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:
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:
(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.
PITNEY BOWES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited; tabular dollars in thousands, except for per share data)
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 theRine lawsuit and stayed all of the other cases filed against Imagitas pending an appellate decision inRine. 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 inNECA-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 ofFinancial 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
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 may change based on various factors. The future is difficult to predict. 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 current expectations as to the future and include, but are not limited to, statements about the transformation initiatives, and amounts, timing and results of possible restructuring charges and future earnings or risks. Words such as “estimate”, “target”, “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, without limitation:
| | |
| • | 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.
23
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 of2010 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) | | Revenue | | EBIT | |
| | | | | |
| | Three Months Ended September 30, | | Three Months Ended September 30, | |
| | | | | |
| | 2010 | | 2009 | | % change | | 2010 | | 2009 | | % change |
| | | | | | | | | | | | | |
U.S. Mailing | | $ | 461,787 | | | $ | 491,036 | | | | (6 | )% | | $ | 169,871 | | | $ | 178,066 | | | | (5 | )% | |
International Mailing | | | 227,844 | | | | 224,681 | | | | 1 | % | | | 38,931 | | | | 29,193 | | | | 33 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Small & Medium Business Solutions | | | 689,631 | | | | 715,717 | | | | (4 | )% | | | 208,802 | | | | 207,259 | | | | 1 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Production Mail | | | 134,943 | | | | 126,434 | | | | 7 | % | | | 15,243 | | | | 11,494 | | | | 33 | % | |
Software | | | 91,544 | | | | 82,361 | | | | 11 | % | | | 7,996 | | | | 8,241 | | | | (3 | )% | |
Management Services | | | 245,113 | | | | 259,370 | | | | (5 | )% | | | 23,508 | | | | 19,517 | | | | 20 | % | |
Mail Services | | | 144,988 | | | | 134,042 | | | | 8 | % | | | 15,139 | | | | 23,024 | | | | (34 | )% | |
Marketing Services | | | 39,523 | | | | 38,896 | | | | 2 | % | | | 8,571 | | | | 7,448 | | | | 15 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Enterprise Business Solutions | | | 656,111 | | | | 641,103 | | | | 2 | % | | | 70,457 | | | | 69,724 | | | | 1 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 1,345,742 | | | $ | 1,356,820 | | | | (1 | )% | | $ | 279,259 | | | $ | 276,983 | | | | 1 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Small & Medium Business Solutions
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.
Enterprise Business Solutions
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
25
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:
| | | | | | | | | | | | | |
(Dollars in thousands) | | Three Months Ended September 30, | |
| | | |
| | 2010 | | 2009 | | % change |
| | | | | | | |
Equipment sales | | $ | 248,228 | | | $ | 225,759 | | | | 10 | % | |
Supplies | | | 77,304 | | | | 83,464 | | | | (7 | )% | |
Software | | | 95,850 | | | | 87,295 | | | | 10 | % | |
Rentals | | | 151,399 | | | | 163,711 | | | | (8 | )% | |
Financing | | | 157,333 | | | | 171,228 | | | | (8 | )% | |
Support services | | | 175,844 | | | | 177,607 | | | | (1 | )% | |
Business services | | | 439,784 | | | | 447,756 | | | | (2 | )% | |
| | | | | | | | | | | | | |
Total revenue | | $ | 1,345,742 | | | $ | 1,356,820 | | | | (1 | )% | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
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.
26
| | | | | | | | | | | | | | | | | |
Costs and expenses | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | Three Months Ended September 30, | |
| | | |
| | | | | | | | | | Percentage of Revenue | |
| | | | | | | | | | | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
| | | | | | | | | |
Cost of equipment sales | | $ | 115,721 | | | $ | 106,326 | | | | 46.6 | % | | | 47.1 | % | |
Cost of supplies | | $ | 23,843 | | | $ | 23,785 | | | | 30.8 | % | | | 28.5 | % | |
Cost of software | | $ | 21,191 | | | $ | 19,413 | | | | 22.1 | % | | | 22.2 | % | |
Cost of rentals | | $ | 36,277 | | | $ | 40,508 | | | | 24.0 | % | | | 24.7 | % | |
Financing interest expense | | $ | 22,189 | | | $ | 23,975 | | | | 14.1 | % | | | 14.0 | % | |
Cost of support services | | $ | 111,521 | | | $ | 119,034 | | | | 63.4 | % | | | 67.0 | % | |
Cost of business services | | $ | 335,588 | | | $ | 335,406 | | | | 76.3 | % | | | 74.9 | % | |
Selling, general and administrative | | $ | 435,292 | | | $ | 435,931 | | | | 32.3 | % | | | 32.1 | % | |
Research and development | | $ | 38,454 | | | $ | 45,052 | | | | 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.
Restructuring charges and asset impairments
See Note 14 to the Condensed Consolidated Financial Statements.
27
Other interest expense
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.
Discontinued operations
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
Revenue by source
| | | | | | | | | | | | | |
(Dollars in thousands) | | Nine Months Ended September 30, | |
| | | |
| | 2010 | | 2009 | | % change |
| | | | | | | |
Equipment sales | | $ | 718,399 | | | $ | 714,780 | | | | 1 | % | |
Supplies | | | 239,635 | | | | 253,466 | | | | (5 | )% | |
Software | | | 265,130 | | | | 254,401 | | | | 4 | % | |
Rentals | | | 456,977 | | | | 487,992 | | | | (6 | )% | |
Financing | | | 476,712 | | | | 528,534 | | | | (10 | )% | |
Support services | | | 531,176 | | | | 531,200 | | | | - | % | |
Business services | | | 1,303,183 | | | | 1,344,493 | | | | (3 | )% | |
| | | | | | | | | | | | | |
Total revenue | | $ | 3,991,212 | | | $ | 4,114,866 | | | | (3 | )% | |
| | | | | | | | | | | | | |
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%.
28
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.
| | | | | | | | | | | | | | | | | |
Costs and expenses | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | |
| | | |
(Dollars in thousands) | | | | | | | | | | Percentage of Revenue | |
| | | | | | | | | | | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
| | | | | | | | | |
Cost of equipment sales | | $ | 325,120 | | | $ | 331,144 | | | | 45.3 | % | | | 46.3 | % | |
Cost of supplies | | $ | 73,381 | | | $ | 68,495 | | | | 30.6 | % | | | 27.0 | % | |
Cost of software | | $ | 61,064 | | | $ | 60,480 | | | | 23.0 | % | | | 23.8 | % | |
Cost of rentals | | $ | 107,658 | | | $ | 114,372 | | | | 23.6 | % | | | 23.4 | % | |
Financing interest expense | | $ | 65,948 | | | $ | 73,865 | | | | 13.8 | % | | | 14.0 | % | |
Cost of support services | | $ | 337,822 | | | $ | 356,620 | | | | 63.6 | % | | | 67.1 | % | |
Cost of business services | | $ | 1,003,712 | | | $ | 1,033,933 | | | | 77.0 | % | | | 76.9 | % | |
Selling, general and administrative | | $ | 1,304,941 | | | $ | 1,317,410 | | | | 32.7 | % | | | 32.0 | % | |
Research and development | | $ | 117,487 | | | $ | 138,623 | | | | 2.9 | % | | | 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.
Restructuring charges and asset impairments
See Note 14 to the Condensed Consolidated Financial Statements.
29
Other interest expense
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.
Discontinued operations
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.
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:
| | | | | | | | | |
(Dollars in thousands) | | Nine Months Ended September 30, | |
| | | |
| | 2010 | | 2009 | |
| | | | | |
Net cash provided by operating activities | | $ | 666,887 | | | $ | 732,424 | | |
Net cash used in investing activities | | | (276,291 | ) | | | (153,577 | ) | |
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 | | |
| | | | | | | | | |
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.
32
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 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) | |
| | | | | | | | | |
Beginning balance | | | | | | | | | | | | | | $ | 150,000 | |
July 2010 | | | 1,248,943 | | | $ | 23.39 | | | | 1,248,943 | | | $ | 120,786 | |
August 2010 | | | 1,770,826 | | | $ | 20.21 | | | | 1,770,826 | | | $ | 85,000 | |
September 2010 | | | 1,667,535 | | | $ | 20.99 | | | | 1,667,535 | | | $ | 50,000 | |
| | | | | | | | | | | | | | | | |
| | | 4,687,304 | | | $ | 21.33 | | | | 4,687,304 | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Item 3: Defaults Upon Senior Securities
None.
Item 4: Removed and Reserved
Item 5: Other Information
None.
Item 6: Exhibits
See Index of Exhibits.
33
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. |
| |
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) |
34
Exhibit Index
| | | | |
Exhibit
Number | | 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
