The following table shows net interest expense for the nine months ended September 30, 2006 and 2005:
Net interest expense increased by $24.1 million or 17.7% in the first nine months of 2006 compared with the prior year primarily due to higher average interest rates and average borrowings, offset by additional interest income as a result of higher short-term investments from funds received upon the sale of Capital Services.
The effective tax rate for the first nine months of 2006 was 37.5% compared with 33.6% in the prior year. The effective tax rate for the first nine months of 2006 included an additional charge of $20 million related to the IRS settlement discussed in Note 16 to the condensed consolidated financial statements.
The following table details minority interest for the nine months ended September 30, 2006 and 2005:
Minority interest includes dividends paid to preferred stockholders in a subsidiary. Minority interest increased by $2.9 million or 41.9% in the first nine months of 2006 compared with the prior year due to an increase in the weighted average dividend rate which is set at auction.
The following table details the components of discontinued operations for the nine months ended September 30, 2006 and 2005:
Net income from discontinued operations increased by $4.6 million in the first nine months of 2006 compared with the prior year primarily due to the run-off of the portfolio and the realization of certain Capital Services tax benefits. See Note 4 in the condensed consolidated financial statements for further discussion and details of the discontinued operations.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
Our primary sources of liquidity and capital resources include cash flows from operating activities. Additionally, we have substantial borrowing capability through our commercial paper program, long-term capital markets and revolving credit line agreements. The primary factors that affect our liquidity position, other than operating results associated with current sales activity, include the following: growth and expansion requirements; customer financing assistance; federal income tax payments; interest and dividend payments; our stock repurchase program; internal investments; and potential acquisitions and divestitures.
Cash Flow Summary
The change in cash and cash equivalents is as follows:
| | | | | | | |
| | Nine Months Ended September 30, | |
| |
| |
(Dollars in thousands) | | 2006 | | 2005 | |
| |
| |
| |
| | | | | | | |
Cash provided by operating activities | | $ | 335,790 | | $ | 425,735 | |
Cash provided by (used in) investing | | | 11,721 | | | (407,122 | ) |
Cash used in financing activities | | | (365,013 | ) | | (38,467 | ) |
Effect of exchange rate changes on cash | | | 2,346 | | | (1,836 | ) |
| |
|
| |
|
| |
Decrease in cash and cash equivalents | | $ | (15,156 | ) | $ | (21,690 | ) |
| |
|
| |
|
| |
The decrease in cash provided by operating activities in the nine months ended September 30, 2006 compared with the nine months ended September 30, 2005 is primarily due to an increase in investment in finance receivables and higher taxes paid in 2006. Cash provided by discontinued operations included in operating activities was approximately $1 million and $65 million in the nine months ended September 30, 2006 and 2005, respectively.
The increase in cash provided by investing activities in the nine months ended September 30, 2006 compared with the nine months ended September 30, 2005 is primarily due to proceeds of $747 million received from the sale of our Capital Services external financing business, $282 million received from the sale of our Imagistics lease portfolio and an advance of $138 million against the cash surrender value of our COLI policies offset by our investment of $779 million in short-term investments.
The increase in cash used in financing activities in the nine months ended September 30, 2006 compared with the nine months ended September 30, 2005 is primarily due to lower borrowings and higher stock repurchases in 2006.
Capital Expenditures
During the first nine months of 2006, capital expenditures included $95.7 million in net additions to property, plant and equipment and $148.2 million in net additions to rental equipment and related inventories compared with $104.9 million and $110.5 million, respectively, in the same period in 2005. The addition of rental equipment relates primarily to postage meters and increased over the prior year due to higher placements of our digital meters during the nine months ended September 30, 2006.
We expect capital expenditures for the full year of 2006 to be slightly higher than the prior year. These investments will also be affected by the timing of our customers’ transition to digital meters.
Financings and Capitalization
We have a commercial paper program that provides short-term liquidity. Commercial paper remains a significant liquidity source. As of September 30, 2006, we have approximately $1.0 billion of outstanding commercial paper issuances. We have unused credit facilities of $3.1 billion of which $1.5 billion supports commercial paper issuances.
In addition to our borrowing capability under the unused credit facilities described above, we have $1.6 billion remaining available under the shelf registration statement filed in February 2005 with the SEC, permitting issuances of up to $2.5 billion in debt securities, preferred stock, preference stock, common stock, purchase contracts, depositary shares, warrants and units.
In May 2006, we took a cash advance totaling $138 million against the cash surrender value in certain COLI policies. This advance is reflected as a reduction to our COLI investment in Other Assets in the Condensed Consolidated Balance Sheet.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net proceeds from the sale of the Imagistics lease portfolio, the sale of our Capital Services external financing business and the proceeds from the COLI advance will be used to pay approximately $1.1 billion of tax obligations resulting from the dispositions and our tax settlement with the IRS. We paid $239 million of the tax obligation in the third quarter and we expect to pay the remainder in the fourth quarter of 2006.
We believe our financing needs in the short and long term can be met with cash generated internally, money from existing credit agreements, debt issued under new and existing shelf registration statements and our existing commercial paper program.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123(R) (revised 2004), “Share-Based Payment.” SFAS 123(R) supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based transactions using APB No. 25 and requires that the compensation costs relating to such transactions be recognized in the condensed consolidated financial statements. SFAS 123(R) requires compensation cost to be recognized immediately for awards granted to retirement eligible employees or over the period from the grant date to the date retirement eligibility is achieved, if that is expected to occur during the nominal vesting period. Prior to our adoption of SFAS 123(R), we used the nominal vesting period approach to determine the pro forma stock-based compensation expense for all awards. SFAS 123(R) also requires additional disclosures relating to the income tax and cash flow effects resulting from share-based payments. We adopted the provisions of SFAS 123(R) on January 1, 2006 using the modified retrospective application. See Note 14 for further disclosures related to our stock-based compensation.
In June 2005, the FASB issued FASB Staff Position (FSP) No. FAS 143-1, “Accounting for Electronic Equipment Waste Obligations,” that provides guidance on how commercial users and producers of electronic equipment should recognize and measure asset retirement obligations associated with the European Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the Directive). The adoption of this FSP did not have a material effect on our financial position, results of operations or cash flows for those European Union (EU) countries that enacted the Directive into country-specific laws.
In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” that provides guidance on the accounting for uncertainty in income taxes recognized in financial statements. The interpretation will be adopted by us on January 1, 2007. We are continuing to evaluate the impact of adopting FIN 48.
In July 2006, the FASB issued FSP No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” that provides guidance on how a change or a potential change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for the lease. FSP No. FAS 13-2 will be adopted by us on January 1, 2007. We are continuing to evaluate the impact of adopting this FSP.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157),to define how the fair value of assets and liabilities should be measured in more than 40 other accounting standards where it is allowed or required. In addition to defining fair value, the statement establishes a framework within Generally Accepted Accounting Principles for measuring fair value and expands required disclosures surrounding fair-value measurements. While it will change the way companies currently measure fair value, it does not establish any new instances where fair-value measurement is required. SFAS 157 defines fair value as an amount that a company would receive if it sold an asset or paid to transfer a liability in a normal transaction between market participants in the same market where the company does business. It emphasizes that the value is based on assumptions that market participants would use, not necessarily only the company that might buy or sell the asset. SFAS 157 takes effect for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption allowed. We are currently evaluating the impact of adopting this Statement.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158) to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. We will adopt the provisions of SFAS 158 on December 31, 2006. The adoption of SFAS 158 is expected to reduce stockholders’ equity at December 31, 2006 by approximately $410 million; however, the final amount will depend on an actuarial estimate prepared as of December 31, 2006. SFAS 158 does not affect our results of operations or cash flows.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Regulatory Matters
There have been no significant changes to the regulatory matters disclosed in our 2005 Annual Report on Form 10-K.
Other Regulatory Matters
In August 2006, we reached a settlement with the IRS governing all outstanding tax audit issues in dispute for tax years through 2000. These disputed items related primarily to the tax treatment of corporate owned life insurance (COLI) and related interest expense, the tax effect of the sale of certain preferred share holdings and the tax treatment of certain Capital Services lease transactions. In the second quarter of 2006, we estimated the tax due as a result of the IRS settlement including our best estimate of the additional liability for these items in all open years, the sale of the Imagistics portfolio and the sale of the Capital Services business to be approximately $1.1 billion. Accordingly we recorded $61 million of additional tax expense. The $1.1 billion tax liability is net of $330 million of IRS tax bonds previously posted. In the third quarter, we paid $239 million of the $1.1 billion obligation to the IRS and we expect to pay the remainder by the end of 2006. These tax obligations are being funded with proceeds previously received from the sale of Imagistics and Capital Services and the advance against the cash surrender value of our COLI assets. $41 million of the $61 million tax expense relates to the Capital Services business and was included in discontinued operations and $20 million was included in continuing operations. We have accrued our best estimate of the probable tax, interest and penalties that we believe is appropriate given the likelihood of tax adjustments in all open tax years. However, the resolution of such matters could have a material effect on our results of operations, financial position and cash flows.
In the second quarter of 2006, we also accrued in discontinued operations an additional tax expense of $16.2 million to record the impact of the recently-enacted Tax Increase Prevention and Reconciliation Act (TIPRA). The TIPRA legislation repealed the exclusion from federal income taxation of a portion of the income generated from certain leveraged leases of aircraft by foreign sales corporations. See Note 4 for further discussion of the discontinued operations.
Forward-Looking Statements
We want to caution readers that any forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 in this Form 10-Q, other reports or press releases or made by our management involve risks and uncertainties which may change based on various important factors. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements are those which talk about our or management’s current expectations as to the future and include, but are not limited to, statements about the amounts, timing and results of possible restructuring charges and future earnings. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” and similar expressions may identify such forward-looking statements. Some of the factors which could cause future financial performance to differ materially from the expectations as expressed in any forward-looking statement made by or on our behalf include:
| | |
| • | changes in international or national political conditions, including any terrorist attacks |
| | |
| • | negative developments in economic conditions, including adverse impacts on customer demand |
| | |
| • | changes in postal 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 its strategy of outsourcing functions and operations not central to its business |
| | |
| • | changes in interest rates |
| | |
| • | foreign currency fluctuations |
| | |
| • | cost, timing and execution of the restructuring plan, including any potential asset impairments |
| | |
| • | regulatory approvals and satisfaction of other conditions to consummation of any acquisitions and integration of recent acquisitions |
| | |
| • | interrupted use of key information systems |
| | |
| • | changes in privacy laws |
| | |
| • | 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 |
| | |
| • | negative income tax adjustments for prior audit years and changes in tax laws or regulations |
| | |
| �� | changes in pension and retiree medical costs |
| | |
| • | acts of nature |
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Item 3: Quantitative and Qualitative Disclosures about Market Risk
There were no material changes to the disclosures made in the Annual Report on Form 10-K for the year ended December 31, 2005 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 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 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, 2006. In addition, no change in internal control over financial reporting occurred during the quarter ended September 30, 2006, that has materially affected, or is 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.
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PART II. OTHER INFORMATION
Item 1: Legal Proceedings
This item updates the legal proceedings more fully described in our 2005 Annual Report on Form 10-K, dated March 13, 2006 and as updated in our first and second quarter Forms 10-Q, dated May 4, 2006 and August 8, 2006, respectively.
On October 30, 2006, the trial began in Ricoh Corporation et al. v. Pitney Bowes Inc. (United States District Court, District of New Jersey, filed November 26, 2002). The trial is expected to last approximately two to three weeks. The United States Supreme Court recently issued its decision in eBay Inc. et al. v. MercExchange L.L.C. which increases the burden on plaintiffs seeking injunctions in patent lawsuits. We expect to prevail in this case; however, as litigation is inherently unpredictable there can be no assurance in this regard. If Ricoh does prevail, the result 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.
During the third quarter and the beginning of the fourth quarter, our wholly-owned subsidiary, Imagitas, Inc. was sued in six purported class actions filed in five different states as follows: Rine v. Imagitas, Inc. (U.S. District Court, Middle District of Florida, filed August 14, 2006; asserting class of allegedly affected residents of both the United States and of Florida only); Mathias v. Imagitas, Inc. (U.S. District Court, Northern District of Ohio, filed September 8, 2006; asserting a class of allegedly affected residents of Ohio); Kracum v. Imagitas, Inc. (U.S. District Court, District of Minnesota, filed September 22, 2006; asserting a class of allegedly affected residents of Minnesota); Ressler v. Imagitas, Inc. (U.S. District Court, Western District of Missouri, filed October 5, 2006; asserting a class of allegedly affected residents of Missouri); Landree v. Imagitas, Inc. (U.S. District Court, District of Minnesota, filed October 6, 2006; asserting a class of allegedly affected residents of Minnesota); Kendron v. Imagitas (U.S. District Court, District of Massachusetts, filed October 17, 2006; asserting a class of allegedly affected residents of the United States). Each of these lawsuits allege that the Imagitas DriverSource program violates the federal Drivers Privacy Protection Act (DPPA). Under the DriverSource program, Imagitas enters 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 assists the state in performing its function of delivering these mailings and funding the costs of them. The plaintiffs in these actions are seeking both statutory damages under the DPPA and an injunction against the continuation of the program. We expect to prevail in these lawsuits; 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.
Item 1A: Risk Factors
There were no material changes to the risk factors identified in the Annual Report on Form 10-K for the year ended December 31, 2005 regarding this matter.
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. This program authorizes repurchases in the open market. We have not repurchased or acquired any other shares of our common stock during 2006 in any other manner.
In September 2005, our Board of Directors authorized $300 million for repurchases of outstanding shares of our common stock in the open market during the subsequent 12 to 24 months of which $241.2 million remained for future purchases at December 31, 2005. We repurchased 5.7 million shares during the nine months ended September 30, 2006 under this program for a total price of $241.2 million. There are no further funds available under this authorization for the repurchase of outstanding shares.
In March 2006, our Board of Directors authorized the repurchase of up to an additional $300 million of our common stock in the open market during the subsequent 12 to 24 months. We repurchased 1.6 million shares during the nine months ended September 30, 2006 under this program for a total price of $70.6 million, leaving $229.4 million remaining for future repurchases under this program.
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The following table summarizes our share repurchase activity under active programs during the first nine months of 2006:
| | | | | | | | | | | | | |
Period | | Total number
of shares
purchased | | Average price
paid per
share | | Total number of
shares purchased as
part of a publicly
announced plan | | Approximate dollar value
of shares that may yet be
purchased under the plan
(in thousands) | |
| |
| |
| |
| |
| |
September 2005 Program | | | | | | | | | |
Balance carried forward | | | — | | | — | | | — | | $ | 241,199 | |
January 1 through 31, 2006 | | | 124,900 | | $ | 42.84 | | | 124,900 | | $ | 235,853 | |
February 1 through 28, 2006 | | | 725,400 | | $ | 42.81 | | | 725,400 | | $ | 204,795 | |
March 1 through 31, 2006 | | | 2,731,500 | | $ | 42.33 | | | 2,731,500 | | $ | 89,174 | |
April 1 through 30, 2006 | | | 2,070,932 | | $ | 43.06 | | | 2,070,932 | | $ | 0 | |
| |
|
| | | | |
|
| | | | |
| | | 5,652,732 | | | | | | 5,652,732 | | | | |
| | | | | | | | | | | | | |
March 2006 Program | | | | | | | | | | | | | |
March 1 through 31, 2006 | | | — | | | — | | | — | | $ | 300,000 | |
April 1 through 30, 2006 | | | 1,180,641 | | $ | 43.06 | | | 1,180,641 | | $ | 249,174 | |
May 1 through 31, 2006 | | | 15,205 | | $ | 42.75 | | | 15,205 | | $ | 248,524 | |
June 1 through 30, 2006 | | | — | | | — | | | — | | $ | 248,524 | |
July 1 through 31, 2006 | | | — | | | — | | | — | | $ | 248,524 | |
August 1 through 31, 2006 | | | 353,787 | | $ | 43.32 | | | 353,787 | | $ | 233,199 | |
September 1 through 30, 2006 | | | 85,800 | | $ | 43.83 | | | 85,800 | | $ | 229,438 | |
| |
|
| | | | |
|
| | | | |
| | | 1,635,433 | | | | | | 1,635,433 | | | | |
| | | | | | | | | | | | | |
| |
|
| | | | |
|
| | | | |
Total repurchases | | | 7,288,165 | | | | | | 7,288,165 | | | | |
| |
|
| | | | |
|
| | | | |
35
Item 6: Exhibits
See Index of Exhibits.
36
Signatures
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.
| |
| PITNEY BOWES INC. |
| |
November 9, 2006 | |
|
| /s/ B. P. Nolop |
|
|
| B. P. Nolop |
| 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) |
37
Index of Exhibits
| | |
Reg. S-K | | |
Exhibits | | Description |
| |
|
|
(12) | | Computation of ratio of earnings to fixed charges. |
| | |
(31.1) | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
(31.2) | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
(32.1) | | Section 1350 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
(32.2) | | Section 1350 Certification of Chief Financial Officer Pursuant Section 906 of the Sarbanes-Oxley Action of 2002. |
38
