, revenue generation and cash flow from operations. Leadership Effectiveness goals concentrated on effective development and communication of the Company’s strategy and execution of short and long-term business plans. The principal pay programs for officers in 2005 and 2006 are briefly described below:

Base Salary Adjustments:   After reviewing competitive data in early 2005, the Committee approved base salary adjustments for select officers. The approved adjustments averaged approximately 3% on an annualized basis. Certain officers received an additional adjustment to their base salary during 2005 as a result of new responsibilities and/or to address specific retention concerns.

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Annual Performance Incentive Plan (APIP):   Under APIP, executive officers of the Company are eligible to receive performance-related cash payments if Committee-established annual performance objectives are met. The Committee approved an annual incentive target and maximum opportunity for 2005, expressed as a percentage of base salary, for each participating officer.

The Committee also set overall threshold, target and maximum measures of performance for the 2005 APIP. The performance measures and weightings for 2005 were revenue (30%), earnings per share (40%) and cash flow from operations (30%). Additional goals for each officer addressed business-unit specific and/or individual performance goals and objectives, including new product launches and executing business growth plans. The weightings associated with these additional performance goals vary.

For 2005, the performance against the overall APIP goals was as follows: Revenue performance was below threshold, earnings per share growth above targeted levels and cash flow from operations exceeded maximum. Accordingly, the Committee approved APIP awards for 2005 to participating officers that on average were less than target, in light of the overall operational results delivered by the Company in 2005. Some individuals received higher or lower bonuses based on their individual and unit performance.

Payments to the named officers for 2005 were paid from a bonus pool established by the Committee early in 2005 under the terms of the Xerox Corporation 2004 Performance Incentive Plan (2004 Plan) approved by shareholders. The pool was funded by 2% of the performance profit achieved during the year. The Committee exercised its discretion in determining the amount of actual bonus paid to each named officer from the available pool. The purpose of the bonus pool was to ensure that bonuses paid to named officers are performance-based and thus fully tax-deductible expenses for the Company.

Long-Term Incentive Awards:   As previously disclosed in last year’s report, the Committee approved a new approach to long-term incentive awards for executives beginning in 2005. The new Executive Long-Term Incentive Program (E-LTIP) provides strong performance-based incentives that are in full alignment with the interests of all shareholders.

E-LTIP awards made to officers reflect their leadership role in the Company, their individual performance, and competitive award levels. The purpose of E-LTIP is to provide the necessary incentives to retain and reward executives for sustained performance improvements over the next three-year period.

E-LTIP awards made to officers are comprised entirely of performance shares that may be earned based on achieving annual performance targets or three-year cumulative performance between threshold and maximum as determined by the Committee. Performance shares that have been earned vest following Committee certification of the performance results for the applicable three-year period. Executives who retire or are involuntarily terminated prior to the end of the three-year performance period will vest in a portion of the performance shares earned on a pro rata basis.

Performance metrics for E-LTIP are Diluted Earnings Per Share (60%) and Net Cash provided by Operating Activities (40%). The Committee has established annual and cumulative targets for each award. Based on annual or cumulative performance versus targets, the number of performance shares earned by officers under E-LTIP may vary from 0% to 150% of the initial number of shares subject to the grant.

Each share granted provides for the cash payment of dividend equivalents at the same time and in the same amounts that the holder of record of a number of shares of Common Stock would be entitled to receive as dividends.

Each participant of E-LTIP must satisfy a meaningful ownership requirement. For Anne M. Mulcahy, the Chairman and CEO, the ownership requirement is five times her base salary. For Ursula M. Burns, Lawrence A. Zimmerman and James A. Firestone, the requirement is three times base salary. For other officers, the ownership requirement is two times base salary. Non-officer participants in E-LTIP have an ownership requirement equal to their base salary. All awards under E-LTIP are subject to a mandatory holding requirement. As determined by the Committee, executives must retain 50% of the net shares until they achieve their required level of ownership.

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Grants for 2005 E-LTIP were made by the Committee effective January 1, 2005. Specific grants made to the named officers are shown in the Long-Term Incentive Plan Awards Table and related footnotes that accompany this report as per current SEC requirements. For the year 2005, Diluted Earnings Per Share and Net Cash provided by Operating Activities performance exceeded target. The Committee, therefore, determined that one-third of the performance shares awarded in 2005 under E-LTIP were earned by participants, including the named executive officers. The number of earned shares and their value (based on the year-end 2005 closing market price of $14.65) is as follows:  Anne M. Mulcahy 98,033 ($1,436,183), Ursula M. Burns 35,300 ($517,145), Lawrence A. Zimmerman 31,367 ($459,527), James A. Firestone 31,367 ($459,527) and Michael C. Mac Donald 21,567 ($315,957). Pursuant to the terms of E-LTIP, earned shares do not vest until the end of the three-year period following the grant.

Grants for 2006 E-LTIP were made by the Committee effective April 1, 2006, as follows:  Anne M. Mulcahy 444,000 ($6,737,700), Ursula M. Burns 170,800 ($2,591,890), Lawrence A. Zimmerman 109,300 ($1,658,628), James A. Firestone 136,700 ($2,074,423) and Michael C. Mac Donald 75,200 ($1,141,160).

Effective in 2004, the Committee discontinued the granting of stock options because it believes the performance shares in E-LTIP provide for a more effective balance of the performance-based incentives needed to attract and retain executive talent at lower cost and with less dilution. Awards under E-LTIP are reflected as compensation expense in the Company’s results of operations.

In order to effectively complete the transition to the new stock-based award programs, the Committee approved accelerating the vesting of approximately 3,616,000 unvested stock options previously granted in 2004 to all employees, including corporate officers. Approximately 2,883,000 of these unvested stock options had been granted to employees who are not corporate officers, and 733,000 to corporate officers including Anne M. Mulcahy (203,000), Ursula M. Burns (46,000), Lawrence A. Zimmerman (40,667), James A. Firestone (40,667) and Michael C. Mac Donald (30,667).

Executive Life Insurance:   The Company provides the Xerox Universal Life Plan (XUL) to eligible employees, including the named officers. Under XUL, participants receive Company-paid life insurance equal to their death benefit under the prior program, or three times their base salary, whichever is greater. Executives are the sole owners of their XUL policies and are responsible for any taxes due from Company contributions.

Policy Regarding Tax Deductibility of Executive Compensation

It is the Company’s goal to have most compensation paid to its top officers qualify as tax deductible for federal tax purposes under Section 162(m) of the Internal Revenue Code. We believe it is appropriate to provide competitive compensation opportunities even though they may not be fully tax deductible in any given year.

Certain compensation paid to named officers in 2005 does not meet the requirements of Section 162(m), most notably the value of restricted stock awards that vested in 2005, to the extent that compensation exceeds $1 million for a named officer. Certain perquisite compensation, such as personal use of company aircraft, also may not be fully tax deductible. It is expected that E-LTIP awards will be fully tax-deductible compensation.

Chief Executive Officer Compensation

In 2005, the Committee took the following actions with respect to the compensation paid to Mrs. Mulcahy, Chairman and Chief Executive Officer of the Company.

Base Salary:   Mrs. Mulcahy’s annualized base salary was maintained at the previously disclosed level of $1,320,000.

2005 Bonus:   Mrs. Mulcahy’s annual target bonus remained at 100% of base salary. Mrs. Mulcahy was awarded an annual bonus of $1,188,000, based on the Company’s overall results as discussed above under APIP.

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Long-Term Incentives:   Effective on January 1, 2005, Mrs. Mulcahy received an award under the 2005 E-LTIP as described earlier. Her 2005 E-LTIP award consisted of a grant of 294,100 performance shares. The grant date fair market value of this grant was $5,001,171.  On the basis of Company performance in 2005 as discussed earlier in this report, 98,033 shares ($1,436,183, based on the year-end 2005 closing market price of $14.65) were earned. Earned shares do not vest until the end of the three-year period following the grant.

Effective on April 1, 2006, Mrs. Mulcahy received an award for 2006 under E-LTIP as described above. Her award consisted of 444,000 performance shares at a grant value of ($6,737,700).

Performance shares may be earned based on annual or cumulative performance targets over a three-year period as determined by the Committee. Based on performance, shares actually received may range from 0% to 150%.

Mrs. Mulcahy’s 2006 APIP incentive target increased to 150% (from 100%) following the Committee’s review of competitive incentive target levels and total compensation levels.

The Committee made these awards to provide the incentives necessary to retain Mrs. Mulcahy and to reward her for her outstanding contributions and leadership in significantly increasing the profitability and operating cash flow of the Company, enhancing confidence in the financial stewardship of the Company, and creating and maintaining the high morale, commitment of the Company’s employees and furthering the Company’s values as a responsible corporate citizen.

The accompanying charts and tables present detailed information on Mrs. Mulcahy’s compensation as well as that of other highly compensated executive officers.

The Committee and the Board believe that the quality of Xerox’s leadership and the caliber and motivation of its management make a significant contribution to our performance and ability to create sustaining value for our shareholders. The Committee believes our executive compensation programs are an important component of our ability to create competitive advantage for Xerox in light of global competition.

Ralph S. Larsen, Chairman
Vernon E. Jordan, Jr.
Hilmar Kopper
N.J. Nicholas, Jr.

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Summary Compensation Table

The Summary Compensation Table below provides compensation information for the Chief Executive Officer and the four most highly compensated key executive officers (named officers) serving at the end of the fiscal year ended December 31, 2005, for services rendered in all capacities during the fiscal years ended December 31, 2005, 2004, and 2003. The table includes the dollar value of base salary, bonus earned, restricted stock awards, option awards (shown in number of shares) and certain other compensation, whether paid or deferred.

SUMMARY COMPENSATION TABLE

(A)    Effective April 1, 2006, the Committee set annualized base salaries of the named officers as follows:  Ursula M. Burns $640,000, Lawrence A. Zimmerman $600,000, James A. Firestone $600,000, Michael C. Mac Donald $509,300. Anne M. Mulcahy’s salary remained unchanged at $1,320,000.

(B)    Amounts in this column represent perquisites and personal benefits including personal use of Company aircraft, financial planning/tax preparation, tax related reimbursements, above market interest credited to nonqualified deferred compensation balances from compensation that was deferred prior to 2002, prizes, and executive physicals. Amounts for Anne M. Mulcahy include reimbursement for home security. Amounts for 2003 include the discontinued executive expense allowance.  For reasons of security and personal safety, the Company requires Anne M. Mulcahy to use Company aircraft for all air travel. The Committee has authorized Lawrence A. Zimmerman to utilize commercial and Company aircraft in an aggregate cost to the Company not to exceed $250,000 per year, inclusive of any applicable tax-related reimbursements, which he intends to use primarily for travel to and from his residences located outside Connecticut. The compensation value of personal Company aircraft usage is calculated at aggregate incremental cost to the Company, which includes primarily the cost of fuel, trip-related service and maintenance, and travel expenses of the flight crew and other contract personnel. Compensation value excludes costs associated with “deadhead” legs. On certain occasions, family members and non-business related passengers may accompany an executive on a business flight. In such situations, a de minimis amount of incremental cost is incurred by the Company. Amounts representing any perquisites and personal benefits that are the greater of $25,000 or 10% of the totals shown above and all above market interest and tax-related reimbursements are as follows.

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Name				Year		Personal Use of Aircraft ($)				Above Market Interest ($)				Tax Related Reimbursements ($)
Anne M. Mulcahy				2005			147,500				5,594				24,955
				2004			92,100				3,795				26,405
				2003			118,400				3,501				166,563
Ursula M. Burns				2005			—				863				1,523
				2004			—				586				1,579
				2003			—				540				—
Lawrence A. Zimmerman				2005			45,200				—				—
				2004			51,500				—				563
				2003			27,000				—				5,717
James A. Firestone				2005			—				—				—
				2004			—				—				—
				2003			—				—				—
Michael C. Mac Donald				2005			—				505				1,222
				2004			—				342				1,337
				2003			—				316				9,622

 

(C)    There were no restricted stock awards granted by the Company to named officers in 2005. The number of restricted shares and units held by the named officers and their value (based on the year-end 2005 closing market price of $14.65) was as follows: Anne M. Mulcahy — 244,000 ($3,574,600), Ursula M. Burns — 55,334 ($810,643), Lawrence A. Zimmerman — 49,334 ($722,743), James A. Firestone — 49,334 ($722,743) and Michael C. Mac Donald — 36,667 ($537,172).

As discussed in the “Report of the Compensation Committee of the Board of Directors,” E-LTIP grants for 2005 and 2006 were comprised entirely of performance shares. All awards granted under E-LTIP are subject to a mandatory holding period. As determined by the Committee, executives must retain 50% of net shares for all awards granted under E-LTIP until they achieve their required ownership level. Each share provides for the cash payment of dividend equivalents at the same time and in the same amounts that the holder of a number of shares of Common Stock would be entitled to receive as dividends. Performance shares earned under E-LTIP vest following Committee certification of three-year cumulative performance results (see “Report of the Compensation Committee of the Board of Directors”).

This column excludes the grants of E-LTIP performance shares made effective on January 1, 2005, (based on the fair market value of $17.005 on the grant effective date) as follows: Anne M. Mulcahy — 294,100 ($5,001,171), Ursula M. Burns — 105,900 ($1,800,830), Lawrence A. Zimmerman — 94,100 ($1,600,171), James A. Firestone — 94,100 ($1,600,171) and Michael C. Mac Donald — 64,700 ($1,100,224). This also excludes the grants of E-LTIP performance shares made effective on April 1, 2006 (based on the fair market value of $15.175 on the grant effective date) as follows: Anne M. Mulcahy — 444,000 ($6,737,700), Ursula M. Burns — 170,800 ($2,591,890), Lawrence A. Zimmerman — 109,300 ($1,658,628), James A. Firestone — 136,700 ($2,074,423) and Michael C. Mac Donald — 75,200 ($1,141,160).

(D)   As discussed in the “Report of the Compensation Committee of the Board of Directors”, there have been no stock options granted by the Company since 2004.

(E)    Based on 2005 business results and as determined by the Committee, each named officer earned one third of his or her 2005 E-LTIP grant. The number of shares and their value (based on the year-end 2005 closing market price of $14.65) were as follows:   Anne M. Mulcahy — 98,033, ($1,436,183), Ursula M. Burns — 35,300 ($517,145), Lawrence A. Zimmerman — 31,367 ($459,527), James A. Firestone — 31,367 ($459,527), and Michael C. Mac Donald 21,567 ($315,957). Under current SEC rules, the value of these performance shares will be reported in this column after their vesting and pay out in 2008.

(F)    The amount shown in this column for 2005 consists of the Company match under the Company’s Savings Plans, for which substantially all U.S. employees are eligible, and Company-paid premiums for the Xerox Universal Life Plan as discussed in the “Report of the Compensation Committee of the Board of Directors.” These premium amounts for 2005 are: Anne M. Mulcahy — $50,881, Ursula M. Burns — $16,104, Lawrence A. Zimmerman — $9,870, James A. Firestone — $22,422 and Michael C. Mac Donald — $23,204.

Option Exercises/Year-End Values

The following table sets forth for each of the named officers the number of shares underlying options and SARs exercised during the fiscal year ended December 31, 2005, the value realized on exercise, the number of options/SARs unexercised at year-end and the value of unexercised in-the-money options/SARs at year-end.

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AGGREGATE OPTION/SAR EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION/SAR VALUE

(A)    All awards granted under the 2004 E-LTIP are subject to a mandatory holding period. As determined by the Committee, executives must retain 50% of net shares for the later of one year, or until they achieve their required ownership level.

(B)    The value of unexercised options/SARs is based on the difference between the exercise price and the fair market value on December 31, 2005, of $14.665. Options/SARs may be accelerated as a result of a change in control as described under “Option Surrender Rights”.

(C)    Under Securities Exchange Commission Rule 10b5-1, on November 5, 2004, Anne M. Mulcahy entered into a pre-arranged plan to sell a portion of her Xerox holdings in 2005. Pursuant to the terms of the plan, Anne M. Mulcahy exercised options and sold 300,000 shares of Xerox stock in 2005. Anne M. Mulcahy entered into a similar pre-arranged Rule 10b5-1 plan on October 27, 2005, to exercise options and sell up to 475,000 shares of Xerox stock in 2006. Both of these plans were previously disclosed by the Company in SEC filings.

(D)   On February 8, 2005, Ursula M. Burns entered into a pre-arranged Rule 10b5-1 plan to sell up to 70,000 shares of Xerox stock in 2005. Pursuant to the terms of the plan, Ursula M. Burns sold 70,000 shares of Xerox stock in 2005. Ursula M. Burns entered into a similar pre-arranged Rule 10b5-1 plan on October 27, 2005, to sell up to 201,481 shares of Xerox stock in 2006. Both of these plans were previously disclosed by the Company in SEC filings.

Long-Term Incentive Plan Awards in January 2005

The following table provides information for each of the named officers on the number of performance shares granted, the performance period and the estimated number of shares that could vest if certain performance measures are achieved under the 2005 E-LTIP. As described in the “Report of the Compensation Committee of the Board of Directors,” performance shares can be earned based on achieving annual performance targets or three-year cumulative performance between threshold and maximum. The performance measurements for these grants are Diluted Earnings Per Share (weighted at 60%) and Net Cash provided by Operating Activities (weighted at 40%). Performance shares that have been earned vest in early 2008.

(A)    Based on 2005 business results and as determined by the Committee, each named officer earned one third of his or her 2005 E-LTIP grant. The number of shares and their value (based on the year-end 2005 closing market price of $14.65) were as follows:   Anne M. Mulcahy — 98,033, ($1,436,183), Ursula M. Burns — 35,300 ($517,145), Lawrence A. Zimmerman — 31,367 ($459,527), James A. Firestone — 31,367 ($459,527), and Michael C. Mac Donald — 21,567 ($315,957).

(B)    Threshold is based on the number of performance shares earned if three-year cumulative performance is achieved at the minimum level for Net Cash provided by Operating Activities. If threshold performance is not achieved on any of the performance measures, no performance shares will be earned. Target reflects the number of performance shares earned if target performance is achieved on all performance measures. Maximum describes the maximum number of performance shares earned if maximum or greater performance is achieved on all performance measures. The number of performance shares earned will be interpolated in the event that the Company’s cumulative performance varies between threshold and maximum as determined by the Committee.

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The table above represents the number of E-LTIP performance shares granted as of January 1, 2005. It excludes the grants of E-LTIP performance shares made effective on April 1, 2006 (based on the fair market value of $15.175 on the grant effective date) as follows: Anne M. Mulcahy — 444,000 ($6,737,700), Ursula M.
Burns — 170,800 ($2,591,890), Lawrence A. Zimmerman — 109,300 ($1,658,628), James A. Firestone — 136,700 ($2,074,423) and Michael C. Mac Donald — 75,200 ($1,141,160). Each share provides for the cash payment of dividend equivalents at the same time and in the same amounts that the holder of a number of shares of Common Stock would be entitled to receive as dividends. Any performance shares that are earned vest following Committee certification of three-year cumulative performance results. As determined by the Committee, executives must retain 50% of net shares for all awards granted under E-LTIP until they achieve their required ownership level (see “Report of the Compensation Committee of the Board of Directors”).

Equity Compensation Plan Information

The Equity Compensation Plan Information table provides information as of December 31, 2005, with respect to shares of Xerox Common Stock that may be issued under our existing equity compensation plans, including the Xerox Corporation 2004 Performance Incentive Plan (the “2004 Plan”); the Xerox Corporation 2004 Equity Compensation Plan for Non-Employee Directors (the “2004 Directors Plan”); the Xerox Corporation Long-Term Incentive Plan (the “1991 Plan’’); the Xerox Corporation 1996 Non-Employee Director Stock Option Plan (the “1996 Plan”); the Xerox Corporation 1998 Employee Stock Option Plan (the “1998 Plan”); the Xerox Mexicana, S.A. de C.V. Executive Rights Plan (the “Mexico Plan”); and the Xerox Canada Inc. Executive Rights Plan (the “Canada Plan”).

EQUITY COMPENSATION PLAN INFORMATION

(1)    Consists of the 2004 Plan, the 2004 Directors Plan, the 1991 Plan, the 1996 Plan and the 1998 Plan.

(2)    Consists of the Mexico Plan and the Canada Plan.

(3)    The 1998 Plan was discontinued as of May 21, 2003; and the 1991 Plan, the 1996 Plan, the Mexico Plan and the Canada Plan were discontinued as of May 20, 2004. No further grants can be made under these plans. However, any shares that are cancelled, forfeited, or lapse under the 2004 Plan, the 1991 Plan, the 1998 Plan, the Mexico Plan and the Canada Plan shall become available again for issuance under the 2004 Plan. Any shares that are cancelled, forfeited, or lapse under the 2004 Directors Plan shall become available again for issuance under the 2004 Directors Plan.

(4)    There is an additional 7,542,329 full-value shares of stock and units outstanding as of 2005 fiscal year end and approximately 6,578,000 full-value shares and units granted to participants in January through April 1, 2006.

(5)    Any full-value shares issued in connection with the 2004 Plan and the 2004 Directors Plan shall be counted against this limit as 1.667 shares for each one (1) share issued. As anticipated, if all remaining shares were issued as full-value shares, approximately 29,610,546 shares would be available for issuance as of fiscal year end.

Xerox Mexicana, S.A. de C.V. Executive Rights Plan

The Mexico Plan provided for the granting of stock rights for the purpose of advancing the interests of Xerox Corporation and shareholders by providing the General Director or Executive Director and other employees with a proprietary interest in the growth and performance of the Company and incentives for continued service. This plan was discontinued in May 2004, following shareholder approval of the 2004 Plan.

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Xerox Canada Inc. Executive Rights Plan

The Canada Plan provided for the granting of stock rights and other related vehicles for the purpose of advancing the interests of Xerox Corporation and shareholders by providing the President or a Vice President of Xerox Canada Inc. and other employees with a proprietary interest in the growth and performance of the Company and incentives for continued service. This plan was discontinued in May 2004, following shareholder approval of the 2004 Plan.

Retirement Plans

Retirement benefits are provided to the executive officers of the Company including the named officers primarily under unfunded executive supplemental retirement plans and, due to Internal Revenue Code limitations, to a much lesser extent under the Company’s Retirement Income Guarantee Plan. The table below shows the approximate total annual retirement benefit that would accrue for the number of years of credited service at the respective average annual compensation levels. The earliest retirement age for benefit commencement generally is age 60. In the event of a change in control (as defined in the plans) there is no age requirement for eligibility. The benefit accrues generally at the rate of 12¤3% per year of credited service, but an accelerated benefit may apply for certain executives. No additional benefits are payable for participation in excess of 30 years for those accruing benefits at the rate of 12¤3% per year. The maximum benefit is 50% of the highest five-year average annual compensation reduced by 50% of the primary Social Security benefit. The benefits shown are payable on the basis of a straight life annuity and a 50% survivor annuity for a surviving spouse.

Accelerated accruals apply to Lawrence A. Zimmerman. The service reported in the table below reflects these accelerated accruals (i.e., using the service and pay reported in the pension table will yield the appropriate benefit amount). Anne M. Mulcahy, who had been accruing benefits on an accelerated basis, will have 30 years of service in 2006 and as a result will have accrued the full plan benefit without any acceleration. She will be eligible for this benefit if she retires at age 55 or later. Lawrence A. Zimmerman is currently vested.

 

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As of December 31, 2005, the following individuals have five-year highest average compensation and years of credited service for purposes of the plans as follows:

(A)           Compensation under the plans includes the amounts shown in the salary and bonus columns under the Summary Compensation Table.

Certain Transactions

Change-In-Control Severance Agreements

The Company has severance agreements with 32 executives (including each of the named officers), that provide severance benefits in the event of termination of employment under certain circumstances, including termination by the Company for reasons other than for “cause” or disability, or by the executives for “good reason” (each as defined in the agreements), following a “change in control of the Company” (as defined in the agreement). The agreements provide for the following:

·       Lump-sum severance payment equal to 2.99 times total annual cash compensation (base pay plus bonus) for Anne M. Mulcahy and generally two times total cash compensation for other executives

·       Continuation of certain welfare benefits following termination of employment for a period of 36 months for Anne M. Mulcahy and 24 months for other executives

·       Gross-up payment if the total payments are subject to excise tax imposed under Section 4999 of the Internal Revenue Code of 1986, as amended

·       Automatic annual renewal of the agreement unless the Company gives notice that it does not wish to extend it

·       Continuation of the agreement for two years after a change in control of the Company.

Each agreement also provides that in the event of a potential change in control, subject to certain exceptions, the executive will remain in the employ of the Company for nine months following the occurrence of any such potential change in control or, if earlier to occur, the date on which the executive is entitled to certain of the benefits described above upon a change in control.

Generally, for purposes of the severance agreements, a change in control is deemed to have occurred, subject to certain exceptions, if: (1) any person beneficially owns 20 percent or more of the combined voting power of our securities, (2) a majority of our Directors are replaced under certain circumstances, (3) there is a merger or consolidation involving the Company, or (4) there occurs the sale of all or substantially all of the Company’s assets or the Company’s shareholders approve a plan of complete liquidation or dissolution.

Grantor Trusts

The Company has established grantor trusts with a bank for the purpose of paying amounts due under certain of the deferred compensation plans and the severance agreements described above, and the unfunded retirement plans described above. The trusts are presently unfunded, but the Company would be required to fund the trusts on the occurrence of a change in control or a potential change in control (each as defined in the grantor trusts).

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Option Surrender Rights

All non-qualified options under the 1991 Plan and the 1998 Plan are accompanied by option surrender rights. If there is a change in control, as defined in the plans, all such rights that are in the money become payable in cash, unless otherwise determined by the Committee, based on a change-in-control price as defined in the plans. The 1991 Plan also provides that on the occurrence of such an event, all restricted stock and incentive stock rights become payable in cash, unless otherwise determined by the Committee. In the case of rights payable in shares, the amount of cash is based on such change-in-control price, and in the case of rights payable in cash, the cash value of such rights. Rights payable in cash that have not been valued at the time of such an event are payable at the maximum value as determined by the Compensation Committee at the time of the award. In the event of accelerated payment, such rights and any related non-qualified stock options will be cancelled.

Related Employment Arrangements

We actively recruit qualified candidates for our employment needs. Relatives of our executive officers and other employees are eligible for hire. We currently have four employees who receive more than $60,000 in annual compensation who are related to our named executive officers. These are routine employment arrangements entered into in the ordinary course of business and the compensation of each such family member is commensurate with that of their peers. None of our named executive officers have a material interest in any of these employment arrangements. None of these family members is a corporate officer, except Thomas J. Dolan, Senior Vice President, who has been with the Company for 35 years and is a sibling of Anne M. Mulcahy, Chairman and Chief Executive Officer. The Compensation Committee of the Board makes compensation decisions involving Mr. Dolan. As determined by the Compensation Committee, Mr. Dolan was paid $719,354 in base salary and bonus compensation for 2005 and was granted 53,000 performance shares during fiscal year 2005. The annual compensation for 2005 for each of the remaining three employees ranged from approximately $75,000 to less than $180,000.

Litigation

Miller, et al. v. Allaire, et al.:   Following the voluntary dismissal without prejudice of In re Xerox Derivative Actions in the Supreme Court of the State of New York, County of New York, the plaintiffs purportedly brought a substantially similar putative shareholder derivative action in Connecticut Superior Court, Judicial District of Stamford-Norwalk at Stamford in the name of and for the benefit of the Company, which is named as a nominal defendant, and its public shareholders against several current and former members of the Board of Directors including William F. Buehler, B.R. Inman, Antonia Ax:son Johnson, Vernon E. Jordan, Jr., Yotaro Kobayashi, Hilmar Kopper, Ralph Larsen, George J. Mitchell, N.J. Nicholas, Jr., John E. Pepper, Patricia Russo, Martha Seger, Thomas C. Theobald, Paul Allaire, G. Richard Thoman, Anne Mulcahy and Barry Romeril, and KPMG LLP. This action is based on substantially the same allegations and seeks substantially the same relief as the discontinued action. The complaint alleges that each of the director defendants breached their fiduciary duties to the Company and its shareholders by, among other things, ignoring indications of a lack of oversight at the Company and the existence of flawed business and accounting practices within the Company’s Mexican and other operations; failing to have in place sufficient controls and procedures to monitor the Company’s accounting practices; knowingly and recklessly disseminating and permitting to be disseminated, misleading information to shareholders and the investing public; and permitting the Company to engage in improper accounting practices. The plaintiffs further alleged that each of the director defendants breached his/her duties of due care and diligence in the management and administration of the Company’s affairs and grossly mismanaged or aided and abetted the gross mismanagement of the Company and its assets. The complaint also asserts claims of negligence, negligent misrepresentation, breach of contract and breach of fiduciary duty against KPMG. Additionally, plaintiffs claimed that KPMG is liable to Xerox for contribution, based on KPMG’s share of the responsibility for any injuries or damages for which Xerox is held liable to plaintiffs in related pending securities class action litigation. On behalf of the Company, the plaintiffs seek a judgment declaring that the director defendants violated and/or aided and abetted the breach of their fiduciary duties to the Company and its shareholders; awarding the Company

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unspecified compensatory damages against the director defendants, individually and severally, together with pre-judgment and post-judgment interest at the maximum rate allowable by law; awarding the Company punitive damages against the director defendants; awarding the Company compensatory damages against KPMG; and awarding plaintiffs the costs and disbursements of this action, including reasonable attorneys’ and experts’ fees. Plaintiffs also demand injunctive relief from the indemnification of six former officers for disgorgements imposed pursuant to their respective settlements with the SEC and related legal fees. On November 23, 2005, defendants filed a motion to dismiss and a separate motion for partial summary judgment. Those motions were argued before the court on March 13, 2006. The court has not yet issued a ruling. The individual defendants deny any wrongdoing.

Indemnification Actions

The Company’s By-Laws provide for indemnification of officers and directors to the full extent permitted by New York law. Consistent with these By-Laws, in connection with the derivative actions mentioned above as well as In re Xerox Corporation Securities Litigation; Carlson v. Xerox Corporation, et al.; Florida State Board of Administration, et al. v. Xerox Corporation, et al.; In re Xerox Corp. ERISA Litigation; National Union Fire Insurance Company v. Xerox Corporation, et al., Miron v. Microsoft Corporation, et al., and the India matter described in Note 16 — Contingencies in the 2005 Annual Report to Shareholders accompanying this Proxy Statement, the Company has advanced counsel fees and other reasonable fees and expenses, actually and necessarily incurred by the present and former directors and officers who are involved, and the Company has advanced, since the previous report to shareholders as to these fees and expenses, an aggregate of approximately $813,799. Each of the individuals is required, in accordance with the requirements of the Business Corporation Law of the State of New York (“BCL”), to execute an undertaking to repay such expenses if they are finally found not to be entitled to indemnification under the Company’s By-Laws and the BCL.

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Five-Year Performance Comparison

The graph below provides a comparison of Xerox cumulative total shareholder return with the Standard & Poor’s 500 Composite Stock Index and the Business Week Computers and Peripherals Industry Group, excluding Xerox (Peer Group).

TOTAL SHAREHOLDER RETURNS

Years Ending

 

The Peer Group consists of the following companies as of December 31, 2005: Apple Computer, Dell Computer, Diebold, EMC, Hewlett-Packard, International Business Machines, Lexmark International, Maxtor, NCR, Network Appliance, Sandisk, Seagate Technology, Storage Technology, Sun Microsystems and Western Digital.

This graph assumes the investment of $100 on December 31, 1999 in Xerox Common Stock, the S&P 500 Index and the Peer Group Common Stock, and reinvestment of quarterly dividends at the monthly closing stock prices. The returns of each company have been weighted annually for their respective stock market capitalizations in computing the S&P 500 and Peer Group indices.

Directors and Officers Liability Insurance and Indemnity

On August 18, 2005, the Company renewed its policies for directors and officers liability insurance. The policies are issued by Federal Insurance Company, XL Specialty Insurance Company, St. Paul Mercury Insurance Company, Twin City Fire Insurance Company, U.S. Specialty Insurance Company, Arch Specialty Insurance Company and ACE American Insurance Company, Axis Reinsurance Company and Allied World Assurance Company. The policies expire August 18, 2006 and the total annual premium is $5,287,360.

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Section 16(a) Beneficial Ownership Reporting Compliance

The Company believes that all reports for the Company’s directors and executive officers that were required to be filed under Section 16 of the Securities Exchange Act of 1934 were timely filed.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE ELECTION OF THE ELEVEN (11) DIRECTORS NOMINATED BY THE BOARD OF DIRECTORS.

PROPOSAL 2 — RATIFICATION OF SELECTION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Audit Committee has selected PricewaterhouseCoopers LLP (PwC), an independent registered public accounting firm, to act as independent auditors of the Company for 2006. Representatives of the firm are expected to be at the meeting to respond to appropriate questions and to make a statement, if they wish.

Principal Auditor Fees and Services

Aggregate fees for professional services rendered for the Company by PwC for the years ended December 31, 2005 and 2004, were ($ in millions):

 

Audit fees for the years ended December 31, 2005 and 2004, were for professional services rendered for the audits of the consolidated financial statements of the Company, statutory and subsidiary audits, assistance with review of documents filed with the SEC, consents, comfort letters, international filings and other services required to be performed by our independent auditors. The 2004 fees included amounts related to the initial audit of internal control over financial reporting, as mandated by the Sarbanes-Oxley Act of 2002.

Audit Related fees for the years ended December 31, 2005 and 2004, were for assurance and related services associated with employee benefit plan audits, information systems control reviews, due diligence reviews, special reports pursuant to agreed upon procedures and other attest services.

Tax fees for the years ended December 31, 2005 and 2004, were primarily for services related to tax compliance.

In accordance with the Audit Committee Charter, all of the foregoing audit and non-audit fees paid to, and the related service provided by, PwC were pre-approved by the Audit Committee.

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