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Pitney Bowes Inc. (NYSE:PBI)

Q4 2008 Earnings Call Transcript

May 5, 2009 5:00 pm ET

Executives

Charles McBride – Vice President, Investor Relations

Murray D. Martin – President and Chief Executive Officer

Michael Monahan – Chief Financial Officer

Analysts

Shannon Cross – Cross Research

Chris Whitmore – Deutsche Bank

Vincent Lin for Julio Quinteros - Goldman Sachs

Operator

Good evening and welcome to the Pitney Bowes 2009 first quarter earnings conference call. (Operator Instructions)

I would now like to introduce your speakers for today’s conference call: Mr. Murray Martin, Chairman, President and Chief Executive Officer; Mr. Michael Monahan, Executive Vice President and Chief Financial Officer; and Mr. Charles McBride, Vice President of Investor Relations. Mr. McBride will now begin the call with the Safe Harbor overview.

Charles McBride

Thank you and good afternoon.

During this presentation are forward-looking statements about our expected future business and financial performance. Forward-looking statements about risks and uncertainties that could actual results to be materially different from our projections. More information about these risks and uncertainties can be found on our Web site at www.pb.com and clicking on Our Company and Investor Relations. Please keep in mind that we do not undertake any obligation to update any forward-looking statements as a result of new information or future events or developments.

Now, our Chairman, President and Chief Executive Officer, Murray Martin, will start with an overview of the quarter.

Murray D. Martin

Good afternoon and thank you for joining us today. I will open by sharing a few thoughts on our performance and Mike will follow with the financial overview of this quarter's results. I will then conclude with our outlook for 2009 and then we will open the line for questions.

I am encouraged by our performance this quarter, given the context in which it occurred and the challenges in the global marketplace. During the quarter we continued to generate robust cash flow, to streamline our cost structure, and reduce our debt.

These actions enabled us to mitigate some of the pressure on earnings, even as we faced declines in revenue. At the same time, we continued to reinvest a portion of the savings from our cost restructuring programs into the long-term growth of the business, including consistent investment in research and development.

Results were sound given the adverse impact of currency, increased pension costs and delayed decision making by many of our customers which characterized our operating environment.

Currency negatively affected our revenue and earnings for the quarter. The 12% decline in our revenue, to $1.4 billion, included a 6% reduction driven by currency.

Our adjusted earnings per share from continuing operations was $0.55. This was only a 3% decline when you exclude the $0.07 per share of negative impact associated with currency and the $0.02 per share negative impact from increased pension costs.

At the business segment level, the adverse impact of currency on revenue was particularly noticeable in International Mailing, Software, and Production Mail. Mike will provide a more detailed breakout of the currency effects later in the call.

During the quarter, we continued our focus on customer retention, expense management, and cash flow generation to mitigate these economic headwinds. Research shows us that two-thirds of business-to-business sales typically occur with existing customers. That is why it is especially important for us to maintain and strengthen our relationships with our current customers in the midst of this economic uncertainty.

Throughout our businesses we are finding opportunities to support our customers in this environment as we seek to leverage the long-term value of these relationships. In U. S. Mailing for example, we are providing customers with more options to extend their lease and keep their existing equipment at no change in cost to them. As a result, during the first quarter we experienced a three-fold increase in the number of lease extensions we provided to our customers so they could retain their existing equipment.

These transactions benefit future periods' profitability but have a less positive impact on our revenue during the current quarter than new equipment placements would have had. We are pleased with our success in customer retention and we remain committed to investing in the continuous improvement of our customer experience.

We are also realizing the benefits of the actions we have taken to streamline our costs and our expenses. We also improved gross margins related to both our Software and support services, while our selling, general, and administrative expenses declined by $53.0 million on a reported basis and we reduced our expenses by nearly $25.0 million on a constant currency basis when compared with the prior year, excluding the incremental pension expense.

Our lower cost structure and expense management also helped improve EBIT margins in Marketing Services, Mail operations in Europe as well as U.S. Management Services.

We continued to have robust free cash flow as a result of our ongoing focus on the balance sheet and lower capital expenditures. The positive momentum that we have seen in our Mail Services operation since we started the business continued as revenues rose along with the volume of mail processed.

We are starting to see improving EBIT margins at the sites we acquired last year, even though their integration has resulted in a slightly lower overall EBIT margin. We expect continued EBIT improvement from the business.

Before I discuss our outlook for 2009, Mike will provide an overview of our financial results.

Michael Monahan

Revenue was $1.4 billion for the quarter, a decline of 6% from the prior year on a constant currency basis and a 12% decline as reported. For the quarter, non-U.S. operations represented about 28% of total revenue. Approximately 10% of the company's revenue is denominated in Euros, 7% is in the British pound, and 5% is based in the Canadian dollar. Since last year the Euro has declined about 13% in value against the U.S. dollar, the British pound has declined about 27% and the Canadian dollar has declined by 19%.

Like most other global companies, this has affected both our revenue and EBIT results. Based on current rates, currency will have a greater impact on our results in the first half of the year than in the second half.

In addition, the strengthening dollar has increased some of our product costs, especially in non-U.S. markets.

As a result, foreign currency translation reduced our overall revenue growth by 6% compared with the prior year.

Breaking revenue down between the U.S. and non-U.S. for the quarter, revenue in the U.S. declined by 7% while revenue outside the U.S. had slightly better results in this difficult economy and declined by 5% versus the prior year on a constant currency basis. On a reported basis, revenue outside the U.S. was down 24%, reflecting the dramatic shift in foreign currency exchange rates from the prior year.

Earnings before interest and taxes, or EBIT, for the quarter, was $229.0 million. EBIT margin declined year-over-year to 16.6% when compared to the adjusted EBIT margin the year before, primarily due to the decline in revenues that resulted from continued economic and currency pressures and increased pension costs. As Murray noted, during the quarter we continued to focus on reducing our fixed cost structure to offset these impacts.

When we add back depreciation and amortization to EBIT, EBITDA for the quarter was $316.0 million, or $1.53 per share.

Net interest expense in the quarter decreased by about $8.0 million compared with the prior year. We benefited in the quarter from a lower average interest rate, which declined from 4.9% last year to 4.2% this year and lower average debt balances, which declined by about $125.0 million compared to the prior year.

Excluding an $11.0 million incremental tax charge associated with out-of-the-money stock options that expired during the quarter, the effective tax rate for the quarter on earnings was 34.2%, which was slightly lower than the tax rate on adjusted earnings during the first quarter of last year. We expect that the tax rate could vary during the course of the year within a range of 34% to 35%.

Adjusted earnings per share for the quarter was $0.55 compared with our adjusted earnings per share of $0.66 for the same period last year.

As I noted earlier, strengthening of the U.S. dollar when compared with last year had a significant negative impact on both our translation and transaction cost for the quarter and resulted in a $0.07 reduction in our adjusted earnings per share. In addition, there was a $0.02 negative impact to earnings associated with incremental pension expense.

Excluding these impacts, our adjusted earnings per share for the quarter would have been $0.64, which is similar to our results last year when the economy was in much better shape.

We took aggressive actions last year to reduce our fixed costs and continue to take additional actions aimed to enhance productivity during this difficult economic downturn.

Also affecting earnings per share was our lower shares outstanding. While we did not repurchase shares during the quarter, based upon share repurchases in 2008, our shares outstanding this quarter were about 3% below what they were in last year's first quarter.

GAAP earnings per share included $0.05 per share of charges for the out-of-the-money stock options that expired during the quarter. Additionally, GAAP earnings per share includes a $0.01 per share gain for discontinued operations, which related to the settlement of bankruptcy claims on an aircraft lease investment made by our former capital services businesses.

Free cash flow was $240.0 million for the quarter, an increase of 19% from the prior year. Our strong free cash flow was the result of our ongoing focus on the balance sheet and cash management during the quarter, particularly in the areas of accounts receivable and capital expenditures. Cash flow also benefited from a decline in finance receivables during the quarter.

During the quarter we increased our dividend and returned $74.0 million to our shareholders.

We further reduced our commercial paper balances by $385.0 million during the quarter to a balance of $226.0 million. About $300.0 million of that reduction came from the proceeds of the debt we issued this quarter and the rest of the reduction came from free cash flow. About 86% of our total debt is fixed rate and 14% is floating rate.

Again, let me emphasize the strength of our liquidity and our continued access to capital. We continue to maintain an A1/P1 rating as a commercial paper issuer and have taken the following additional actions this quarter to ensure that we preserve our liquidity and financial flexibility.

We issued $300.0 million of 10-year notes at an attractive interest rate of 6.25%. We reduced our reliance on the commercial paper market by reducing our balances outstanding, and we again have chosen not to repurchase shares.

Additionally, let me remind you that we have only $150.0 million in bonds maturing in 2009 and no debt maturing in 2010 or 2011. We have a $1.5 billion credit facility, which supports almost 7x our current commercial balance and our debt and our credit facility have no financial covenants or Mac clauses and our credit facility does not mature until 2011 and all of the original bank commitments remain.

While the company has substantial retained earnings, our stockholders' equity was adversely affected by $59.0 million in currency translation adjustments. After factoring in earnings and dividends paid, the stockholders' deficit increased by approximately $14.0 million to a deficit of $202.0 million at the end of the quarter.

It is important to note that this does not impact our debt, our ability to continue to pay dividends, or our credit ratings, and the company remains in a strong financial position.

Let me now update you on our transition initiatives announced in November of 2007. In the first quarter we eliminated an additional 352 positions, bringing the total to almost 2,600 positions eliminated since the inception of the program in the fourth quarter of 2007. The remainder of the 3,000 identified positions will be eliminated during the balance of 2009.

We had $33.0 million in cash payments related to severance during the quarter. We generated about $32.0 million in incremental benefits in the quarter, a portion of which is being reinvested in the business to enhance customer value and gain operational efficiencies. These savings continue to help mitigate the impact of the current economic downturn on our financial results.

So that concludes my remarks. Now Murray will provide some insight about our plans going forward.

Murray D. Martin

We continue to believe in the underlying soundness of our business and our value proposition to our global customer base. We maintain a high percentage of contractual business which provides recurring revenue, earnings, and cash flow.

In addition, our recent restructuring initiatives have reduced our fixed cost base and we are continuing to take actions to further reduce our operating expenses.

We have reduced our debt and maintained a consistent investment in the growth in the growth of the business, yet earlier this year when we provided 2009 guidance we noted that prolonged economic weakness, unanticipated currency fluctuation, and the significant increase in pension costs could continue to offset the benefits from our actions and impact the 2009 reported results.

We have seen the impact of these headwinds reflected in our results for the quarter. We have also seen the global economic deterioration continue and the related impact on customer behavior and decision making for capital spending in the office technology market. That is why we are adjusting our guidance.

On a constant currency basis we now expect 2009 revenue to decline in the range of 1% to 4%. This is down 2% from our prior guidance. On a reported basis we now expect revenue to decline in the range of 6% to 9%, which includes an estimated 5% negative impact from currency.

As a result, we expect adjusted earnings per diluted share from continuing operations for the year will be in the range of $2.40 to $2.60. This range includes the expected negative impact of $0.30 to $0.35 per dilutes share from currency and incremental pension expense.

Adjusted earnings per diluted share from continuing operations excludes an annual estimated $0.06 per share non-cash tax charge associated with out-of-the-money stock options that expire principally in the first quarter of 2009.

On a GAAP basis we expect earnings per diluted share from continuing operations for the year will be in the range of $2.34 to $2.54.

The strength of our cash flow in the first quarter gives us confidence that we affirm our free cash flow guidance in the range of $700.0 million to $800.0 million for the year.

We remain committed to enhancing our operational efficiency. We will continue to take the necessary actions to address the immediate needs of the business while providing the flexibility to invest in growth and enhanced customer value. We are focused on strengthening our position for the long-term value creation and we believe we are poised to generate strong, profitable growth when the economy begins to improve.

Thank you and now let's open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Shannon Cross – Cross Research.

Shannon Cross – Cross Research

Can you talk a little bit about linearity in the quarter? Obviously you are hearing push back in terms of decision making but curious on a geographic basis how customers were responding and how sales progressed versus a typical first quarter.

Murray D. Martin

We have, particularly in Production Mail and in our Software business, continued to see deferrals in decision making and we see this as long-term. The opportunity is still there and we still are looking forward to getting those transactions at a later date. But they continue to hold back.

In the Mailing Business, as I mentioned, we have had customers not looking to make long-term commitments the way they have in the past, or capital expenditures, so we have extended our lease program to included the ability to extend the lease itself.

And this is very positive for us on the long-term but in the short-term has a negative impact on the revenue side as the revenue comes in over term rather than a new equipment sale.

In answer to your question around the world, the U.K. has been similar to the U.S. The rest of Europe has been slightly better, as you can see in our results, that on a constant currency basis we are performing 2% in Europe. Asia Pacific has seen, on the large transactions, similar results to the U.S. So that is sort of a general overview. The Mailing side in Asia continues at about its historical pace.

Shannon Cross – Cross Research

As you went through the quarter did things get worse or sort of stabilize? Any indication now that we are a little bit into this month?

Murray D. Martin

We certainly saw early through the first part of the quarter a significant change from the fourth quarter and it's now running more in line towards where it was. But it's still not to the level that we would want it to be.

Shannon Cross – Cross Research

So it's not getting worse but it's not rebounding either, which is kind of what we've heard from a number of companies.

Murray D. Martin

Yes. There was a real heavy holdback early but it hasn't really bounced back.

Shannon Cross – Cross Research

And from the standpoint of working capital, Mike maybe you can discuss—and sources of cash since you're holding to your cash estimates. Just how you're thinking about where the cash is going to come from and if there's been any change since when you talked to us after fourth quarter.

Michael Monahan

Sure. I think we feel very good about the cash flow. We did see less working capital usage in the quarter, which is typical in the first quarter scenario. We saw good movement in our accounts receivable balances in terms of freeing up cash. And we did have tighter controls around our capital expenditures so we saw that come in as well.

So I think as we look out over the course of the year, we do expect the cash flow to be pretty consistent in terms of its sources. We did see some generated out of the finance receivables as well. The only variable quarter-to-quarter would certainly be tax payment timing can be different over the course of the year.

Shannon Cross – Cross Research

When you are thinking about the numbers, because this is obviously the second time you've taken numbers down and we're in a kind of unprecedented economic climate, how would you say you're doing this guidance? I mean, are you being conservative? Is it sort of, as things remain where they're at—we're just trying to get an idea of when you approached—

Murray D. Martin

Let me take that because I think it's helpful to put it in context. I think, as you said, we have an economic overlay here that's quite unique and when you look at the guidance that we've given, ex-currency, which I think it's only appropriate to look at it on a constant currency basis, we are talking about revenue down of 1% to 4% in an office technology business and if you just take the midpoints, and I'm not suggesting that's our guidance but I'm just using that as a reference point, the midpoint of our guidance range, and add back the impacts of currency and pension you would come to a number that is around flat to plus 2% in terms of EPS growth.

So when you look at that relatively small revenue decline and you look at the positive leverage that comes from the actions that we've taken, and that's reflected in EPS, we think it was prudent to take the guidance down given the fact that I think everyone would say the first quarter was a more challenging economic environment than the fourth quarter. We obviously wanted to reflect that in our guidance to be confident that we had adjusted our numbers to reflect the outlook.

I think the other is if you look at the comparisons first half to second half, the first half of last year we didn't have the same economic environment that we had in the second half of the year. So that's reflected in our guidance as well.

Operator

Your next question comes from Chris Whitmore – Deutsche Bank.

Chris Whitmore – Deutsche Bank

I was hoping to get some color on the mail volume trends you're seeing, particularly in first class metered mail. I saw some data recently that suggested those mail volumes were declining in the double digits. Is that consistent with what you're seeing?

Murray D. Martin

Yes. There's been, if you average a couple of quarters, it's been in the high single to low-double digits. So it's been right around double-digit decline in Mail, which is sort of in line with historical events where there's been recessionary economies and what we have seen historically is that volume comes back pretty close to where it left. And so we are seeing that.

At the same time, our business model is not directly dependent on volume. Certainly some of our revenues are volume-related when you look at our Services business, which has a volume base or our Mail business when you get into supplies. But the devices are really access devices rather than pure volume driven.

Chris Whitmore – Deutsche Bank

To what extent is there access capacity of mail creation equipment out there in the install base and what is your exposure to that segment of the industry?

Murray D. Martin

I wouldn't say there is an access. It depends on which market segment you're looking at. In the low- to mid-market I wouldn't see an excess of equipment but I do see a slowdown there as people put off those larger capital expenditures, similar to the higher end.

On the higher end there has been consolidation in the space and that's where we have really benefited with our highly integrated equipment with ensuring the integrity of the Mail where we lead in that space.

So there's been contraction of units but expansion in the capabilities and therefore the cost of those units.

Chris Whitmore – Deutsche Bank

In previous calls you talked about the bulk of significant leases coming due this year and that perhaps driving a little bit of a tailwind to the business. What are your expectations now? What's factored into our existing guidance in terms of the amount of lease extensions or renewals versus upgrades?

Murray D. Martin

We are seeing the increased leases coming through. They are up significantly in the quarter and we expect to continue to see that. That has been offset by the lease extension program where we have tripled in the quarter the number of lease extensions. So when you look at the revenues generated from the lease extension versus the new, you get a significant change. If you go through the entire period of the extension, the profitability is fairly strong compared to a new placement.

So there is a definite impact there on the revenue and the timing on the profit. But we are seeing them, we see it as a continued positive but with the shift we aren't getting the direct benefit in the current period.

Chris Whitmore – Deutsche Bank

With that as the backdrop, I'm trying to understand the rental line a little bit better. You know, being incrementally weaker on a year-on-year basis despite this phenomenon within your install base. Can you help flush that out a little bit for me?

Michael Monahan

Just to let you know, if you look at the rental line, it's down 9% but if you adjust for currency it's down 5%, which I think is more consistent with what we've seen in prior periods. So I think the bulk of that adjustment is related to currency.

Operator

Your next question comes from Vincent Lin for Julio Quinteros - Goldman Sachs.

Vincent Lin for Julio Quinteros - Goldman Sachs

Just a quick question on the constant currency revenue growth guidance. It sounds like the full year guidance implied less decline for the rest of the year than the 6% decline posted this quarter. I just wanted to make sure that it was just purely a function of easier comparison moving through the year. Or is there something else that we should be expecting.

Murray D. Martin

Clearly the second half of the year of 2008 reflected some of the impacts of the economic environment and so that's reflected in our guidance.

Vincent Lin for Julio Quinteros - Goldman Sachs

And secondly, I wanted to understand, maybe you just comment on, your revenue exposure to the larger enterprises versus small-medium businesses. Obviously you have been seeing a lot more bankruptcies on the SMB side and I'm just wondering whether you're seeing any impact because of that.

Michael Monahan

Actually bankruptcy impacts to us in terms of our credit losses actually declined in the quarter relative to the fourth quarter of 2008. So on a sequential basis we have seen an improvement there. In fact, our credit loss provision, or credit losses in the quarter were lower than the fourth quarter as well. So we have seen good performance out of our collections organization to manage that, but also in absolute terms, fewer bankruptcy-related credit losses.

Vincent Lin for Julio Quinteros - Goldman Sachs

Looking at the guidance on the margin side, just based on the midpoint of the guidance it looks like the EPS reduction is more pronounced than on the revenue side. I am assuming that probably implies a lower margin trajectory than you previously were assuming, so maybe you can provide a little more color on that. Just specifically when we were looking at this March quarter Production Mail and the Software had a larger, on a year-to-year basis, larger decline than operating margins.

Murray D. Martin

If you look at software, actually their gross margins improved. So there is a fixed cost base there and in particular investment in the R&D, in product, and in the change over the R&D infrastructure that we talked about that would impact their operating margin. So that is reflected there.

Production Mail's margins have been impacted somewhat by the fact that a good portion of the revenue we generate in production mail is outside the U.S. and the product is generally manufactured in the U.S. so there is some impact of the difference in cost base for non-U.S. entities.

Operator

There are no further questions in the queue.

Murray D. Martin

We are encouraged by our results and our ability to minimize earning declines, even with continuing declines in revenue. These results are even more notable given the adverse impact of currency, of pension expense, and the continued severity of the economic environment.

To mitigate the economic headwinds during the quarter, we have focused on customer retention, expense management, and cash flow generation. We continue to focus and see robust cash flow generation, we continue to streamline our operations, and to reduce our debt.

Thank you for joining us.

Operator

This concludes today’s conference call. This conference will be available for replay after 7:00 p.m. Eastern time today through May 19 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code of 994734. International participants may dial 1-320-365-3844.

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Source: Pitney Bowes Inc. Q1 2009 Earnings Call Transcript
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