Fellow shareholders:

Our results included:

• Net income of $1.1 billion.
• Earnings per share of $1.19, which compares to 2006 earnings per share of $1.22. On an adjusted basis, our earnings per share grew 13 percent in 2007.*
• Operating cash flow of $1.9 billion.
• Total revenue of $17.2 billion, an increase of $1.3 billion or 8 percent. Excluding the benefit of our acquisition of Global Imaging Systems, which we purchased in May last year, revenue was up 4 percent in 2007.*
• Investments in strategic acquisitions totaling $1.6 billion.
• And disciplined cost management that kept our gross margins and selling, administrative and general costs right in line with our business model.

* See below for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP.

At the same time, we continued to take steps to build shareholder value. All the credit rating agencies rank us as investment grade. We reinstated a dividend. We repurchased $631 million in Xerox stock, bringing the total repurchased since 2005 to $2.1 billion. And, as we entered 2008, our Board of Directors authorized the repurchase of an additional $1 billion of Xerox stock.

We feel good about the state of our business. And, we know that consistently delivering double-digit earnings per share growth and strong operating cash flow make for the best long-term investment. It’s a value proposition we’re strengthening every day.

The numbers, as they say, speak for themselves but they don’t tell the entire story. Turnarounds are easy to track and to talk about; transformations evolve more slowly and are harder to define. Over the past several years – step by step and brick by brick – we have built a new Xerox.

I believe we are at an inflection point. We have evolved into a services-led technology company that is known for innovation and customer focus. We help manage the massive flow of information and communication in businesses today. We’re a content management provider and a trusted partner that can help our customers make the most of their IT infrastructure and bridge the paper and digital worlds.

The Xerox once known for copiers, printers and paper has greatly expanded its footprint. New technology and services offerings are generating billions of dollars in recurring revenue for us.

We’ve made some critical strategic bets in the past few years that are now differentiating Xerox in the marketplace and fueling our growth. We invested heavily in color, determined to be the market leader. We coined the term “The New Business of Printing” and vowed to bring digital technology to what was largely the province of offset or lithographic printing. We also invested in technology and distribution to aggressively attack the office market and expand the business we do with small and mid-size companies. And we vowed to become a services-led partner in large enterprises.

I’m not given to exaggeration or hyperbole, but I feel strongly that we have achieved considerable success on all four fronts.

Accelerating the adoption of color

We’ve led the transition to color from top to bottom across the markets we serve – color that’s both the highest quality and highly affordable. Last year, more than 40 billion pages were printed on Xerox color systems. That’s an increase of 31 percent over 2006 and way ahead of our competitors. In fact, according to estimates by InfoTrends, a leading independent research firm, Xerox accounts for half of the total worldwide color pages printed by high-speed digital systems.

And, for us, the power really is in the pages. We operate an annuity-based business with more than 70 percent of our total revenue coming from recurring revenue streams, what we call our “post sale.” This includes interest income from financing our customers’ purchases; service, such as technical support as well as consulting and outsourcing services; and supplies, like ink, paper and toner. The latter is why pages are so important to our business. Post-sale revenue from color pages was up 18 percent year-over-year, so we know the model is working. As that continues to grow, so will Xerox.

Color now accounts for about 39 percent of our total revenue, but only 12 percent of our total pages (excluding the benefit of Global Imaging Systems) – indicating a tremendous growth opportunity that we’re well positioned to mine. Last year, we shook up the marketplace by launching an office printer that makes the cost of printing a color page as affordable as black and white. It’s the Phaser® 8860 and it uses our proprietary solid ink, cartridge-free technology, minimizing the impact on the environment. We announced 18 color products in 2007, strengthening what is already the industry’s broadest portfolio of digital color printing systems. Look for more worldclass color technology this year – technology that promises to widen our significant competitive advantage and generates the pages that boost our annuity.

Driving The New Business of Printing^®

Our leadership in digital high-volume printing complements traditional offset printing. This market transition is The New Business of Printing. The opportunity for digital production printing is about $25 billion, and Xerox’s advantages are the ability to print on demand, produce short runs of books, and customize each and every document that comes off a digital press. In The New Business of Printing, the Xerox iGen3® Digital Production Press continues to be the star performer, but it has a great supporting cast. We’ve now installed more than 2,000 iGen3s around the world. Many customers – 126 to be precise – are printing more than a million pages a month on these market-making marvels. Perhaps the best testimony to their success is that 275 of our customers, many of whom run commercial print shops, have purchased at least two iGen3s and have seen their business soar by offering more digital printing capabilities.

At the same time, we’re seeing accelerated demand for the high end of our DocuColor® series and the recently launched Xerox Nuvera® systems. We’re going after the continuous feed market with new technology that redefines the industry standards of speed and quality and gives us a competitive advantage. And we’re partnering with photo imaging companies to use Xerox technology for printing photo applications. In fact, if you order a photo calendar from a retailer that works with Fujifilm, the calendar will be printed on a Xerox press using Xerox paper. As Xerox leads advancements in quality for digital printing, the lines are blurring between the traditional photo imaging business and document processing. InfoTrends predicts the specialty photo printing market – that’s calendars, greeting cards and photo books – will grow at a rate of 24.5 percent per year through 2010, reaching $800 million. Xerox is well on its way to capturing a good share of this growth.

Expanding participation in small/medium businesses

We also see great opportunity in the office market where we’re investing heavily to win. In 2007, we launched 29 office products that garnered 190 industry awards and broadened and deepened our offerings in this highly competitive market.

At the same time, we acquired Global Imaging Systems, which immediately put some 1,400 new sales people on the street and brought more than 200,000 new customers into the Xerox fold. The acquisition has exceeded our expectations and then some. One year ago, this billion-dollar enterprise sold NO Xerox products. By year’s end, 50 percent of the document technology Global Imaging was selling carried the Xerox brand and it is getting better every month.

In addition, much of Xerox’s 11 percent growth in developing markets has been fueled by small and mid-size businesses (SMB). We’ve been increasingly building a competitive portfolio of products and services that cater directly to the fast-growing SMB market. We’re making inroads with today’s small businesses that may be tomorrow’s large enterprises. Xerox wants to be with them every step of the way.

Leading with services

Perhaps the greatest transformation has been in our services business, which quietly has become an engine of growth. A few facts make the point. In 2007, the value of services signings was up 18 percent. Services generated $3.4 billion in annuity revenue – up 8 percent over the previous year.

Some of the most prestigious enterprises in the world – brands as diverse as United Technologies, HSBC, NASA, EUROPART, The University of California, Raytheon Corp., the United States Navy, and many, many more – are turning to Xerox for help in simplifying work processes, managing their office technology around the world, helping them bridge the paper and digital divide and maximizing their investments in information technology.

We’re constantly expanding our service offerings, especially targeting what we call “document-intensive” industries that generate lots of paperwork and digital files. Think health care, where filling out forms for each doctor visit is still the norm. Or, the legal industry, where documentation can make or break cases. All these documents, in any form, need to be managed – scanned, searched, stored and more. And that’s where Xerox’s expertise comes in.

We like to say that no one knows the document better than Xerox. The ability to manage document-intense processes has opened doors to new business and new markets. And, it’s why we’re investing in acquisitions that further carve out our niche in this space. Last year, we acquired Advectis® Inc. and started Xerox Mortgage Services, which provides one of the mortgage industry’s most widely used solutions for sharing electronic documents. In 2006, we acquired Amici LLC and launched Xerox Litigation Services to become a leading provider of electronic discovery and document services that support legal and regulatory compliance.

So just about everywhere you look there are proof points that our strategy is right, our execution focused and our momentum building. That said, Xerox shareholders and the management team share a common belief; as good as our progress has been, it’s now a part of our history. Yesterday’s accomplishments are only important insofar as they provide a bridge to tomorrow’s promise.

Growing the business faster

Accelerating growth in a competitive environment remains a priority. We’re not yet where we want to be. Key to expanding growth is expanding our distribution channels. It’s the area of improvement where I believe we can make more progress and where we are focusing considerable time, talent and resources. We’re advantaged with a rich portfolio of technology and services, the industry’s smartest experts in document management and a respected brand known around the world. We’re skilled at managing global accounts in big businesses and the commercial print market. But to really ratchet up growth, we need to reach even more potential customers in businesses of any size. Acquiring Global Imaging was a step in the right direction, as was giving our agents and resellers access to more Xerox products and packaged services to sell. We need to – and we will – take this to the next level now by broadening the availability of the Xerox brand through diverse direct and indirect channels.

To do this well, we’re connecting even more closely with our customers, predicting and responding to their needs. It’s no secret that I spend a lot of time with customers. So does my entire team. Some of that time is spent fixing problems and some of it selling, but most of it is spent listening – really listening. And when you do that, you learn some pretty interesting stuff.

The CEOs I meet with – and they are from a wide variety of industries and geographies – worry that they are not harnessing new technology to leverage growth and better serve their customers. They worry about escalating costs and where to place their IT investment bets so they stay ahead of the curve. They see an explosion of digital information in their enterprises, but are also confronted with a legacy of paper and don’t know how to make sense of it all. They understand the need for information to flow freely and easily throughout their organizations and around the world, but worry about security breaches.

They’re eager to embrace the promise of a “greener” world, but don’t know how to harness technology to make their infrastructure more sustainable. They are awed by the complexity and potential of technology, but yearn for someone to make it all simpler and more effective.

Here’s what excites me. In each of these areas – top-line growth and bottom-line productivity… bridging the digital and paper domains… making document management secure and sustainable… making IT decisions that provide good returns… and making a complex world simple – in all these areas Xerox has answers.

Our innovation community is aligned with our strategy and is the best in our industry. Last year, Xerox was awarded 584 U.S. utility patents. Together with our research partner Fuji Xerox, we hold about 8,600 active U.S. patents and continue to invest $1.4 billion a year in research and development. In 2007, we were awarded the National Medal of Technology, America’s highest such honor. It’s a singular accomplishment for Xerox innovators past and present.

Our product development community is bringing a steady stream of worldclass technology to market. In the past three years, we have brought more than 100 new products to market. Together with our intelligent software, targeted solutions and tailored services, they bring value to our customers today and assure us continued industry leadership tomorrow.

Our distribution channels, already the broadest in our industry, are getting stronger. We have a powerful blend of direct sales people and indirect agents, concessionaires, resellers, dealers and Web-based channels. They have at their disposal a wide array of experts in color, production printing, solutions, software, services and more.

Our reach is worldwide, providing a competitive advantage that is unique in our industry. We are on the ground in some 160 countries in every corner of the globe. That becomes increasingly important as our larger customers want help in designing, implementing and maintaining document networks and processes that span the world.

Our annuity business model provides a consistent and profitable revenue stream that drives strong cash flow. As I mentioned earlier, more than 70 percent of our revenue comes from post-sale. In 2007, we grew post-sale revenue by 9 percent (6 percent excluding the benefit of Global Imaging*) and added more than $1 billion to our post-sale revenue stream.

* See below for the reconciliation of the difference between this financial measure that is not in compliance with Generally Accepted Accounting Principles (GAAP) and the most directly comparable financial measure calculated in accordance with GAAP.

And our leadership team is my personal pride and joy. It’s a terrific blend of seasoned Xerox veterans, some great additions from outside the company and some new leaders who have emerged from our own ranks. It’s a team that leads 57,400 Xerox people who consistently deliver on their commitments, have grown earnings in the 10 to 15 percent range, and are determined to do whatever it takes to be successful. It is a team that I am exceptionally proud to lead.

Rest assured that we are hardly satisfied with what we have accomplished. We love change and hate the status quo. We embrace challenges and obstacles. We’ve developed a culture that I like to call “problem-curious.” We want to grow faster and win more, not by a little but by a lot. We pride ourselves on listening intently to our customers, connecting with them on a one-to-one basis and committing to finding them the right answer for their unique needs – not some of the time but all of the time. You’ll read more about just that in this report – how we listen, connect and are committed to you.

Playing offense with high expectations and great opportunities

Our performance in 2008 will be driven by growing our profitable annuity stream – fueled by color and services – and continued discipline in managing costs while generating significant operating cash flow. And, with our strong balance sheet, we’ll focus on share repurchase while being opportunistic in making acquisitions.

We do business in a $125 billion market that has attracted a set of competitors we regard with great respect. We know that our customers have choices. We realize that the better we get, the higher our customers’ expectations will get.

We are also proud but not content with our record on corporate responsibility. I invite you to read our second Report on Global Citizenship. It’s online at www.xerox.com/citizenship. You will see that we continue to invest in the communities in which we work and live, that our people are active and constructive participants in making our world better, that we have one of the most diverse workforces in the world and that we are a leader but hardly a newcomer in the fight for a sustainable world and a greener planet.

This Annual Report to Shareholders is the first to carry our new brand identity, which we launched the first week of 2008. Companies often use new identities in an aspirational way – to signal what they want to become. Our launch is both a statement that we have already arrived at a new place and a promise that our journey continues.

I truly believe that our best days are ahead of us. We are playing to our strengths, ushering in a period of great growth for our shareholders, our customers and our people.

So, to sum it all up, here’s why I’m confident Xerox will increase value for you:

We operate a global business with about half of our revenue generated from customers outside of the U.S. From small and medium businesses and the public sector to large enterprises and commercial printers, we serve a wide range of markets – giving us diversification globally and in market scope.

We’re an annuity-based business that continues to boost profitable recurring revenues.

We’re an investment-grade firm that generates strong cash flow. We’re investing in our business and in our stock.

All of us at Xerox are eager to play offense and to give you a good return on your trust. We’re listening, we’re connecting and we’re committed. We know that you, like our customers, have choices. You chose Xerox and we take that very seriously. You can be sure we will do whatever it takes to continue to earn your trust.

That’s a promise.