UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number: 1-3579
PITNEY BOWES INC.
(Exact name of registrant as specified in its charter)
Delaware
06-0495050
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1 Elmcroft Road, Stamford, Connecticut
06926-0700
(Address of principal executive offices)
(Zip Code)
(203) 356-5000(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ
No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o
No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of November 3, 2010.
Class
Outstanding
Common Stock, $1 par value per share
203,353,768 shares
PITNEY BOWES INC.INDEX
Page Number
Part I - Financial Information:
Item 1:
Financial Statements (Unaudited)
Condensed Consolidated Statements of Income for the Three andNine Months Ended September 30, 2010 and 2009
3
Condensed Consolidated Balance Sheets at September 30, 2010 andDecember 31, 2009
4
Condensed Consolidated Statements of Cash Flows for theNine Months Ended September 30, 2010 and 2009
5
Notes to Condensed Consolidated Financial Statements
6
Item 2:
Management’s Discussion and Analysis of Financial Conditionand Results of Operations
23
Item 3:
Quantitative and Qualitative Disclosures about Market Risk
32
Item 4:
Controls and Procedures
Part II - Other Information:
Legal Proceedings
33
Item 1A:
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Removed and Reserved
Item 5:
Other Information
Item 6:
Exhibits
Signatures
34
2
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited; in thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
2010
2009
Revenue:
Equipment sales
$
248,228
225,759
718,399
714,780
Supplies
77,304
83,464
239,635
253,466
Software
95,850
87,295
265,130
254,401
Rentals
151,399
163,711
456,977
487,992
Financing
157,333
171,228
476,712
528,534
Support services
175,844
177,607
531,176
531,200
Business services
439,784
447,756
1,303,183
1,344,493
Total revenue
1,345,742
1,356,820
3,991,212
4,114,866
Costs and expenses:
Cost of equipment sales
115,721
106,326
325,120
331,144
Cost of supplies
23,843
23,785
73,381
68,495
Cost of software
21,191
19,413
61,064
60,480
Cost of rentals
36,277
40,508
107,658
114,372
Financing interest expense
22,189
23,975
65,948
73,865
Cost of support services
111,521
119,034
337,822
356,620
Cost of business services
335,588
335,406
1,003,712
1,033,933
Selling, general and administrative
435,292
435,931
1,304,941
1,317,410
Research and development
38,454
45,052
117,487
138,623
Restructuring charges and asset impairments
33,805
12,845
103,039
Other interest expense
29,310
27,244
86,172
84,548
Interest income
(393
)
(668
(1,851
(3,153
Total costs and expenses
1,202,798
1,188,851
3,584,493
3,589,182
Income from continuing operations before income taxes
142,944
167,969
406,719
525,684
Provision for income taxes
46,880
57,691
155,302
192,375
Income from continuing operations
96,064
110,278
251,417
333,309
(Loss) gain from discontinued operations, net of income tax
(2,536
(2,429
(8,332
5,296
Net income before attribution of noncontrolling interests
93,528
107,849
243,085
338,605
Less: Preferred stock dividends of subsidiaries attributable to noncontrolling interests
4,593
4,622
13,730
13,714
Pitney Bowes Inc. net income
88,935
103,227
229,355
324,891
Amounts attributable to Pitney Bowes Inc.:
91,471
105,656
237,687
319,595
(Loss) gain from discontinued operations
Basic earnings per share attributable to Pitney Bowes Inc. common stockholders (1):
Continuing operations
0.44
0.51
1.15
1.55
Discontinued operations
(0.01
(0.04
0.03
Net income
0.43
0.50
1.11
1.57
Diluted earnings per share attributable to Pitney Bowes Inc. common stockholders (1):
1.54
Dividends declared per share of common stock
0.365
0.36
1.095
1.08
(1) The sum of the earnings per share amounts may not equal the totals above due to rounding.
See Notes to Condensed Consolidated Financial Statements
PITNEY BOWES INC.CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited; in thousands, except share and per share data)
September 30, 2010
December 31, 2009
ASSETS
Current assets:
Cash and cash equivalents
386,046
412,737
Short-term investments
21,351
14,682
Accounts receivables, gross
760,532
859,633
Allowance for doubtful accounts receivables
(34,865
(42,781
Accounts receivables, net
725,667
816,852
Finance receivables
1,357,187
1,417,708
Allowance for credit losses
(48,366
(46,790
Finance receivables, net
1,308,821
1,370,918
Inventories
187,875
156,502
Current income taxes
112,719
101,248
Other current assets and prepayments
102,838
98,297
Total current assets
2,845,317
2,971,236
Property, plant and equipment, net
458,766
514,904
Rental property and equipment, net
315,489
360,207
1,266,309
1,380,810
(20,511
(25,368
1,245,798
1,355,442
Investment in leveraged leases
241,125
233,359
Goodwill
2,312,304
2,286,904
Intangible assets, net
304,186
316,417
Non-current income taxes
108,546
108,260
Other assets
484,376
387,182
Total assets
8,315,907
8,533,911
LIABILITIES, NONCONTROLLING INTERESTS AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable and accrued liabilities
1,694,745
1,748,254
130,114
144,385
Notes payable and current portion of long-term obligations
135,674
226,022
Advance billings
461,573
447,786
Total current liabilities
2,422,106
2,566,447
Deferred taxes on income
304,765
310,274
Tax uncertainties and other income tax liabilities
546,314
525,253
Long-term debt
4,242,845
4,213,640
Other non-current liabilities
573,447
625,079
Total liabilities
8,089,477
8,240,693
Noncontrolling interests (Preferred stockholders’ equity in subsidiaries)
296,370
Commitments and contingencies (See Note 18)
Stockholders’ deficit:
Cumulative preferred stock, $50 par value, 4% convertible
Cumulative preference stock, no par value, $2.12 convertible
804
868
Common stock, $1 par value (480,000,000 shares authorized; 323,337,912 shares issued)
323,338
Additional paid-in capital
247,800
256,133
Retained earnings
4,293,549
4,291,393
Accumulated other comprehensive loss
(451,880
(459,792
Treasury stock, at cost (119,999,023 and 116,140,084 shares, respectively)
(4,483,555
(4,415,096
Total Pitney Bowes Inc. stockholders’ deficit
(69,940
(3,152
Total liabilities, noncontrolling interests and stockholders’ deficit
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
Cash flows from operating activities:
Restructuring charges and asset impairments, net of tax
67,027
8,300
Restructuring payments
(90,713
(66,757
Proceeds (payments) for settlement of derivative instruments
31,774
(20,281
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
231,605
262,683
Stock-based compensation
15,866
16,964
Changes in operating assets and liabilities, excluding effects of acquisitions:
(Increase) decrease in accounts receivables
109,603
134,789
(Increase) decrease in finance receivables
168,673
203,588
(Increase) decrease in inventories
(31,336
(6,844
(Increase) decrease in prepaid, deferred expense and other assets
(792
(14,787
Increase (decrease) in accounts payable and accrued liabilities
(68,023
(195,842
Increase (decrease) in current and non-current income taxes
3,017
73,457
Increase (decrease) in advance billings
(8,215
1,002
Increase (decrease) in other operating capital, net
(4,684
(2,453
Net cash provided by operating activities
666,887
732,424
Cash flows from investing activities:
Short-term and other investments
(112,902
(19,616
Capital expenditures
(90,177
(126,509
Net investment in external financing
(3,117
(1,216
Acquisitions, net of cash acquired
(75,500
-
Reserve account deposits
5,405
(6,236
Net cash used in investing activities
(276,291
(153,577
Cash flows from financing activities:
Decrease in notes payable, net
(89,232
(445,460
Proceeds from long-term obligations
297,513
Principal payments on long-term obligations
(150,000
Proceeds from issuance of common stock
8,687
8,984
Stock repurchases
(100,000
Dividends paid to common stockholders
(227,199
(223,182
Dividends paid to noncontrolling interests
(9,953
(13,714
Net cash used in financing activities
(417,697
(525,859
Effect of exchange rate changes on cash and cash equivalents
410
11,469
(Decrease) increase in cash and cash equivalents
(26,691
64,457
Cash and cash equivalents at beginning of period
376,671
Cash and cash equivalents at end of period
441,128
Cash interest paid
169,042
169,219
Cash income taxes paid, net
186,079
133,808
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited; tabular dollars in thousands, except for per share data)
1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Pitney Bowes Inc. and its subsidiaries (PBI, the company, we, us, and our) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In addition, the December 31, 2009 Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In our opinion, all adjustments (consisting of only normal recurring adjustments) considered necessary to present fairly our financial position at September 30, 2010 and December 31, 2009, our results of operations for the three and nine months ended September 30, 2010 and 2009 and our cash flows for the nine months ended September 30, 2010 and 2009 have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for any other interim period or the year ending December 31, 2010.
These statements should be read in conjunction with the financial statements and notes thereto included in our 2009 Annual Report to Stockholders on Form 10-K (2009 Annual Report).
Certain prior year amounts have been reclassified to conform with the current period presentation.
2. Nature of Operations
We are the largest provider of mail processing equipment and integrated mail solutions in the world. We offer a full suite of equipment, supplies, software and services for end-to-end mailstream solutions which enable our customers to optimize the flow of physical and electronic mail, documents and packages across their operations. We conduct our business activities in seven reporting segments within two business groups: Small & Medium Business Solutions and Enterprise Business Solutions. See Note 7 to the Condensed Consolidated Financial Statements for details of our reporting segments and a description of their activities.
3. Recent Accounting Pronouncements
In July 2010, new guidance was introduced which would increase disclosures regarding the credit quality of an entity’s financing receivables and its allowance for credit losses. In addition, the guidance would require an entity to disclose credit quality indicators, past due information, and modifications of its financing receivables. The guidance will be effective for our 2010 Annual Report. The adoption of this guidance will not have an impact on our consolidated financial statements, but will result in additional disclosures.
In September 2009, new guidance was introduced addressing the accounting for revenue arrangements with multiple elements and certain revenue arrangements that include software. This guidance will allow companies to allocate consideration in a multiple element arrangement in a way that better reflects the economics of the transaction and will result in the elimination of the residual method. In addition, tangible products that have software components that are “essential to the functionality” of the tangible product will be scoped out of the software revenue guidance. The new guidance may also result in more expansive disclosures. The new guidance will be effective on January 1, 2011. We do not expect the adoption of this guidance to have a material impact on our financial position, results of operations, or cash flows.
4. Acquisitions
On July 5, 2010, we acquired Portrait Software plc (Portrait) for $65.2 million in cash, net of cash acquired. Portrait provides software to enhance existing customer relationship management systems, enabling clients to achieve improved customer retention and profitability. The preliminary allocation of the purchase price to the fair values of the assets acquired and liabilities assumed is shown below. The primary items that generated goodwill are the anticipated synergies from the compatibility of the acquired technology with our existing product and service offerings, and employees of Portrait, neither of which qualify as an amortizable intangible asset. None of the goodwill will be deductible for tax purposes.
Purchase price allocation:
Current assets
7,919
Other non-current assets
2,352
Intangible assets
31,332
Goodwill (1)
47,354
Current liabilities
(13,014
Non-current liabilities
(10,793
Purchase price, net of cash acquired
65,150
Intangible assets:
Customer relationships
18,744
Software and technology
11,497
Trademarks and trade names
1,091
Total intangible assets
Intangible assets amortization period:
10 years
5.8 years
5.7 years
Total weighted average
8.3 years
(1) Goodwill was assigned to the Software segment.
During the second quarter of 2010, we also completed a smaller acquisition for a purchase price of $11.5 million in cash, of which $10.3 million was paid at closing. The acquisition did not have a material impact on our financial results.
The following table provides unaudited pro forma consolidated revenue for the three and nine months ended September 30, 2010 and 2009 as if the above acquisitions had occurred on January 1 of each year. The pro forma earnings results of these acquisitions were not material to net income or earnings per share. The pro forma consolidated amounts do not purport to be indicative of actual results that would have occurred had the acquisitions been completed on January 1, 2010 and 2009, nor do they purport to be indicative of the results that will be obtained in the future.
1,367,206
4,015,036
4,144,840
7
5. Discontinued Operations
The following table shows selected financial information included in discontinued operations for the three and nine months ended September 30, 2010 and 2009, respectively:
Pre-tax income
754
20,624
Tax provision
(9,086
(15,328
The loss for the three and nine months ended September 30, 2010 and three months ended September 30, 2009 primarily relates to the accrual of interest on uncertain tax positions. The gain for the nine months ended September 30, 2009 includes $10.9 million ($6.7 million after tax) from the release of reserves related to the expiration of an indemnity agreement associated with our former Capital Services business and $9.8 million ($6.0 million after tax) for a bankruptcy settlement. We received a bankruptcy settlement for unsecured claims pertaining to the lease of certain aircraft originally executed by the Capital Services business. At the time of the Capital Services sale, we retained the rights to the bankruptcy claims. These amounts were partially offset by the accrual of interest on uncertain tax positions.
6. Earnings per Share
The calculation of basic and diluted earnings per share (EPS) for the three and nine months ended September 30, 2010 and 2009 is as follows:
Numerator:
Income from continuing operations attributable to Pitney Bowes Inc., net of tax
(Loss) gain from discontinued operations, net of tax
Pitney Bowes Inc. net income (numerator for diluted EPS)
Less: Preference stock dividend
(17
(50
(55
Income attributable to Pitney Bowes Inc. common stockholders (numerator for basic EPS)
88,918
103,210
229,305
324,836
Denominator (in thousands):
Weighted-average shares used in basic EPS
205,761
207,076
206,745
206,610
Effect of dilutive shares:
Preferred stock
Preference stock
498
554
511
578
Stock options and stock purchase plans
13
20
Other stock plans
8
Weighted-average shares used in diluted EPS
206,282
207,644
207,291
207,198
Basic earnings per share:
Diluted earnings per share:
Anti-dilutive shares (in thousands):
Anti-dilutive shares not used in calculating diluted weighted-average shares
16,107
18,032
15,704
18,701
Note: The sum of the earnings per share amounts may not equal the totals above due to rounding.
On February 8, 2010, we made our annual stock compensation grant which consisted of approximately 1.7 million stock options and 0.8 million restricted stock units.
7. Segment Information
We conduct our business activities in seven reporting segments within two business groups, Small & Medium Business Solutions and Enterprise Business Solutions, based on the customers they primarily serve. The principal products and services of each of our reporting segments are as follows:
Small & Medium Business Solutions:
U.S. Mailing: Includes the U.S. revenue and related expenses from the sale, rental and financing of our mail finishing, mail creation, shipping equipment and software; supplies; support and other professional services; and payment solutions.
International Mailing: Includes the non-U.S. revenue and related expenses from the sale, rental and financing of our mail finishing, mail creation, shipping equipment and software; supplies; support and other professional services; and payment solutions.
Enterprise Business Solutions:
Production Mail: Includes the worldwide revenue and related expenses from the sale, financing, support and other professional services of our high-speed, production mail systems, sorting and production print equipment.
Software:Includes the worldwide revenue and related expenses from the sale and support services of non-equipment-based mailing, customer relationship and communication and location intelligence software.
Management Services: Includes worldwide revenue and related expenses from facilities management services; secure mail services; reprographic, document management services; secure document destruction; and litigation support and eDiscovery services.
Mail Services: Includes presort mail services and cross-border mail services.
Marketing Services: Includes direct marketing services for targeted customers.
We manage, measure and analyze the operational profitability of each reporting segment based on earnings before interest and taxes (EBIT), a non-GAAP measure. EBIT is determined by deducting from segment revenue the related expenses attributable to the segment. Segment EBIT excludes interest and taxes, which are generally managed across the entire company on a consolidated basis, and general corporate expenses, restructuring charges and asset impairments.
9
Revenue and EBIT by business segment for the three and nine months ended September 30, 2010 and 2009 are as follows:
U.S. Mailing
461,787
491,036
1,406,464
1,517,377
International Mailing
227,844
224,681
678,961
679,893
Small & Medium Business Solutions
689,631
715,717
2,085,425
2,197,270
Production Mail
134,943
126,434
380,114
366,000
91,544
82,361
251,877
240,559
Management Services
245,113
259,370
748,538
789,635
Mail Services (1)
144,988
134,042
416,245
413,891
Marketing Services
39,523
38,896
109,013
107,511
Enterprise Business Solutions
656,111
641,103
1,905,787
1,917,596
EBIT:
169,871
178,066
507,921
561,232
38,931
29,193
105,469
87,201
208,802
207,259
613,390
648,433
15,243
11,494
35,111
26,974
7,996
8,241
18,136
16,064
23,508
19,517
65,781
49,294
15,139
23,024
44,813
63,322
8,571
7,448
20,430
17,323
70,457
69,724
184,271
172,977
Total EBIT
279,259
276,983
797,661
821,410
Unallocated amounts:
Interest, net (2)
(51,106
(50,551
(150,269
(155,260
Corporate expenses
(51,404
(45,618
(137,634
(127,621
(33,805
(12,845
(103,039
(1)
The Mail Services segment for the nine month period ended September 30, 2010 includes a one-time out of period adjustment primarily to correct rates used to estimate earned but unbilled revenue for the periods 2007 through first quarter 2010. The adjustment reduced 2010 year-to-date revenue and EBIT by $21 million and $16 million, respectively. The impact of this adjustment was not material to any individual quarter or year during these periods and is not material to anticipated 2010 results.
(2)
Interest, net includes financing interest expense, other interest expense and interest income.
10
8. Inventories
September 30,2010
December 31,2009
Raw materials and work in process
50,820
36,331
Supplies and service parts
73,224
69,506
Finished products
63,831
50,665
Total
9. Fixed Assets
Property, plant and equipment
1,819,355
1,820,797
Accumulated depreciation
(1,360,589
(1,305,893
Rental property and equipment
662,927
728,537
(347,438
(368,330
Depreciation expense was $59.4 million and $70.1 million for the three months ended September 30, 2010 and 2009, respectively. Depreciation expense was $183.8 million and $209.7 million for the nine months ended September 30, 2010 and 2009, respectively. In 2010, we recorded asset impairment charges of $1.4 million associated with a restructuring program and included these charges in the restructuring charges and asset impairments line of the Condensed Consolidated Statements of Income. See Note 14 for further details.
10. Intangible Assets and Goodwill
Intangible assets are composed of the following:
GrossCarryingAmount
AccumulatedAmortization
NetCarryingAmount
445,128
(220,351
224,777
428,888
(197,497
231,391
Supplier relationships
29,000
(15,467
13,533
(13,292
15,708
Software & technology
172,400
(113,709
58,691
164,211
(103,388
60,823
Trademarks & trade names
36,448
(29,651
6,797
35,855
(27,898
7,957
Non-compete agreements
7,815
(7,427
388
7,753
(7,215
538
690,791
(386,605
665,707
(349,290
During 2010, we acquired $42.2 million of identified intangible assets with a weighted average amortization period of 8.5 years. See Note 4 for further details. Amortization expense for intangible assets for the three months ended September 30, 2010 and 2009 was $15.4 million and $17.4 million, respectively. Amortization expense for intangible assets for the nine months ended September 30, 2010 and 2009 was $47.8 million and $53.0 million, respectively. In 2010, we recorded impairment charges of $4.7 million and included these charges in the restructuring charges and asset impairments line of the Condensed Consolidated Statements of Income. See Note 14 for further details.
11
The estimated future amortization expense related to intangible assets is as follows:
Amount
Remaining for year ended December 31, 2010
15,000
Year ended December 31, 2011
58,000
Year ended December 31, 2012
52,000
Year ended December 31, 2013
47,000
Year ended December 31, 2014
43,000
Thereafter
89,186
Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, changes in foreign currency exchange rates, impairment of intangible assets, accelerated amortization of intangible assets and other events.
Changes in the carrying amount of goodwill by business segment for the nine months ended September 30, 2010 are as follows:
Balance atDecember 31,2009
Acquiredduring theperiod
Other (1)
Balance atSeptember 30,2010
217,458
(196
217,262
342,549
(7,503
335,046
560,007
(7,699
552,308
138,475
(5,862
132,613
633,938
(3,581
677,711
500,055
(4,341
495,714
Mail Services
259,632
(471
259,161
194,797
1,726,897
(14,255
1,759,996
(21,954
(1) “Other” is primarily foreign currency translation adjustments.
11. Long-term Debt
In August 2010, we unwound two interest rate swaps with an aggregate notional amount of $250 million that were entered into in March 2008. These interest rate swaps effectively converted the fixed rate of 5.6% on $250 million of notes, due 2018, into variable interest rates. We paid variable rates in connection with the swap agreements based on six-month LIBOR plus 111.47 basis points and received fixed rate payments of 5.6%.
The transaction was not undertaken for liquidity purposes, but rather to fix our effective interest rate to 3.7% for the remaining term of the notes. In connection with unwinding these interest rate swaps, we received $31.8 million, excluding accrued interest. This amount will be recognized as a reduction in interest expense over the remaining term of the notes.
There have been no other significant changes to long-term debt since December 31, 2009.
12
12. Noncontrolling Interests (Preferred Stockholders’ Equity in Subsidiaries)
At January 1, 2009, Pitney Bowes International Holdings, Inc. (PBIH), a subsidiary of ours, had 3,750,000 shares outstanding, or $375 million, of variable term voting preferred stock owned by certain outside institutional investors. These preferred shares were entitled as a group to 25% of the combined voting power of all classes of capital stock of PBIH. All outstanding common stock of PBIH, representing the remaining 75% of the combined voting power of all classes of capital stock, was owned directly or indirectly by the company. The preferred stock was entitled to cumulative dividends at rates set at auction. The weighted average dividend rate was 4.8% for the three and nine months ended September 30, 2009. In the fourth quarter 2009, PBIH redeemed all 3,750,000 outstanding shares of variable term voting preferred stock with the combined proceeds from the issuance of the Preferred Stock (see below), cash flows from operations and the issuance of commercial paper.
In October 2009, PBIH issued 300,000 shares, or $300 million, of perpetual voting preferred stock (the Preferred Stock) to certain outside institutional investors. The holders of the Preferred Stock are entitled as a group to 25% of the combined voting power of all classes of capital stock of PBIH. All outstanding common stock of PBIH, representing the remaining 75% of the combined voting power of all classes of capital stock, is owned directly or indirectly by the company. The Preferred Stock is entitled to cumulative dividends at a rate of 6.125% for a period of seven years after which it becomes callable and, if it remains outstanding, will yield a dividend that increases by 150% every six months thereafter.
The carrying value of the Preferred Stock is reported as Noncontrolling interests (Preferred stock) on the Condensed Consolidated Balance Sheets. Preferred Stock dividends are reported in the Condensed Consolidated Statements of Income as Preferred stock dividends of subsidiaries attributable to noncontrolling interests. Preferred Stock dividends were $4.6 million for the three months ended September 30, 2010 and 2009, and $13.7 million for the nine months ended September 30, 2010 and 2009. No dividends were in arrears at September 30, 2010 or December 31, 2009.
A rollforward of noncontrolling interests is as follows:
Beginning balance at January 1, 2009
374,165
Movements:
Share issuances, net of issuance costs of $3.6 million.
Share redemptions
(374,165
Ending balance at December 31, 2009 and September 30, 2010
13. Comprehensive Income
Comprehensive income for the three and nine months ended September 30, 2010 and 2009 are as follows:
Other comprehensive income, net of tax:
Foreign currency translation adjustments
124,539
67,778
(16,432
115,512
Net unrealized (loss) gain on derivatives
(648
(319
853
6,195
Net unrealized gain (loss) on investment securities
345
139
2,427
(91
Amortization of pension and postretirement costs
7,064
4,423
21,064
13,175
Comprehensive income
220,235
175,248
237,267
459,682
PITNEY BOWES INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited; tabular dollars in thousands, except for per share data)
14. Restructuring Charges and Asset Impairments
2009 Program
In July 2009, we announced that we were undertaking a series of initiatives designed to transform and enhance the way we operate as a global company. In order to enhance our responsiveness to changing market conditions, we are executing a strategic transformation program designed to create improved processes and systems to further enable us to invest in future growth in areas such as our global customer interactions and product development processes. This program is expected to continue into 2012 and will result in the reduction of about 10 percent of the positions in the company. Total pre-tax costs of this program are expected to be between $250 million to $350 million primarily related to severance and benefit costs in connection with such workforce reductions. Currently, we are targeting annualized benefits by 2012, net of system and related investments, in the range of at least $150 million to $200 million on a pre-tax basis. These costs and the related benefits will be recognized as different actions are approved and implemented.
During the nine months ended September 30, 2010, we recorded pre-tax restructuring charges and asset impairments associated with this program of $103.0 million, of which $62.2 million related to severance and benefit costs, $34.8 million related to other exit costs and $1.4 million related to asset impairments. Additional charges of $4.7 million related to the impairment of certain intangible assets unrelated to this program, were also recorded during 2010. The cumulative charges for this program from inception to September 30, 2010 were $170.4 million. As of September 30, 2010, approximately 1,700 employee terminations have occurred under this program. The majority of the liability at September 30, 2010 is expected to be paid during the next twelve months from cash generated from operations.
Activity in the reserves for the restructuring actions taken in connection with the 2009 program for the nine months ended September 30, 2010 is composed of the following:
Expenses
Cashpayments
Non-cashcharges
Severance and benefit costs
45,895
62,166
(47,652
60,409
Other exit costs
6,807
34,805
(28,074
13,538
Asset impairments
6,068
(6,068
52,702
(75,726
73,947
2007 Program
In 2007, we announced a program to lower our cost structure, accelerate efforts to improve operational efficiencies, and transition our product line. The program included charges primarily associated with older equipment that we had stopped selling upon transition to the new generation of fully digital, networked, and remotely-downloadable equipment.
The cumulative charges for this program from inception to September 30, 2010 were $445.7 million. As of September 30, 2010, approximately 3,000 positions were eliminated under this program. The majority of the liability at September 30, 2010 is expected to be paid during the next six months from cash generated from operations.
Activity in the reserves for the restructuring actions taken in connection with the 2007 program for the nine months ended September 30, 2010 is composed of the following:
27,897
(12,218
15,679
8,027
(2,769
5,258
35,924
(14,987
20,937
14
15. Pensions and Other Benefit Programs
Defined Benefit Pension Plans
The components of net periodic benefit cost for defined benefit pension plans for the three months ended September 30, 2010 and 2009 are as follows:
United States
Foreign
Service cost
5,770
6,128
1,620
1,772
Interest cost
22,523
23,745
6,895
6,567
Expected return on plan assets
(30,772
(30,009
(7,206
(7,107
Amortization of transition credit
(2
Amortization of prior service (credit) cost
(644
(637
69
119
Amortization of net loss
8,059
6,593
2,594
644
Settlement
521
Net periodic benefit cost
5,457
5,820
3,970
1,993
The components of net periodic benefit cost for defined benefit pension plans for the nine months ended September 30, 2010 and 2009 are as follows:
17,312
18,384
5,114
5,047
67,572
71,231
20,523
18,576
(92,320
(90,021
(21,476
(20,090
(6
(1,933
(1,911
208
334
24,177
19,779
7,595
1,835
3,961
18,769
17,462
11,958
5,696
As we previously disclosed in our 2009 Annual Report, we expect to contribute up to $20 million to each of our U.S. and foreign pension plans during 2010. As of September 30, 2010, $18.5 million and $7.6 million have been contributed to the U.S. and foreign pension plans, respectively.
Nonpension Postretirement Benefit Plans
The components of net periodic benefit cost for nonpension postretirement benefit plans for the three and nine months ended September 30, 2010 and 2009 are as follows:
931
918
2,793
2,730
3,455
3,669
10,367
10,959
Amortization of prior service credit
(628
(618
(1,883
(1,858
1,699
1,035
5,096
3,103
5,004
16,373
14,934
We made contributions of $12.2 million and $7.9 million for the three months ended September 30, 2010 and 2009, respectively, and $25.4 million and $21.3 million for the nine months ended September 30, 2010 and 2009, respectively, to cover benefit payments.
15
16. Income Taxes
The effective tax rate for the three months ended September 30, 2010 and 2009 was 32.8% and 34.3%, respectively. The effective tax rate for the nine months ended September 30, 2010 and 2009 was 38.2% and 36.6%, respectively. The year-to-date 2010 rate includes a $9.1 million charge for the write-off of deferred tax assets related to the recent U.S. health care reform legislation signed in March 2010. This legislation includes a provision eliminating the tax deduction for retiree health care costs to the extent of federal subsidies received by companies that provide retiree prescription drug benefits equivalent to Medicare Part D coverage. The year-to-date tax rates for 2010 and 2009 also include a charge of $9.7 million and $12.2 million, respectively, related to the write-off of deferred tax assets associated with the expiration of out-of-the-money vested stock options and the vesting of restricted stock units previously granted to our employees. These write-offs of deferred tax assets will not require us to pay any additional taxes. The 2010 year-to-date rate also includes benefits associated with previously unrecognized deferred taxes on outside basis differences and alternative tax return filing elections, and charges associated with previously unrecognized deferred taxes on unremitted earnings.
During 2010, an analysis of prior year non-U.S. income tax returns indicated that lease rental income associated with certain leveraged lease transactions was not properly captured. As a result, the year-to-date 2010 tax provision includes additional tax expense of $3.3 million for the periods 2007 through 2009. A $14.4 million adjustment was also made to opening retained earnings to establish the related tax liabilities for earlier years. The impact of the adjustments was not material to any previously reported period.
We regularly assess the likelihood of tax adjustments in each of the tax jurisdictions in which we have operations and account for the related financial statement implications. Tax reserves have been established which we believe to be appropriate given the possibility of tax adjustments. Determining the appropriate level of tax reserves requires us to exercise judgment regarding the uncertain application of tax law. The amount of reserves is adjusted when information becomes available or when an event occurs indicating a change in the reserve is appropriate. Future changes in tax reserve requirements could have a material impact on our results of operations.
We are continually under examination by tax authorities in the United States, other countries and local jurisdictions in which we have operations. The years under examination vary by jurisdiction. The current IRS exam of tax years 2001-2004 is estimated to be completed within the next two years and the examination of years 2005-2008 has commenced. In connection with the 2001-2004 exam, we have received notices of proposed adjustments to our filed returns. Tax reserves have been established which we believe to be appropriate given the possibility of tax adjustments. We are also disputing a formal request from the IRS in the form of a civil summons to provide certain company workpapers. We believe that certain documents being sought should not be produced because they are privileged. A variety of post-1999 tax years remain subject to examination by other tax authorities, including the U.K., Canada, France, Germany and various U.S. states. Tax reserves have been established which we believe to be appropriate given the possibility of tax adjustments. However, the resolution of such matters could have a material impact on our results of operations, financial position and cash flows.
17. Fair Value Measurements and Derivative Instruments
The fair value measurement guidance established a fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of the fair value hierarchy are as follows:
Level 1 – Unadjusted quoted prices in active markets for identical assets and liabilities.
Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity, may be derived from internally developed methodologies based on management’s best estimate of fair value and that are significant to the fair value of the asset or liability.
16
The following tables show, by level within the fair value hierarchy, our financial assets and liabilities that are accounted for at fair value on a recurring basis at September 30, 2010 and December 31, 2009, respectively. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect their placement within the fair value hierarchy.
Level 1
Level 2
Level 3
Assets:
Investment securities
Money market funds / commercial paper
183,783
5,950
189,733
Equity securities
21,463
Debt securities - U.S. and foreign governments, agencies and municipalities
84,400
32,916
117,316
Debt securities - corporate
20,878
Asset-backed securities
984
Mortgage-backed securities
80,934
Derivatives
Interest rate swaps
12,398
Foreign exchange contracts
1,685
268,183
177,208
445,391
Liabilities:
1,280
225,581
21,027
53,173
28,754
81,927
13,305
296
19,708
13,284
2,390
278,754
98,764
377,518
3,050
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Investment Securities
For our investments, we use the market approach for recurring fair value measurements and the valuation techniques use inputs that are observable, or can be corroborated by observable data, in an active marketplace.
The following information relates to our classification into the fair value hierarchy:
• Money Market Funds / Commercial Paper: Money market funds typically invest in government securities, certificates of deposit, commercial paper of companies and other highly liquid and low-risk securities. Money market funds are principally used for overnight deposits and are classified as Level 1 when unadjusted quoted prices in active markets are available and as Level 2 when they are not actively traded on an exchange. Direct investments in commercial paper are not listed on an exchange in an active market and are classified as Level 2.
• Equity Securities: Equity securities are comprised of mutual funds investing in U.S. and foreign common stock. These mutual funds are classified as Level 2 as they are not separately listed on an exchange.
• Debt Securities – U.S. and Foreign Governments, Agencies and Municipalities: Debt securities are classified as Level 1 where active, high volume trades for identical securities exist. Valuation adjustments are not applied to these securities. Debt securities valued using quoted market prices for similar securities or benchmarking model derived prices to quoted market prices and trade data for identical or comparable securities are classified as Level 2.
• Debt Securities – Corporate: Corporate debt securities are valued using recently executed transactions, market price quotations where observable, or bond spreads. The spread data used are for the same maturity as the security. These securities are classified as Level 2.
• Asset-Backed Securities (ABS) and Mortgage-Backed Securities (MBS): These securities are valued based on external pricing indices. When external index pricing is not observable, ABS and MBS are valued based on external price/spread data. These securities are classified as Level 2.
Investment securities are largely composed of investments by The Pitney Bowes Bank (PBB). PBB, our wholly-owned subsidiary, is a Utah-chartered Industrial Loan Company (ILC). The bank’s investments at September 30, 2010 were $271.3 million. These investments were reported in the Condensed Consolidated Balance Sheets as cash and cash equivalents of $96.6 million, short-term investments of $17.5 million and other assets of $157.2 million. The bank’s investments at December 31, 2009 were $222.4 million and were reported as cash and cash equivalents of $151.3 million, short-term investments of $14.2 million and other assets of $56.9 million.
We have not experienced any write-offs in our investment portfolio. The majority of our MBS are either guaranteed or supported by the U.S. government. Market events have not caused our money market funds to experience declines in their net asset value below $1.00 per share or to incur imposed limits on redemptions. We have no investments in inactive markets which would warrant a possible change in our pricing methods or classification within the fair value hierarchy. Further, we have no investments in auction rate securities.
18
PITNEY BOWES INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited; tabular dollars in thousands, except for per share data)
Derivative Instruments
In the normal course of business, we are exposed to the impact of interest rate changes and foreign currency fluctuations. The company limits these risks by following established risk management policies and procedures, including the use of derivatives. We use derivatives to manage the related cost of debt and to limit the effects of foreign exchange rate fluctuations on financial results. We do not use derivatives for trading or speculative purposes.
As required by the fair value measurements guidance, we have incorporated counterparty credit risk and our credit risk into the fair value measurement of our derivative assets and liabilities, respectively. We derive credit risk from observable data related to credit default swaps. We have not seen a material change in the creditworthiness of those banks acting as derivative counterparties.
The valuation of our interest rate swaps is based on the income approach using a model with inputs that are observable or that can be derived from or corroborated by observable market data. Our foreign exchange derivatives are measured at fair value using observable market inputs, such as forward rates.
The following is a summary of our derivative fair values at September 30, 2010 and December 31, 2009:
Fair Value
Designation of Derivatives
Balance Sheet Location
Derivatives designated as hedging instruments
Other current assets and prepayments:
98
456
Other assets:
Accounts payable and accrued liabilities:
865
1,114
Derivatives not designated as hedginginstruments
1,587
1,934
415
1,936
Total Derivative Assets
14,083
15,674
Total Derivative Liabilities
Total Net Derivative Assets
12,803
12,624
Interest Rate Swaps
Derivatives designated as fair value hedges include interest rate swaps related to fixed rate debt. Changes in the fair value of both the derivative and item being hedged are recognized in income.
At September 30, 2010, we have outstanding interest rate swaps with an aggregate notional value of $400 million that effectively convert fixed rate interest payments on $400 million, 4.625% fixed rate notes due in 2012, into variable interest rates. We pay a weighted-average variable rate based on one month LIBOR plus 249 basis points and receive a fixed rate of 4.625%. At September 30, 2010 and December 31, 2009, the fair value of the interest rate swaps was an asset of $12.4 million and $4.7 million, respectively.
In March 2008, we entered into two interest rate swaps for an aggregate notional amount of $250 million to effectively convert the fixed rate of 5.6% on $250 million of our notes, due 2018, into variable interest rates. In August 2010, we unwound these interest rate swaps. See Note 11 – Long-term Debt for further information. At December 31, 2009, the fair value of these interest rate swaps was an asset of $8.6 million.
19
The following represents the results of our derivatives in fair value hedging relationships for the three months ended September 30, 2010 and 2009:
Derivative Gain (Loss)Recognized in Earnings
Hedged Item Income (Expense)Recognized in Earnings
DerivativeInstrument
Location of Gain (Loss)
Interest expense
2,699
4,615
(5,792
(8,125
The following represents the results of our derivatives in fair value hedging relationships for the nine months ended September 30, 2010 and 2009:
11,318
7,871
(22,042
(15,125
Foreign Exchange Contracts
We enter into foreign currency exchange contracts arising from the anticipated purchase of inventory between affiliates and from third parties. These contracts are designated as cash flow hedges. The effective portion of the gain or loss on the cash flow hedges is included in other comprehensive income in the period that the change in fair value occurs and is reclassified to earnings in the period that the hedged item is recorded in earnings. At September 30, 2010 and December 31, 2009, we had outstanding contracts associated with these anticipated transactions with a notional amount of $24.4 million and $27.8 million, respectively. The fair value of these contracts at September 30, 2010 and December 31, 2009 was a liability of $0.8 million and $0.7 million, respectively.
The following represents the results of cash flow hedging relationships for the three months ended September 30, 2010 and 2009:
Derivative Gain (Loss)Recognized in OCI(Effective Portion)
Location of DerivativeGain (Loss) Reclassifiedfrom AOCI to Earnings(Effective Portion)
Gain (Loss) Reclassifiedfrom AOCI to Earnings(Effective Portion)
Derivative Instrument
(1,781
(1,236
Revenue
509
(9
(164
197
Cost of sales
(119
(549
(1,945
(1,039
390
(558
The following represents the results of cash flow hedging relationships for the nine months ended September 30, 2010 and 2009:
Location of DerivativeGain (Loss)Reclassified fromAOCI to Earnings(Effective Portion)
(2,001
(662
976
(56
1,193
(1,168
(277
(857
(808
(1,830
699
(913
As of September 30, 2010, $0.6 million of the $0.8 million net derivative loss recognized in AOCI will be recognized in earnings within the next 12 months.
No amount of ineffectiveness was recorded in the Condensed Consolidated Statements of Income for these designated cash flow hedges.
We also enter into foreign exchange contracts to minimize the impact of exchange rate fluctuations on short-term intercompany loans and related interest that are denominated in a foreign currency. The revaluation of the intercompany loans and interest and the mark-to-market on the derivatives are both recorded in earnings. At September 30, 2010, outstanding foreign exchange contracts to buy or sell various currencies had a net asset value of $1.2 million. The contracts will mature by December 31, 2010. At December 31, 2009, outstanding foreign exchange contracts to buy or sell various currencies had a net liability value of less than $0.1 million.
The following represents the results of our non-designated derivative instruments for the three months ended September 30, 2010 and 2009:
Derivatives Not Designatedas Hedging Instruments
Location of Derivative Gain (Loss)
Selling, general and administrative expense
(6,364
13,029
The following represents the results of our non-designated derivative instruments for the nine months ended September 30, 2010 and 2009:
(13,835
(25,690
Credit-Risk-Related Contingent Features
Certain of our derivative instruments contain provisions that would require us to post collateral upon a significant downgrade in our long-term senior unsecured debt ratings. At September 30, 2010, our long-term senior unsecured debt ratings were BBB+ / A1. Based on derivative values at September 30, 2010, we would have been required to post $0.6 million in collateral if our long-term senior unsecured debt ratings had fallen below BB- / Ba3.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, investment securities, accounts receivable, loans receivable, accounts payable, notes payable, long-term debt and derivative instruments. The carrying value for cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate fair value because of the short maturity of these instruments.
The carrying values and estimated fair value of our remaining financial instruments at September 30, 2010 and December 31, 2009 is as follows:
Carryingvalue (1)
Fairvalue
438,967
443,706
360,800
361,845
Loans receivable
444,041
478,191
Derivatives, net
(4,276,231
(4,465,009
(4,271,555
(4,409,961
(1) Carrying value includes accrued interest and deferred fee income, where applicable.
The fair value of long-term debt is estimated based on quoted market prices for the identical issue when traded in an active market. When a quoted market price is not available, the fair value is determined using rates currently available to the company for debt with similar terms and remaining maturities.
21
18. Commitments and Contingencies
In the ordinary course of business, we are routinely defendants in or party to a number of pending and threatened legal actions. These may involve litigation by or against us relating to, among other things, contractual rights under vendor, insurance or other contracts; intellectual property or patent rights; equipment, service, payment or other disputes with customers; or disputes with employees. Some of these actions may be brought as a purported class action on behalf of a purported class of employees, customers or others.
Our wholly-owned subsidiary, Imagitas, Inc., was a defendant in ten purported class actions filed in six different states. These lawsuits have been coordinated in the United States District Court for the Middle District of Florida, In re: Imagitas, Driver’s Privacy Protection Act Litigation (Coordinated, May 28, 2007). Each of these lawsuits alleged that the Imagitas DriverSource program violated the federal Drivers Privacy Protection Act (DPPA). Under the DriverSource program, Imagitas entered into contracts with state governments to mail out automobile registration renewal materials along with third party advertisements, without revealing the personal information of any state resident to any advertiser. The DriverSource program assisted the state in performing its governmental function of delivering these mailings and funding the costs of them. The plaintiffs in these actions were seeking statutory damages under the DPPA. On April 9, 2008, the District Court granted Imagitas’ motion for summary judgment in one of the coordinated cases, Rine, et al. v. Imagitas, Inc. (United States District Court, Middle District of Florida, filed August 1, 2006). On July 30, 2008, the District Court issued a final judgment in the Rine lawsuit and stayed all of the other cases filed against Imagitas pending an appellate decision in Rine. On August 27, 2008, the Rine plaintiffs filed an appeal of the District Court’s decision in the United States Court of Appeals, Eleventh Judicial Circuit (the “Circuit Court”). On December 21, 2009, the Circuit Court affirmed the District Court decision. On February 22, 2010, the Circuit Court denied the Rine plaintiffs’ petition for rehearing en banc. The Rine plaintiffs’ ability to pursue further review of this decision has expired. With respect to the remaining stayed cases, Imagitas filed its motion to dismiss these cases on October 8, 2010.
On October 28, 2009, the Company and certain of our current and former officers, were named as defendants in NECA-IBEW Health & Welfare Fund v. Pitney Bowes Inc. et al., a class action lawsuit filed in the U.S. District Court for the District of Connecticut. The complaint asserts claims under the Securities Exchange Act of 1934 on behalf of those who purchased the common stock of the Company during the period between July 30, 2007 and October 29, 2007 alleging that the company, in essence, missed two financial projections. Plaintiffs filed an amended complaint on September 20, 2010. We believe this case is without merit and intend to defend it vigorously.
We expect to prevail in the legal actions above; however, as litigation is inherently unpredictable, there can be no assurance in this regard. If the plaintiffs do prevail, the results may have a material effect on our financial position, future results of operations or cash flows, including, for example, our ability to offer certain types of goods or services in the future.
Product Warranties
We provide product warranties in conjunction with certain product sales, generally for a period of 90 days from the date of installation. Our product warranty liability reflects our best estimate of probable liability for product warranties based on historical claims experience, which has not been significant, and other currently available evidence. Accordingly, our product warranty liability at September 30, 2010 and December 31, 2009, respectively, was not material.
22
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) contains statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in “Forward-Looking Statements” and elsewhere in this report.
The following analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements contained in this report and our 2009 Annual Report.
Forward-Looking Statements
•
negative developments in economic conditions, including adverse impacts on customer demand
changes in postal or banking regulations
timely development and acceptance of new products
success in gaining product approval in new markets where regulatory approval is required
successful entry into new markets
mailers’ utilization of alternative means of communication or competitors’ products
our success at managing customer credit risk
our success at managing costs associated with our strategy of outsourcing functions and operations not central to our business
changes in interest rates
foreign currency fluctuations
cost, timing and execution of our transformation plans including any potential asset impairments
regulatory approvals and satisfaction of other conditions to consummation and integration of any acquisitions
interrupted use of key information systems
changes in international or national political conditions, including any terrorist attacks
intellectual property infringement claims
impact on mail volume resulting from current concerns over the use of the mail for transmitting harmful biological agents
third-party suppliers’ ability to provide product components, assemblies or inventories
negative income tax adjustments or other regulatory levies for prior audit years and changes in tax laws or regulations
changes in pension, healthcare and retiree medical costs
Overview
Third Quarter
For the third quarter 2010, revenue decreased 1% to $1.35 billion compared to the prior year. Foreign currency translation had a 1% unfavorable impact on revenue and acquisitions had a 1% favorable impact on revenue.
During the quarter, equipment sales and software revenue worldwide increased 10% compared to the prior year. The improvement in equipment sales was offset however, by declines in rentals and financing revenue, supplies revenue and business services revenue. The company had revenue growth in five of its seven business segments compared to the prior year.
Earnings before interest and taxes (EBIT) increased in four of our seven business segments when compared to the third quarter of 2009 primarily due to our ongoing productivity investments and cost reduction initiatives.
Pitney Bowes net income from continuing operations was $91 million, or $0.44 per diluted share in the third quarter of 2010 compared to $106 million or $0.51 per diluted share in the prior year. Diluted earnings per share from continuing operations for the third quarter 2010 included $0.10 for restructuring charges and less than $0.01 for out-of-the money stock options that expired during the quarter.
Cash flow from operating activities was $243 million for the third quarter 2010 compared to $249 million for the same period in the prior year. Cash flow from operations included proceeds from the unwinding of interest rate swap agreements of $32 million and restructuring payments of $24 million.
During the quarter, we completed the acquisition of Portrait Software plc (Portrait) for $65.2 million, net of cash acquired. Portrait provides software to enhance existing customer relationship management systems, enabling clients to achieve improved customer retention and profitability.
Year-to-Date
For the nine months ended September 30, 2010, revenue was $4.0 billion, a decrease of 3% compared to revenue of $4.1 billion for the nine months ended September 30, 2009. Foreign currency translation had a 1% favorable impact on revenue.
Net income from continuing operations for the nine months ended September 30, 2010 was $238 million, or $1.15 per diluted share, compared to $320 million, or $1.54 per diluted share for the prior year. Diluted earnings per share for the nine months ended September 30, 2010 was reduced by $0.32 for restructuring charges and asset impairments, $0.04 for recently enacted health care legislation and $0.07 for tax charges primarily related to out-of-the-money stock options that expired during the period.
Cash flow from operating activities was $667 million for the year-to-date 2010 period compared to $732 million for the same period in the prior year. Cash flow from operations was negatively impacted by lower net income and higher restructuring and tax payments.
Outlook
We have begun to see some positive signs in our business this quarter. However, the worldwide economy and business environment continues to be uncertain, especially among small businesses. This uncertain economic environment has impacted our financial results and in particular our recurring revenue streams, including our high-margin financing, rental and supplies revenue streams. Recovery of these recurring revenue streams will lag a recovery in equipment sales. While we have been successful in reducing our cost structure across the entire business and shifting to a more variable cost structure, these actions have not been sufficient to offset the impact of lower revenues. We remain focused on streamlining our business operations and creating more flexibility in our cost structure.
We continue to expect our mix of revenue to change, with a greater percentage of revenue coming from service-based sources and diversified revenue streams associated with fully featured smaller mailing systems. We expect that our future results will continue to be impacted by changes in global economic conditions and their impact on mail intensive industries. It is not expected that total mail volumes will rebound to prior peak levels in an economic recovery, and future mail volume trends will continue to be a factor for our businesses.
24
RESULTS OF OPERATIONS
Third Quarter of 2010 compared to Third Quarter of 2009
Business segment results
The following table shows revenue and EBIT for the three months ended September 30, 2010 and 2009 by business segment. We use EBIT, a non-GAAP measure, to determine our segment profitability. Refer to the reconciliation of segment amounts to income from continuing operations before income taxes in Note 7 to the Condensed Consolidated Financial Statements.
(Dollars in thousands)
EBIT
% change
)%
(5
1
%
(4
(3
(34
(1
During the third quarter of 2010, Small & Medium Business Solutions revenue decreased 4% to $690 million and EBIT increased 1% to $209 million, compared to prior year. Within Small & Medium Business Solutions:
U.S. Mailing revenue decreased 6% to $462 million and EBIT decreased 5% to $170 million, compared to the prior year. While equipment sales improved over the prior year, lower financing, rental, and supplies revenue more than offset the improvement in equipment sales. The decrease in financing revenue is due to a decline in our leasing portfolio from reduced equipment sales in prior periods.
International Mailing revenue increased 1% to $228 million compared to the prior year, with foreign currency translation having an unfavorable impact of 2%. Revenue growth was driven by postal rate increases in France and stronger sales in certain parts of Europe and Latin America, and Canada, as compared to prior year. The increase was partially offset by continued declines in financing and rentals revenue due to reduced equipment sales in prior periods. International Mailing EBIT increased 33% to $39 million compared to the prior year, and was favorably impacted by a $0.03 per diluted share adjustment related to certain leveraged lease transactions in Canada as well as our initiatives to improve productivity and consolidate administrative functions globally.
During the third quarter of 2010, Enterprise Business Solutions revenue increased 2% to $656 million and EBIT increased 1% to $70 million, compared to prior year. Within Enterprise Business Solutions:
Production Mail revenue increased 7% over the prior year to $135 million due to increased demand in the U.S. for inserting equipment and our first installation of production print equipment. Demand for inserting equipment continued to experience a delayed recovery in certain countries outside North America as many large enterprises in these regions continue to delay capital expenditures due to economic uncertainty. Production Mail EBIT increased 33% to $15 million compared to the prior year due to the increase in revenue over the prior year and our initiatives to improve productivity and consolidate administrative functions.
Software revenue increased 11% over the prior year to $92 million, and includes an unfavorable impact from foreign currency translation of 1% and a favorable impact of 9% from the acquisition of Portrait. We continue to expand our software-as-a-service
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license offerings and recurring revenue streams from term licenses. Software EBIT decreased 3% to $8 million, and was negatively impacted by transaction-related fees of $2.2 million associated with the Portrait acquisition, partly offset by our efforts to integrate our operations and focus our product offerings.
Management Services revenue decreased 5% to $245 million compared to the prior year, which included the unfavorable impact of foreign currency translation of 1%. Revenue was adversely impacted by lower business activity in prior periods and decreased print volumes. Management Services EBIT however, increased 20% to $24 million primarily due to our actions to align costs with changing volumes through a more variable cost infrastructure, ongoing productivity initiatives and a focus on more profitable contracts.
Mail Services revenue increased 8% to $145 million compared to the prior year, and included the favorable impact of 4% from an acquisition completed in the second quarter of 2010, while EBIT decreased 34% to $15 million. The increase in revenue is driven by an expanding customer base and higher volumes of Standard Class mail processed in our Presort business. EBIT was negatively impacted by lower margins in our International Mail Services business due to higher shipping rates charged by international carriers for our International Mail Services business, which more than offset the favorable EBIT margin impacts in our Presort business.
Marketing Services revenue increased 2% to $40 million compared to the prior year period primarily due to increased vendor advertising for the Movers’ Source kits despite a decline in the household moves compared to the prior year. EBIT increased 15% to $9 million due to the increased revenue and ongoing productivity initiatives.
Revenue by source
The following table shows revenue by source for the three months ended September 30, 2010 and 2009:
(7
(8
Equipment sales revenue increased 10% compared to the prior year and was negatively impacted by foreign currency translation of 1%. This growth was driven by higher sales of mailing and production mail equipment in the U.S. and revenue from the postal rate increases in France.
Supplies revenue decreased 7% compared to the prior year. This decline was due to lower supplies usage resulting from lower mail volumes and fewer installed meters in the U.S. and internationally. Foreign currency translation had a 1% negative impact.
Software revenue increased 10% compared to the prior year. Foreign currency translation had less than 1% negative impact and the Portrait acquisition had a positive 8% impact. Revenue has been negatively impacted as many businesses continued to delay certain capital spending worldwide as well as the impacts of expansion of our software-as-a-service offerings.
Rentals revenue decreased 8% as a result of fewer equipment sales and meter rental placements in prior periods. Foreign currency translation had an unfavorable impact of 1%.
Financing revenue decreased 8% compared to the prior year. Lower equipment sales in prior periods have resulted in a decline in our U.S. and international lease portfolios. Foreign currency translation had less than a 1% negative impact.
Support services revenue decreased 1% compared to the prior year as lower new equipment placements in prior periods have slowed growth. Foreign currency translation had a 1% negative impact.
Business services revenue decreased 2% compared to the prior year primarily due to lower net new business and print volumes at Management Services. Foreign currency translation had a 1% negative impact.
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Costs and expenses
Percentage of Revenue
46.6
47.1
30.8
28.5
22.1
22.2
24.0
24.7
14.1
14.0
63.4
67.0
76.3
74.9
32.3
32.1
2.9
3.3
Cost of equipment sales as a percentage of revenue improved to 46.6% in the third quarter of 2010 compared with 47.1% in the prior year primarily due to high-margin sales related to scale upgrades due to postal rate increases in France and the benefits from our productivity initiatives.
Cost of supplies as a percentage of revenue was 30.8% in the third quarter of 2010 compared with 28.5% in the prior year primarily due to the increasing mix of lower margin product sales worldwide.
Cost of software as a percentage of revenue was 22.1% in the third quarter of 2010, relatively unchanged compared with 22.2% in the prior year.
Cost of rentals as a percentage of revenue was 24.0% in the third quarter of 2010 compared with 24.7% in the prior year. Rental margins have been positively impacted by a higher level of lease extensions.
Financing interest expense as a percentage of revenue was 14.1% in the third quarter of 2010, comparable to 14.0% in the prior year. In computing our financing interest expense, which represents our cost of borrowing associated with the generation of financing revenues, we assumed a 10:1 leveraging ratio of debt to equity and applied our overall effective interest rate to the average outstanding finance receivables.
Cost of support services as a percentage of revenue improved to 63.4% in the third quarter of 2010 compared with 67.0% in the prior year driven by the impacts of our ongoing productivity initiatives and cost reduction programs in our U.S. Production Mail and International Mailing businesses.
Cost of business services as a percentage of revenue was 76.3% in the third quarter of 2010 compared with 74.9% in the prior year. Positive impacts of cost reduction programs in our Management Services and Presort businesses were more than offset by higher shipping costs in our International Mail Services businesses.
Selling, general and administrative (SG&A) expense as a percentage of revenue was 32.3% for the third quarter of 2010 compared with 32.1% in the prior year. SG&A expense was negatively impacted by transaction related costs associated with the acquisition of Portrait and includes the negative impacts of foreign currency translation of $4.6 million.
Research and development expenses for the third quarter of 2010 decreased $6.6 million from the prior year. The decline in overall spending is due to the wind-down of redundant costs related to our transition to offshore development capabilities and the launch of the new Connect+TM mailing system. Research and development expenses as a percentage of revenue was 2.9% in the third quarter of 2010 compared with 3.3% in the prior year.
See Note 14 to the Condensed Consolidated Financial Statements.
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Other interest expense increased $2.1 million or 8%, to $29.3 million in the third quarter of 2010 compared to $27.2 million in the prior year period due to higher average borrowings during the quarter.
Income taxes / effective tax rate
The effective tax rate for the three months ended September 30, 2010 and 2009 was 32.8% and 34.3%, respectively. The 2010 rate includes benefits associated with previously unrecognized deferred taxes on outside basis differences and alternative tax return filing elections, and charges associated with previously unrecognized deferred taxes on unremitted earnings.
See Note 5 to the Condensed Consolidated Financial Statements.
Noncontrolling interests (Preferred stock dividends of subsidiaries)
See Note 12 to the Condensed Consolidated Financial Statements.
Nine Months Ended September 30, 2010 compared to Nine Months Ended September 30, 2009
(10
Equipment sales revenue increased 1% compared to the prior year. Foreign currency translation had a positive impact of 1%. Despite the improvement in equipment sales during the third quarter, equipment sales growth year-to-date has been negatively impacted by lower placements of mailing equipment earlier in the year as customers delayed purchases of new equipment and extended their leases on existing equipment due to the economic conditions. Revenue also continues to be adversely affected by the ongoing changing mix in equipment placements to more fully featured smaller systems.
Supplies revenue decreased 5% compared to the prior year due to lower supplies usage resulting from lower mail volumes and fewer installed meters due to customer consolidations worldwide. Foreign currency translation had a favorable impact of 1%.
Software revenue increased 4% compared to the prior year. The increase is driven by the positive impact of the Portrait acquisition of 3%. Foreign currency translation had a favorable impact of 2%. Revenue growth is also impacted by the expansion of our software-as-a-service offerings and recurring revenue streams from term leases.
Rentals revenue decreased 6% compared to the prior year as customers in the U.S. continue to downsize to smaller, fully featured machines. The weak economic conditions have also impacted our international rental markets, specifically in Canada and France. Foreign currency translation had a less than 1% positive impact.
Financing revenue decreased 10% compared to the prior year. Lower equipment sales over the past year have resulted in a decline in both our U.S. and international lease portfolios. Foreign currency translation had a 1% positive impact.
Support services revenue was flat compared to the prior year. Growth has been negatively impacted by lower placements of mailing equipment. Foreign currency translation had a positive impact of 1%.
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Business services revenue decreased 3% compared to the prior year due to lower volumes at Management Services and the impact of the one-time out of period adjustment recorded in the second quarter of 2010 of $21 million associated with our International Mail Services business.
45.3
46.3
30.6
27.0
23.0
23.8
23.6
23.4
13.8
63.6
67.1
77.0
76.9
32.7
32.0
3.4
Cost of equipment sales as a percentage of revenue was 45.3% in the first nine months of 2010 compared with 46.3% in the prior year, primarily due to a favorable mix of higher margin mailing equipment worldwide.
Cost of supplies as a percentage of revenue was 30.6% in the first nine months of 2010 compared with 27.0% in the prior year due the increasing mix of lower margin products sales worldwide.
Cost of software as a percentage of revenue improved to 23.0% in the first nine months of 2010 compared with 23.8% for the first nine months of 2009 due to business integration measures and productivity investments.
Cost of rentals as a percentage of revenue was 23.6% in the first nine months of 2010, compared to 23.4% in the prior year due to the fixed costs associated with meter depreciation and lower revenues.
Financing interest expense as a percentage of revenue was 13.8% for the first nine months of 2010 compared with 14.0% in the prior year primarily due to lower borrowing costs.
Cost of support services as a percentage of revenue improved to 63.6% in the first nine months of 2010 compared with 67.1% in the prior year due to margin improvements from our ongoing productivity investments in U.S. and International mailing and production mail businesses.
Cost of business services as a percentage of revenue was 77.0% in the first nine months of 2010 compared with 76.9% in the prior year. Positive impacts of cost reduction programs in our Management Services and Mail Services businesses were offset by higher shipping costs in our International Mail Services business and the one-time out-of-period adjustment recorded in the second quarter of 2010 associated with our International Mail Services business.
SG&A expense as a percentage of revenue was 32.7% in the first nine months of 2010 compared to 32.0% in the prior year. SG&A expense declined $12.5 million and was negatively impacted by foreign currency translation of 1% and transaction costs associated with the acquisition of Portrait.
Research and development expenses decreased $21.1 million in the first nine months of 2010 compared to the prior year, primarily due to the wind down of redundant costs related to our transition to offshore development capabilities and the launch of the new Connect+TM mailing system. Research and development expenses as a percentage of revenue was 2.9% for the first nine months of 2010 compared to 3.4% in the prior year.
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Other interest expense decreased $1.6 million or 2%, to $86.2 million for the nine months ended September 30, 2010 compared to $84.5 million for the prior year.
Income taxes
The effective tax rate for the nine months ended September 30, 2010 and 2009 was 38.2% and 36.6%, respectively. The year-to-date 2010 rate includes a $9.1 million charge for the write-off of deferred tax assets related to the recent U.S. health care reform legislation signed in March 2010. This legislation includes a provision eliminating the tax deduction for retiree health care costs to the extent of federal subsidies received by companies that provide retiree prescription drug benefits equivalent to Medicare Part D coverage. The year-to-date tax rates for 2010 and 2009 also include a charge of $9.7 million and $12.2 million, respectively, related to the write-off of deferred tax assets associated with the expiration of out-of-the-money vested stock options and the vesting of restricted stock units previously granted to our employees. These write-offs of deferred tax assets will not require us to pay any additional taxes. The 2010 year-to-date rate also includes benefits associated with previously unrecognized deferred taxes on outside basis differences and alternative tax return filing elections, and charges associated with previously unrecognized deferred taxes on unremitted earnings.
LIQUIDITY AND CAPITAL RESOURCES
We believe that cash flow from operations, existing cash and liquid investments, borrowing capacity under our commercial paper program and our existing credit facility, as well as access to the debt and equity markets should be sufficient to finance our capital requirements and to cover our customer deposits. Our potential uses of cash include but are not limited to the following: growth and expansion opportunities; internal investments; customer financing; restructuring payments; tax payments; interest and dividend payments; pension and other benefit plan funding; acquisitions; and share repurchases.
We continue to review our liquidity profile. We carefully monitor for material changes in the creditworthiness of those banks acting as derivative counterparties, depository banks or credit providers to us through credit ratings and the credit default swap market. We have determined that there has not been a material variation in the underlying sources of cash flows currently used to finance our operations and we have had consistent access to the commercial paper market.
Cash Flow Summary
The change in cash and cash equivalents is as follows:
2010 Cash Flows
Net cash provided by operating activities consists primarily of net income adjusted for non-cash items and changes in operating assets and liabilities. Cash provided by operating activities included decreases in finance receivable and accounts receivable balances of $168.7 million and $109.6 million, respectively. Due to declining equipment sales since 2008, our finance receivables portfolio has declined as strong cash collections exceed new business. Similarly, the decrease in accounts receivable is primarily due to strong cash collections in excess of new billings. Cash flow also benefited from the proceeds of $31.8 million from the unwinding of interest rate
30
swaps related to a March 2008 debt issuance. Partially offsetting these factors was an increase in inventory of $31.3 million, payments of accounts payable and accrued liabilities of $68.0 million and restructuring payments of $90.7 million.
Net cash used in investing activities consisted of the net purchase of investment securities of $112.9 million, acquisitions of $75.5 million and capital expenditures of $90.2 million.
Net cash used in financing activities included net payments on commercial paper borrowings of $89.2 million, dividends paid to common stockholders and noncontrolling interests of $237.2 million and the repurchase of our common stock of $100.0 million.
2009 Cash Flows
Net cash provided by operating activities included decreases in finance receivable and accounts receivable balances of $203.6 million and $134.8 million, respectively, resulting from lower levels of new business and strong collections and an increase in current and non-current income taxes of $73.5 million primarily due to the timing of tax payments. Partially offsetting these sources of cash were a reduction in accounts payable and accrued liabilities of $195.8 million, primarily due to lower compensation accruals, restructuring payments of $66.8 million and a $20.3 million payment for the unwinding of derivatives related to the March 2009 debt issuance.
Net cash used in investing activities consisted principally of capital expenditures of $126.5 million.
Net cash used in financing activities consisted primarily of a decrease in notes payable of $445.5 million due to the repayment of commercial paper, $150.0 million principal repayment on long-term obligations and dividends paid to common stockholders and noncontrolling interests of $236.9 million. These were partially offset by proceeds of $297.5 million from the issuance of long term debt in March 2009.
Capital Expenditures
During the first nine months of 2010, capital expenditures included $44.5 million in net additions to property, plant and equipment and $45.7 million in net additions to rental equipment and related inventories compared with $66.0 million and $60.5 million, respectively, in the same period in 2009. The decrease in capital expenditures is due to lower placement of new postage meters and tighter control over capital spending.
Financings and Capitalization
We have a commercial paper program that is a significant source of liquidity for the company. During 2010, we continued to have consistent access to the commercial paper market. As of September 30, 2010, we had $132 million of outstanding commercial paper issuances. We also have a committed line of credit which supports commercial paper issuance and is provided by a syndicate of 15 banks. The line of credit expires in 2013. In May 2010, we renewed our line of credit for $1.25 billion. As of September 30, 2010, this line of credit had not been drawn down. We are a Well-Known Seasoned Issuer with the SEC which allows us to issue debt securities, preferred stock, preference stock, common stock, purchase contracts, depositary shares, warrants and units in an expedited fashion.
We believe our financing needs in the short and long-term can be met from cash generated internally, the issuance of commercial paper, debt issuance under our effective shelf registration statement and borrowing capacity under our existing credit agreements.
Recent Accounting Pronouncements
See Note 3 to the Condensed Consolidated Financial Statements.
Regulatory Matters
With exception of the impact of the U.S. health care reform legislation disclosed in Note 16 to the Condensed Consolidated Financial Statements, there have been no significant changes to the regulatory matters disclosed in our 2009 Annual Report.
31
Item 3: Quantitative and Qualitative Disclosures about Market Risk
There were no material changes to the disclosures made in the 2009 Annual Report regarding this matter.
Item 4: Controls and Procedures
Disclosure controls and procedures are designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed to reasonably assure that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate to allow timely decisions regarding required disclosure.
Under the direction of our CEO and CFO, we evaluated the effectiveness of our disclosure controls and procedures and internal control over financial reporting. The CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2010. In addition, no changes in internal control over financial reporting occurred during the three months ended September 30, 2010, that have materially affected, or are reasonably likely to materially affect, such internal control over financial reporting. It should be noted that any system of controls is based in part upon certain assumptions designed to obtain reasonable (and not absolute) assurance as to its effectiveness, and there can be no assurance that any design will succeed in achieving its stated goals. Notwithstanding this caution, the disclosure controls and procedures are designed to provide reasonable assurance of achieving their stated objectives, and the CEO and CFO have concluded that the disclosure controls and procedures are effective at that reasonable assurance level.
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
See Note 18 to the Condensed Consolidated Financial Statements.
Item 1A: Risk Factors
There were no material changes to the risk factors identified in the 2009 Annual Report.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of Equity Securities
We repurchase shares of our common stock under a systematic program to manage the dilution created by shares issued under employee stock plans and for other purposes. In May 2010, the Board of Directors approved an expansion of our share repurchase authorization to $150 million. This program authorizes repurchases in the open market. We have not repurchased or acquired any other shares of our common stock during 2010 in any other manner.
The following table summarizes our share repurchase activity under active programs during the third quarter of 2010. There were no share repurchases during the first six months of 2010.
Total number ofshares purchased
Average price paidper share
Total number ofshares purchased aspart of a publiclyannounced plan
Approximate dollarvalue of shares that mayyet be purchased underthe plan (in thousands)
Beginning balance
150,000
July 2010
1,248,943
23.39
120,786
August 2010
1,770,826
20.21
85,000
September 2010
1,667,535
20.99
50,000
4,687,304
21.33
Item 3: Defaults Upon Senior Securities
None.
Item 4: Removed and Reserved
Item 5: Other Information
Item 6: Exhibits
See Index of Exhibits.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 5, 2010
/s/ Michael Monahan
Michael Monahan
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
/s/ S. J. Green
S. J. Green
Vice President – Finance and
Chief Accounting Officer
(Principal Accounting Officer)
Exhibit Index
ExhibitNumber
Description
Status or incorporation by reference
3 (a.2)
Certificate of Amendment of Restated Certificate of Incorporation of Pitney Bowes Inc.
Incorporated by reference to Exhibit (3) (a.2) to Form 8-K as filed with the Commission on May 12, 2010. (Commission file number 1-3579)
3 (b.1)
Amendment to the Pitney Bowes Inc. Amended and Restated By-laws (effective May 10, 2010)
Incorporated by reference to Exhibit (3)(b.1) to Form 8-K as filed with the Commission on May 12, 2010. (Commission file number 1-3579)
(12)
Computation of ratio of earnings to fixed charges
Page 36
(31.1)
Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended
Page 37
(31.2)
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended
Page 38
(32.1)
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
Page 39
(32.2)
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
Page 40
101.INS
XBRL Report Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Calculation Linkbase Document
101.DEF
XBRL Taxonomy Definition Linkbase Document
101.LAB
XBRL Taxonomy Label Linkbase Document
101.PRE
XBRL Taxonomy Presentation Linkbase Document
35