Pitney Bowes Inc. Q4 2009 Earnings Call Transcript

Feb. 5.10 | About: Pitney Bowes (PBI)

Pitney Bowes Inc. (NYSE:PBI)

Q4 2009 Earnings Call

February 4, 2010 5:00 pm ET

Executives

Murray Martin – Chairman, President, Chief Executive Officer

Michael Monahan – Executive Vice President, Chief Financial Officer

Charles McBride – Vice President, Investor Relations

Analysts

Julio Quinteros - Goldman Sachs

Shannon Cross - Cross Research

Ananda Baruah - Brean Murray, Carret & Co.

Chris Whitmore - Deutsche Bank Securities

Steve Surrell - Conning Asset Management

Lloyd Zeitman - Bernstein Investment Research and Management

Operator

Ladies and gentlemen, good evening and welcome to the Pitney Bowes fourth quarter and full year 2009 earnings results 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, Investor Relations.

Mr. McBride will now begin the call with a Safe Harbor overview.

Charles McBride

Included in this presentation are forward-looking statements about our expected future business and financial performance. Forward-looking statements involve risks and uncertainties that could cause actual results to be materially different from our projections. More information about these risks and uncertainties can be found in our 2008 Form 10-K annual report and other reports filed with the SEC and are located on our website at www.pb.com. by 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?

Murray Martin

Thanks, Charlie. Good afternoon and thanks for joining us today. Let me start by sharing some thoughts on our performance. Mike will follow with the details of our fourth quarter and full year results and then we will take your questions.

In 2009, we took definitive actions to position ourselves for long term growth while also addressing the immediate challenges presented by an uncertain business environment. As a result, we achieved adjusted earnings per diluted share for the year of $2.28, which was near the high of our guidance range of $2.19 to $2.31. We enhanced productivity, reduced expenses and increased the variability of our cost structure, all of which helped offset the impact of revenue declines driven by macroeconomic conditions. We produced year-over-year EBIT and EBIT margin improvements in four of our business segments, Software, Management Services, Mail Services and Marketing Services. These actions also resulted in a $170 million reduction in reported SG&A expenses on a year-over-year basis.

This will help us leverage revenue more efficiently as markets improve. During the year, we took a balanced approach to our reinvestment into the business, which has allowed us to remain very profitable and generate significant free cash flow. Our free cash flow was $889 million for the year, which exceeded our guidance range of $750 to $850 million for the year. Free cash flow for the year benefited from lower levels of receivables and inventories, as well as reduced capital expenditures.

For the 28th consecutive year, our Board of Directors approved an increase in the quarterly dividend to $0.365 per common share for the first quarter of 2010. As we exited 2009, we began to see some early signs of improved economic activity. There was an increased backlog of orders in our production mail business; our solutions sales activity increased during December in our mailing businesses; and a moderating decline in the total U.S. mail volumes, especially within standard mail.

Last quarter we announced our partnership with Hewlett-Packard to deliver the industry’s only integrated print and mail solution into the market. The Pitney Bowes Intelligent Printing System leverages the trend towards increased usage of color to deliver higher value transactional and trans-promotional mail that can help businesses grow revenues while reducing their mailing costs.

As we announced today, production mail recently sold its first units of this exciting solution. Additionally, in our Software business, we had an increase in the number of transactions over $500,000, many of which will be recorded as recurring revenue. In 2010, we will continue to expand our recurring revenue stream as we move more towards a Software as a service model. We believe that these activities signal some changing customer behaviors and an affirmation of the value of our solutions in supporting our customer’s growth and efficiency.

Throughout the year, we continued to invest in future growth through innovation, new products, partnerships and enhancing customer facing processes. We also initiated a comprehensive transformation process to lay the foundation for increasing, long term customer and shareholder value. This transformation is designed to give us the capacity to invest in future growth and the flexibility and organizational capability to succeed in a range of conditions.

Now let me turn it over to Mike for a discussion of the fourth quarter and our full year financial results. Mike?

Michael Monahan

Thank you, Murray. Our revenue for the year was $5.6 billion, which represented an 11% decline from the prior year, but was a 9% decline when you excluded currency effects. Recorded revenue for the year was within our guidance range.

Revenue was $1.5 billion for the quarter, a decline of 6% compared with the prior year. Revenue growth in this quarter had about a 3 percentage point benefit from currency. Breaking down our revenue for the quarter between U.S. and non-U.S. operations, U.S. revenue declined by 8% when compared with the prior year. Outside the U.S., revenue declined by 3%, but was down 13% when you exclude the positive impact from currency exchange rates. Non-U.S. operations represented 30% of total revenue in the fourth quarter.

Adjusted earnings before interest and taxes or EBIT for the quarter was $256 million. The adjusted EBIT margin for the quarter declined year-over-year to 17.6% on lower revenue and a shift in the mix of business, but benefited from our cost management and productivity actions. Our adjusted EBIT margin improved by 50 basis points when compared with the third quarter.

We reduced our costs as a percentage of revenue for equipment sales, software, business services and support services, as well as lowering our SG&A expenses for the year, primarily because of the productivity improvements that we have put in place. On a constant currency basis we had a year-over-year reduction in SG&A expense of $13 million in the quarter and $113 million for the year.

EBIT margins improved sequentially for three consecutive quarters for production mail, software and management services and for two consecutive quarters for international mailing. These improvements in EBIT margins were a result of our continued focus on reducing our cost structure and increasing our operational efficiency. While we’ve clearly done a lot to improve our productivity, we’re committed to doing even more through our transformation program. Strategic transformation will enable us to improve the way we go to market and interact with our customers. Plus we will put in place new processes and systems that will make our operations more efficient and more profitable.

When we add back depreciation and amortization to our adjusted EBIT, EBITDA for the quarter was $333 million or $1.60 per share. Net interest expense in the quarter including financing interest was about $49 million, essentially flat to the prior year. The average interest rate in the quarter was about 4.2%, again comparable with the prior year.

The effective tax rate for the quarter on adjusted earnings was 32.1%. This was lower than our tax rate on adjusted earnings last year, which was 33.6%. While the tax rate can vary during the course of the year depending on timing and mix of business, the tax rate for the year on adjusted earnings was 33.7%, only slightly lower than our expected tax rate range for the year.

Adjusted earnings per share for the quarter was $0.64 compared with our adjusted earnings per share of $0.77 for the same period last year. The decline in earnings per share versus last year is primarily due to lower revenue and a shift in the mix of business. However, our adjusted earnings per share this quarter is 16% higher than our adjusted earnings per share of $0.55 in each of the first three quarters of the year. For the year, adjusted earnings per share was $2.28, which was near the high end of our guidance range of $2.19 to $2.31.

Currency exchange rates compared with last year benefited our adjusted earnings per share by $0.01 this quarter, but reduced our earnings per share for the year by $0.04. GAAP earnings per share included pretax restructuring charges of $36 million in the quarter and $49 million for the year. This represented $0.11 per share in the quarter and $0.15 for the year. Additionally, GAAP earnings per share in the quarter included a $0.01 benefit related to adjustments to certain leverage lease transactions in Canada and a $0.06 per share loss for discontinued operations, which is related primarily to interest on uncertain tax positions related to our former capital services business.

For the year, GAAP EPS includes non-cash, net tax adjustments of $0.05, primarily associated with out of the money stock options that expired during the year and a $0.04 loss associated with discontinued operations. Free cash flow was $223 million for the quarter, which was comparable to the third quarter. For the full year, free cash flow was $889 million, which exceeded our guidance range of $750 to $850 million of free cash flow for the year. Free cash flow for the year benefited from lower levels of receivables and inventory as well as reduced capital expenditures.

During the quarter we returned $74 million to our common shareholders in the form of dividends and paid $298 million in dividends for the year. We used commercial paper to reduce our preferred stock outstanding by $75 million. We made a $100 million contribution to our U.S. pension fund and we contributed a total of $25 million to our UK and Canadian pension funds. As a result, our commercial paper balances increased $56 million versus the prior quarter. However, because of our strong free cash flow for the year, we reduced overall debt by $242 million. About 77% of our total debt is fixed rate and 23% is floating rate.

Now let me highlight a few points about our transformation program. In the fourth quarter, we began to implement some of the initiatives identified by our project teams and we’re in the process of finalizing the planning for other initiatives we will implement throughout 2010 and 2011. During the fourth quarter, our restructuring charges were largely for severance costs related to the elimination of more than 300 positions across the company. We continue to target net benefits of about $50 million in 2010 and annualized net benefits in the range of at least $150 to $200 million by the end of 2011. As previously discussed, we expect the phased implementation of this program will occur over the next 18 to 24 months. Therefore, we expect to achieve the full annualized run rate of benefits in 2012.

So that concludes my remarks. Now Murray will provide some insight about our plans going forward and then we’ll take your questions.

Murray Martin

As you saw in our earnings release, we are reaffirming our 2010 guidance. We believe that the economy will gradually improve throughout the year, which should translate into a moderation in the decline of U.S. mail volumes, especially in standard mail. We expect a greater percentage of our 2010 earnings will occur in the second half of the year, given the seasonality of our business in a more normal economic environment, the expected lessening of headwinds from lower financing revenue as equipment sales begin to improve and the increasing benefits from our transformation initiatives.

We expect 2010 revenue to be in the range of flat to plus 3% which includes approximately 2% benefit from currency. Adjusted earnings per diluted share are expected to be in the range of $2.30 to $2.50 for the year. Adjusted earnings per share excludes the expected impact of $100 to $150 million of pretax restructuring charges associated with our transformation initiatives. This range also excludes an expected non-cash tax charge of approximately $0.07 per diluted share associated with out of the money stock options that expire principally in the first quarter of 2010.

On a GAAP basis, we expect 2010 earnings per diluted share from continuing operations in the range of $1.75 to $2.11. We expect to generate free cash flow for 2010 in the range of $650 to $750 million. Cash flow is expected to benefit from improved earnings and ongoing asset management, but will be partially reduced by an anticipated increased investment in finance receivables from higher levels of equipment sales.

We believe that we are making the right moves to position ourselves to fully leverage the opportunities available in 2010 and beyond. We are fully committed to acting swiftly and decisively to transform our ability to deliver sustained, long term value for shareholders and for customers.

Thank you. Now let’s open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Julio Quinteros - Goldman Sachs.

Julio Quinteros - Goldman Sachs

Just real quickly in trying to think through the order of spending, so assuming discretionary spending comes back in 2010 and you guys go talk to your clients, can you just help us sort of put in some kind of order where are they going to spend first? And then ultimately where does the types of services that Pitney Bowes sell fall out so do you spend on technology, software, infrastructure and then mail meters? What I’m really trying to get to is how far in that cycle if you will of spending will they get around to the types of products and services that you guys can provide? Any perspective on that would be helpful.

Murray Martin

Well, it’s always certainly difficult to predict how our customers will spend their money, but if we were to speculate a couple of things. One, there have been deferrals on high end production equipment and that equipment is and has been aging and we would expect them to look to enhance their productivity and enhance their communications to their customers. And hence our engagement into high end color print, because we really see that as a market that will come out as the economy begins to accelerate. Because people are looking at how to generate more revenue from their customers and this is a way of focusing on that.

On the second part of your question around the metering business, I would think that customers would be more likely to react to new equipment than to lease extensions and that would be a positive for us. So during uncertainty, the extension of the lease which gives us lower up front revenue but good profitability over the term would probably switch to more investment in new assets. And I think that would just change with confidence in the market dynamics and wouldn’t be affected as a choice, because it’s money that’s already being spent. It’s just a matter of changing the term and going to new assets.

Julio Quinteros - Goldman Sachs

And what about the Software business? How early in the cycle would you consider the type of software products that you guys provide could see demand?

Murray Martin

Well, as we’ve seen there’s been other predictions in the market that IT spend will start increasing. And certainly our software tools are right in there around the growth of customers businesses, their ability to do analytics and their ability to communicate more effectively with their customers. So we think that should follow the standard IT spend pattern.

Operator

Your next question comes from Shannon Cross - Cross Research.

Shannon Cross - Cross Research

My first question is just if you could give us a little more color in terms of the linearity during the quarter. You know Murray you talked about things getting better. I’m just curious as sort of a follow up to the prior question. I know we’re all sort of grasping at straws in terms of improvement here, but did you see any sort of slowdown in terms of people asking for lease extensions? Your backlog increased a bit. At that point in time do you think it was truly new demand or perhaps more sort of budget flesh or people thinking about budgets? Again, we’re just trying to get an idea of how we should sort of think about the year ramping from first quarter on.

Michael Monahan

With respect to the mailing business, we saw a similar level of lease extensions in the fourth quarter as we did in the third quarter. So similar there. I think where Murray referred to some improvement in the mailing business, particularly in December was around some of the what we would call solutions products. So more of the mail creation, folding and inserting in an office environment, those types of solutions. In terms of lease extensions, there was probably twice the level versus the prior year. So we’ve seen a leveling of that between the third and the fourth quarter, but still a higher level than the prior year.

Murray Martin

I think also, Shannon, what I was referring to is the higher written business in the DMT area and in the software spaces. So one month does not a trend make, but as we looked at the month of December we saw a considerable positive and we didn’t hear anything that would suggest it had anything to do with budgeting, but rather the desire of customers to enhance their communication with their customers and particularly in how they can generate revenue from their customer base. So it looks like a positive, but of course its one month and we’ll be looking as we go through the first quarter if that trend continues, particularly in the higher ticket. It will then have a ripple down effect throughout the economy.

Shannon Cross - Cross Research

Is there anything we should think about with regard to this being an election year in terms of increased mail volumes or perhaps more demand for your direct mailing software solutions? Is that anything that’s sort of played in in the past?

Murray Martin

Well, certainly, when there’s election there’s more communication that goes out. So I would see it as one of the things that should dampen the decline that we’ve been experiencing to date. But I wouldn’t see it as something that would create a major swing. Certainly as they spend money they have to communicate and direct mail is certainly one of the ways they do that.

Shannon Cross - Cross Research

Can you talk a little bit about your thoughts on capital structure? You know clearly your cash flow is extremely strong. Your thoughts on the paper market, short versus long term maturities. I know the Board has to talk about share repurchase but just any thoughts you have on sort of cash usage and how you want your capital structure maybe as you go through the year.

Michael Monahan

Sure. Obviously we’re watching interest rates, as everyone is. We’ve tended to keep our portfolio more long term and fixed rate and we think that that’s been the right place for us to be in this environment. In terms of share repurchase, we do have an outstanding authorization of about $73 million but we’ll continue to be prudent in how we look to do that. So I would say given the current environment, we’ll probably continue along the lines of the strategy we’ve used to date.

Shannon Cross - Cross Research

Even with almost $900 million in cash?

Murray Martin

Well, we’re using that for various things. We’re giving back to our shareholders as well as reinvesting in the business.

Operator

Your next question comes from Ananda Baruah - Brean Murray, Carret & Co.

Ananda Baruah - Brean Murray, Carret & Co.

The equipment sales numbers were really good this quarter, at least it was sort of up sequentially as much as one would expect in line with typical kind of seasonality. And the U.S. mailing business for the first time in a couple quarters is actually up. So could you maybe just talk about what the drivers of those two businesses were? The up sequentially relative I guess in the context of you’re still seeing, you know, 2x the number of lease extensions as you did a year ago?

Murray Martin

I think there’s a couple things there. One, the lease extensions although they hurt at the front they do have benefit over time. So we’re getting some positive longer term effect out of the earlier lease extensions. We have seen more activity and as I mentioned there has been a lessening in the decline rate in mail, and that would show the potential for more confidence there. And then also we took new solutions to the market. If you think back to the beginning of the fourth quarter or the end of the third quarter, we launched a new model of mailing equipment. And it’s been very successful in the quarter.

Ananda Baruah - Brean Murray, Carret & Co.

Is it safe to assume given your revenue guidance for 2010 that you’ve reiterated, 0 to 3% I guess, say it’s 1% kind of organic and you saw both the mailing business and the equipment supplies kind of up this quarter versus September, I guess is it safe to assume your revenue guidance and the December results that we can feel free to model on those kind of key businesses? I guess typical, seasonal patterns for revenue, even though they might be on the softer side given that you’re expecting slightly kind of less dampening going forward in mail volumes?

Michael Monahan

Yes, I think the guidance obviously on an annual basis that we’ve provided considers seasonality as we would typically see in the business. So that’s why we indicated expectations of a back half of the year being a bigger proportion of our revenue and profits than the front half of the year. And as you said I think this quarter’s reflective of that seasonality as well.

Ananda Baruah - Brean Murray, Carret & Co.

Can you comment a little bit more on the timing of the $50 million savings benefit you expect to realize in 2010? I guess sort of related to that the SG&A dollars are a little bit higher than at least I had modeled this quarter and maybe could you sort of discuss if they were higher than what you had expected as well, maybe what the driver to that was.

Michael Monahan

On SG&A one of the drivers is the impact of currency. Currency was favorable this year in the quarter but obviously that has the impact of then increasing the SG&A expenses as well. So when you factor that out, we actually would have reduced expenses by $13 million in the quarter, so in line with our expectations.

In terms of your other question about the transformation benefits, in a program like this as we started this late in 2009 really in a diagnostic phase as we described and then obviously beginning to implement the plan, we would expect that those benefits are going to be less in the beginning of the year and obviously build as we implement the actions over the course of the year.

Operator

Your next question comes from Chris Whitmore - Deutsche Bank Securities.

Chris Whitmore - Deutsche Bank Securities

I wanted to follow up on the mail volume question. You mentioned the rate of decline for mail volume slowed in the quarter. Can you quantify that and maybe give us some color on the first class mail versus standard mail?

Murray Martin

Yes. In the quarter we saw, if you go back in the year it was in the negative 14. And then it’s declined and the non-quarter ending we saw was in the negative 11 range. And the Post Office has been predicting 2010 to be as low as 6 and they’re banding it at sort of a 6 to 9 range. So we did see, although it wasn’t a quarter end number that we had, it was through the end of November, we did see a reduction in that rate. And from their predictions, they’re expecting it and we would concur with what they’re predicting that there would be a decrease in that rate.

Chris Whitmore - Deutsche Bank Securities

Is that total mail or is that first class mail?

Murray Martin

That’s in total mail.

Chris Whitmore - Deutsche Bank Securities

I think in your prepared comments you mentioned that you’re seeing a bit of greater improvement in the standard mail. Is that correct? And maybe you can discuss what’s driving the divergence between the two mail streams.

Murray Martin

Well, the standard mail had actually had a significant impact as the financial sectors slowed down in going after their solicitation for growth. So we are starting to see some of that move back where companies are now focusing back into revenue growth and how they will get there. I think everyone is sort of taking a reset in their economic outlook and they’re saying we still need to grow revenue. And that’s really what’s starting to pick up the advertising mail as people move away from just cost management into saying fine, I’m managing costs but I now have to run with growing revenue. So that’s sort of, I think, what is driving the change on the standard side.

Certainly during the time period there has been some substitution in first class that has occurred, but with the trans promo we see opportunity to move back into the transactional space and provide opportunities for customers to grow their revenue rather than just have it as an expense. And that’s really the intent of adding color print at cost that’s affordable and then incorporate into that the ability to deliver promotional messages that are focused on the recipient and what the recipient’s interest is in. And we think that will have a longer term positive in the retention of the first class mail stream.

Chris Whitmore - Deutsche Bank Securities

So based on your early analysis, what are the response rates for this type of targeted first class mail versus this type of targeted email?

Murray Martin

There’s a very significant difference between the response rates of the two, but rather than us quoting numbers we’re looking to get external numbers on that that we’ll be happy to share with you as we get confirmation of them. But the comparatives of the companies we worked with is significantly higher and is valued on a cost performance basis. But we do want to get third party validation rather than taking numbers that we might put out.

Chris Whitmore - Deutsche Bank Securities

One last one for me is around the recurring revenue streams like rental and financing income. What’s your outlook in terms of the distribution throughout the year? To what extent does rental and financing income lag the expected recovery in equipment?

Michael Monahan

Yes, Chris, that’s a good question. You know generally we see, and I think you could see in the trend of particularly the financing revenue as it trended down over the last several quarters, really on the heels of the slowdown in equipment sales that we saw sort of the fourth quarter of last year. So generally there’s a two to four quarter lag in those recurring revenue streams in terms of financing or rental, where additional equipment sale will start to contribute to those and obviously fewer equipment sales will slow that down. So that’s why we referred to the fact that we see as equipment sales come back, we would see a lag, but some improvement in financing as we grow equipment sales.

Operator

Your next question comes from Steve Surrell - Conning Asset Management.

Steve Surrell - Conning Asset Management

You indicated you do expect some growth in finance receivables in 2010. Could you quantify that for us?

Michael Monahan

Well, it’s really going to be dependent upon the equipment sales growth. So at the end of the day I think we’ll see typically, if we have an equal amount of sales year-over-year, then that will keep us relatively steady. To the extent we can get some growth in the equipment sales line that should, particularly in our core mailing business that has the highest lease sale ratio, that would drive the finance receivables.

Steve Surrell - Conning Asset Management

You indicated probably similar capital allocation approach as you have in recent quarters, so should we assume from that general or gradual continued reduction in total debt levels?

Michael Monahan

Given the free cash flow that we have, that would certainly be one of the things that we would be able to do with our excess free cash flow beyond obviously making our dividend payments and the other investments we might make in the business.

Steve Surrell - Conning Asset Management

Given the pension fund contribution, can you comment on what your funding status was at the year end?

Michael Monahan

Sure. We’re funded at about 90% both on a PDO and an ABO basis. You know its plus or minus 1% either side of that. So in reasonably good shape there.

Steve Surrell - Conning Asset Management

You recently announced the hire of a Joseph Timko, as Chief Strategy and Innovation Officer. Can you elaborate a little bit on what his role is going to be at the company?

Murray Martin

Sure. Mr. Timko has come on board. We had David Dobson, who was our Chief Strategy and Innovation Officer and he has moved on to run our services business. And so Joe is going to be filling that space. He will be leading all of our ongoing strategy development and initiatives from a strategic point of view, looking at how we can leverage our position across all of our businesses and how we can take advantage of the capabilities that we have within our businesses in creating new combined solutions. At the same time, he will be managing our advance concepts and technology group, as well as our corporate marketing function. So he will be managing all of those functions on a go forward basis.

Steve Surrell - Conning Asset Management

Does this suggest any increase in the focus on M&A for growth over time?

Murray Martin

I would not say it suggests anything specific from that point of view. We’re very focused on our organic opportunities and certainly we’re always looking at how we could accelerate our organic growth by the addition of other complementary goods and services. So I would not see it as a specific signal.

Operator

Your next question comes from Shannon Cross - Cross Research.

Shannon Cross - Cross Research

Just a few follow up questions. I guess the first one is can you give us an idea, you’ve talked about verticals before in terms of exposure from a revenue standpoint, I’m kind of curious at this point what your exposure is to the financials and if you don’t have it, we can always follow up.

Michael Monahan

I don’t have a specific percentage. It has traditionally been a little more than 20%, I think about in 2008 it was about 23% of our total revenue base. And that obviously varies by business, that’s being less in our core mailing business and higher in some of our bigger ticket items like the production mail business. Obviously it would be probably a bit less than that at this point, but I don’t have a highly accurate number at this point yet for 2009.

Shannon Cross - Cross Research

Can you talk a little bit about how, and I’m sure it’s on the margin, but when you moved to software as service how we should think about maybe the shift in terms of how that impacts the P&L?

Murray Martin

Yes, in terms of our software business there’s two components to that business. There is a larger ticket component that’s particularly focused around our address hygiene, address cleansing type software products. And those have traditionally been sold more as a perpetual license, with a sales value up front. We’re looking at, as we both develop product that operates in a software as a service model but also looking at pricing strategies that provide our customers the ability to license that software over a period of time. What that will do is smooth the revenue in the software business over multiple years for a given customer and provide a little bit higher level of recurring revenue stream in that business. So obviously in the short term we won’t get as much immediate sales value, but we certainly get the benefit of that recurring revenue stream over time, matching it to the development investments we make and all.

Shannon Cross - Cross Research

My last question is just with regard to the restructuring you’re doing and changes in your business, have you made any changes to your sales comp plans, sort of how you’re addressing the customers and how you’re comping the sales people? Just to what they’re actually driven to sell?

Michael Monahan

Our sales comp plans remain somewhat similar, although we do have a more intense focus on the retention of our existing customers and insuring that we continue to grow within our customer base. As to type of product and solution, we certainly are doing more within offering full solutions to customers rather than point products. And so that is tailored into compensation and will continue to be an area that we’ll look for long-term growth in.

Operator

Your next question comes from Ananda Baruah - Brean Murray, Carret & Co.

Ananda Baruah - Brean Murray, Carret & Co.

Murray, in terms of operating margins, I guess now that it feels like the business is more stable and I guess I’m particularly thinking about the U.S. mailing business, should we think of those margins at this point until restructuring kicks in as really moving with the revenue?

Murray Martin

I think that there are two components for you to think about there. One is the operating margins from the equipment and services side. Those really have stayed pretty stable. The majority of the effect has got to do with the change in finance receivables and so that’s where the incremental leverage is. So I think you need to balance those two as you look at the overall margins. As we see equipment sales come and start to return, that will have as Mike spoke an effect on the finance receivables and that’s what gives the leverage.

Now at the same time, the things that we’ve done in changing the model and reducing costs will give us incremental leverage when we see things change as we go forward.

Ananda Baruah - Brean Murray, Carret & Co.

I don’t remember if this was addressed yet or not, but could you guys just sort of touch on what was the driver of, I guess, the rental and financing from being a little softer than typical this quarter?

Michael Monahan

Ananda, it’s really related to the history of equipment sales over the last four to six quarters, where we had the lower equipment sales. What happens is as you have that run off, obviously if you have lower equipment sales you have lower meter placements that’s going to reduce your rental revenue. On the financing side as the financing asset balance comes down, there’s less financing income. So that tends to lag a little behind the sales side of the equation. And obviously on the other side, if you get sales improvement, that will begin to turn the corner on those recurring revenue streams.

Ananda Baruah - Brean Murray, Carret & Co.

But nothing fundamentally has changed sort of what’s been going on with the business or how you guys are going to market?

Michael Monahan

No, it’s really reflective of the trend of the business over time.

Operator

Your next question comes from Lloyd Zeitman - Bernstein Investment Research and Management.

Lloyd Zeitman - Bernstein Investment Research and Management

The software as a service, is that going to require any additional PP&E investment on your part?

Michael Monahan

No, there shouldn’t be substantial PP&E related to that. Obviously there’s development costs but that’s built into our overall development plans. In terms of software as a service, it often is provided through a third party platform so we would not have PP&E in the sense of building or large server farms or that type of thing.

Lloyd Zeitman - Bernstein Investment Research and Management

On that note, as far as PP&E could you tell us what your capital spending was in 2009 and how that breaks down between rentals and PP&E?

Michael Monahan

Yes. It was about $170 million in the year in total and was roughly 50-50 between rental and other capital expenditures.

Lloyd Zeitman - Bernstein Investment Research and Management

As far as your finance operations, could you go through some of the metrics there and just give us an idea as to how that’s performing?

Michael Monahan

Are you talking in terms of credit loss?

Lloyd Zeitman - Bernstein Investment Research and Management

Credit losses, just overall credit quality.

Michael Monahan

Yes, overall credit quality is good. I’d say in line with what we’ve seen throughout most of the year. Our provision expense in the fourth quarter was a bit higher, about $2 to $3 million higher than the prior year. That’s not necessarily related to higher write offs but higher provisioning rate because we look over a period of time of performance of the portfolio and provision against that. And we found that that as well as obviously identifying specific accounts is the most effective way for us to provision. And obviously when you add years like 2008 and 2009, with the credit environment the way it is, into that mix it drives you towards a higher provisioning rate. But we’re very comfortable with the quality of the portfolio, the performance, delinquency rates are good. So we don’t see anything that concerns us around the portfolio.

Lloyd Zeitman - Bernstein Investment Research and Management

Earlier you mentioned lease extensions are running at about twice last year’s level. Is that correct?

Michael Monahan

That’s correct for the quarter, but pretty much in line with what we saw in the third quarter.

Lloyd Zeitman - Bernstein Investment Research and Management

And if I remember correctly, I believe sometime maybe in the first half of the year I think you folks said that they were running about three times above prior year levels and I was just wondering if the trend were to hold, when would we reach a point where let’s say it would be roughly flat on a year to year basis?

Michael Monahan

Yes, it would probably be about the second quarter of next year because that three times was really based on the prior year having a relatively low level. And so in absolute numbers, you know probably by the second quarter into the third quarter we are sort of at a run rate.

Lloyd Zeitman - Bernstein Investment Research and Management

And the cost of equipment sales in the quarter was about 49%, which is really a marked improvement over what we’ve been seeing lately. And was that just productivity or were there some mix issues involved as well?

Michael Monahan

Yes, it’s both. There’s clearly some productivity in terms of the programs we’ve implemented over the last two years. But in addition to that, there was a somewhat lower percentage of production mail to mailing, which would obviously have an impact of improving the gross margin average.

Lloyd Zeitman - Bernstein Investment Research and Management

So then if this trend that you saw toward the end of the year with some improvement in production were to continue, that would have a negative impact on the margin but of course a beneficial impact to the sales line.

Michael Monahan

Yes. We really focus on the margins on a business by business basis because they have different profiles.

Lloyd Zeitman - Bernstein Investment Research and Management

So essentially that would be correct, that we could see some shift in that to a somewhat worse margin with a better sales line.

Michael Monahan

I guess I would say it a little different, Lloyd, that if we had higher percentage of production mail, we would see a lower relative average margin of those businesses.

Operator

And at this time we have no additional questions in queue.

Murray Martin

Well, thank you very much for the questions and as we look forward at 2009, as I mentioned we took definitive actions to position ourselves for long-term growth while addressing immediate, challenging business conditions. As a result, we remained solidly profitable, generated strong free cash flow, reduced our fixed cost structure, invested for the future as well as increased our dividend for the 28th consecutive year.

We are fully committed to acting swiftly and decisively to transform our ability to deliver sustained, long-term value for our shareholders and our customers. Thank you.

Operator

Ladies and gentlemen, this conference will be made available for replay after 7:30 PM today through February 18 at midnight. You may access the AT&T Teleconference replay system at any time by dialing 320-365-3844 and entering the access code 141693. Those numbers again are 320-365-3844 with the access code, 141693.

That does conclude our conference for today. We do appreciate your participation and you may now disconnect.

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