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Pitney Bowes (NYSE:PBI)

Q2 2011 Earnings Call

August 04, 2011 5:00 pm ET

Executives

Unknown Speaker -

Charles McBride - Vice President of Investor Relations

Michael Monahan - Chief Financial Officer and Executive Vice President

Murray Martin - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Chris Whitmore - Deutsche Bank AG

Ananda Baruah - Brean Murray, Carret & Co., LLC

Hale Holden - Barclays Capital

Shannon Cross - Weeden & Co., LP

Operator

Good afternoon and welcome to the Pitney Bowes Second Quarter 2011 Earnings Results Conference Call. [Operator Instructions] Today's call is also being recorded. [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 the safe harbor overview.

Charles McBride

Thank you. Good afternoon. 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 2010 Form 10-K annual report and other reports filed with the SEC that 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 developments.

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

Murray Martin

Thanks, Charlie. Good afternoon and thanks for joining us. Let me start by sharing some thoughts on our performance, and then Mike will follow with the details on our second quarter results, I'll then discuss our guidance for the full year. After that, we will take your questions.

During the quarter, we continued to see the benefits of our ongoing actions to lay the foundation for long-term growth and profitability across our business portfolio. There were 3 positive trends that underscored our progress in executing our plans: First, there was continued growth in equipment and software sales. Equipment sales increases were lead by strong sales of our high-speed inserting systems in North America and Asia, as well as good placements of our Connect+ in North America and the U.K.

When we launched the innovative Connect+ system last year, we stated our expectation that it would be a key component in driving the future mailing equipment sales. Software growth continued to be fueled by strong demand worldwide for our customer communication and data management software solutions.

Software’s recurring revenue streams also continue to grow this quarter as the number of multiyear licensing agreements increased.

The second positive trend during the quarter was that the combined recurring SMB revenue streams of supplies, rental and financing declined at a lesser rate than both the prior quarter and the prior year. These declines should continue to moderate as SMB equipment sales improve.

The third positive trend was our improvement in EBIT margin, particularly in our SMB and Software businesses. This was despite an unsettled global economic environment. We continue to focus on streamlining our operations and increasing the variability of our cost structure.

Our disciplined approach is enabling us to enhance margins, even as we experience revenue softness, particularly in our SMB markets. It is also helping us to better leverage revenue growth as we saw in our Software business.

It's also important to note that as expected, the quarter's revenue and earnings were reduced by the impact of the fire that destroyed our largest presort facility in the first quarter of this year.

The lower mail services revenues associated with the fire at our Dallas presort facility reduced our second quarter revenue growth by approximately 1% and lowered our earnings per share by $0.03 per diluted share. The substantial savings made possible by strategic transformation have allowed us to make critical investments in new solutions and enhancements to our customers' experience.

During the quarter, we continued to invest in the development of the customer communications, management market and introduced a number of new solutions. We've added pbSmartMarketer and pbSmartCodes to our family of pbSmart solutions, our cloud-based customer communications management solutions for small and medium Businesses.

PbSmartMarketer is a cloud-based software solution that allows businesses to identify potential new customers modeled after their existing customer base, create customized direct mail marketing campaigns and track and measure the success of those campaigns.

PbSmartCodes is a cloud-based software solution that enables businesses to create interactive marketing campaigns using a unique quick response or QR code.

Before I discuss our guidance for the year and provide some closing remarks, Mike will provide an overview of our second quarter financial results.

Michael Monahan

Thanks, Murray. Our revenue for the quarter was $1.3 billion, an increase of about 1% on a reported basis when compared with the prior year. Revenue would have grown 2% if not -- if it were not for the adverse impact from the February fire at our presort facility in Dallas.

Currency was a 3% benefit to revenue growth during the quarter. Breaking down our revenue for the quarter between U.S. and non-U.S. operations, U.S. revenue declined by about 4%. Outside the U.S., revenue on a reported basis, increased 16% versus the prior-year.

Excluding the impact of currency, revenue outside the U.S. increased 4%. Non-U.S. operations now represent 33% of our total revenue. While the Dallas fire impacted our first half revenue growth, less than 5 months after the fire, at the end of June, we opened a new facility.

This new facility reestablishes our unique ability to achieve a high level of presort discounts naturally. We expect the new site to be operating at full efficiency during the third quarter.

In the second quarter, revenue and EBIT were adversely impacted by about $9 million each, as a result of the facility disruption.

As of today, we have received partial payments totaling approximately $25 million from our insurance carriers, of which $15 million was received prior to June 30th.

We will not recognize the portion of current and future proceeds related to business interruption and other recoveries in earnings, until the allocations of these proceeds are resolve with the insurance company. If the insurance claim is not finalized in the current year, we estimate 2011 adjusted earnings could be reduced by about $0.06 to $0.08 per diluted share, of which $0.05 was already incurred in the first half of the year.

Adjusted earnings before interest and taxes or EBIT for the quarter was $213 million which was 5% higher than last year. EBIT margin was 16.2%, an improvement of 60 basis points versus the prior year. EBIT margin would have been even higher except for the Dallas fire impacts.

Adjusting for the impact of the fire, EBIT margin would have been 16.7%. We continue to see the benefits of our productivity initiatives across our cost structure.

SG&A expense in the quarter increased about $10 million when compared with the prior year. Excluding the effects of currency, SG&A actually declined by about $7 million when compared with the prior year.

SG&A benefited not only from our ongoing productivity initiatives but also from lower credit losses, which we had seen continue this quarter. EBIT margins in this quarter improved year-over-year in both in our SMB and Enterprise solutions groups. These improvements are primarily a result of our continued focus on increasing our operating efficiency across all of our businesses.

We continue to reap the benefits of the strategic transformation, actions that we have taken since the fourth quarter of 2009. Through multiple initiatives including reinvestments in the business, we had significantly increased the variable portion of our cost space to allow us to leverage future revenue growth and quickly and cost-effectively respond to a changing business mix.

When we add back depreciation and amortization to our adjusted EBIT, adjusted EBITDA for the quarter was $281 million or $1.38 per share. Net interest expense in the quarter, including financing interest was $49 million, a modest decrease of less than $2 million on lower debt levels when compared with the prior year.

The average interest rate in the quarter was 4.68%, 29 basis points higher than the prior year, due to changes in our debt portfolio mix. The effective tax rate for the quarter on adjusted earnings was 33% versus 31.5% last year.

The tax rate for this quarter is in-line with our expectations. We expect the average tax rate for the year on adjusted earnings to be in the range of 32% to 34%, excluding the impact of a recent tax settlement with the IRS, which Murray will discuss as part of guidance. The GAAP tax rate for the quarter was 33.3%.

Adjusted earnings per share from continuing operations for the quarter was $0.52, which compares with our adjusted earnings per share of $0.48 for the same period last year.

Our adjusted EPS would have been $0.55 this quarter, except we had incremental losses of about $0.03 per share this quarter related to the Dallas fire.

Also, as we planned, we invested in Volly this quarter, which further reduced our adjusted earnings per share by about $0.01.

GAAP earnings per share for the quarter included restructuring charges and asset impairments that totaled $0.02 per share. GAAP EPS for the quarter also included a less than $0.01 per share reduction for each -- reduction each for a tax charge associated with out-of-the-money stock options that expired during the quarter, and a loss from discontinued operations.

GAAP earnings per share for the quarter increased 68% over the prior year. Free cash flow was $269 million for the quarter. In comparison to the prior year, free cash flow for the quarter benefited from the timing of tax payments and refunds and an improvement in working capital.

During the quarter, we returned $85 million of cash to our shareholders in the form of dividends. We also repurchased approximately 2.1 million shares of Pitney Bowes' common stock outstanding for $50 million.

We have $100 million of share repurchase authorization remaining, which we expect to use over the next 6 to 12 months. Additionally, we made contributions to the U.S. pension fund of about $123 million.

As of the end of the quarter, we had completely paid down our commercial paper balances and we have no debt coming due until September of 2012.

About 76% of our debt is now fixed rate and 24% is floating rate. Let me now update you on our strategic transformation program.

In the second quarter, we continued to implement initiatives identified by our project team. During the second quarter, our pretax restructuring charges of $5 million were primarily for severance-related costs.

Approximately 3,400 positions have been eliminated since the beginning of the program. Due to the timing of the implementation of different initiatives, the charges related to strategic transformation will vary from quarter-to-quarter, as we experienced this quarter. We still expect total charges for the year related to the strategic transformation program to be in the range of $0.25 to $0.35 per share.

We continue to target annualized net benefits for the full program in the range of $250 million to $300 million in 2012.

So that concludes my remarks. Now Murray will discuss our guidance.

Murray Martin

Thanks, Mike. Turning to our guidance for the year, we are reaffirming our adjusted earnings per diluted share, our GAAP earnings per diluted share and our free cash flow guidance.

However, we are modifying our revenue guidance for the year based on 2 factors: First, is the impact of the presort facility fire in Dallas; and second, is the overall economic outlook particularly, given what we have experienced in our SMB markets in the first half of the year.

Economic growth is now weaker than we originally anticipated when we first provided guidance. As a result, we now expect 2011 revenue, excluding the impacts of currency to be in the range of minus 2% to positive 1%.

As previously noted, in 2011, we anticipated generating incremental revenues of $0.32 to $0.42 per share from operations, growth and productivity, excluding the impact of SMB stream revenues.

We anticipate a lower SMB stream revenues as a result of lower equipment sales in prior periods to negatively impact earnings by $0.25 to $0.30 per share.

As a result, we expect comparative earnings for the year of $2.25 to $2.40 per share. We also plan to invest $0.05 to $0.10 per share to develop the market for mark -- Volly, our secure digital mail delivery system.

As a result of the improve margins, we continue to expect adjusted earnings per share from continuing operations to remain in the range of $2.15 to $2.35. We also continue to expect 2011 GAAP earnings per diluted share from continuing operations in the range of $1.80 to $2.10.

This includes the expected impact of $0.25 to $0.35 per share for restructuring charges and asset impairments associated with strategic transformation.

Earnings per share guidance assumes recoveries this year of losses related to the Dallas fire. As part of negotiations to settle the company's 2001 to 2004 IRS examination, we agreed with the IRS on the tax treatment of a number of issues, as well as revised tax calculation.

As a result, we anticipate paying nearly $400 million of tax and interest for the years 2001 to 2004 by releasing previously funded tax bonds and as a result, this payment will not impact our cash position.

Additionally, we expect to reduce tax reserves in the third quarter by about $50 million with about $30 million recorded in discontinued operations. The impact of this agreement is not included in our earnings guidance for the year.

We continue to expect to generate strong free cash flow for 2011 in the range of $750 million to $850 million.

In closing, let me update you on Volly. We are advancing our market development activities with large mailers and are on track for phased consumer rollout of Volly, our secure digital mail delivery system. In the last 90 days, we have trained more than 50 of our existing sales representatives to sell Volly in addition to their current product portfolio.

We have signed agreements with multiple large third-party mailers, representing over 1,500 companies that send out billions of pieces of mail annually.

We remain confident that the actions we are taking are moving us closer to our goals for the longer term growth and profitability of our business, despite current uncertain business conditions.

We remain focused on maximizing our operating efficiency, enhancing the customer experience and investing in the growth of our business. Thank you. Now let's take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ananda Baruah with Brean Murray.

Ananda Baruah - Brean Murray, Carret & Co., LLC

A couple of questions. I guess, the first is can you just sort of walk us a little bit through the, I guess, through the pieces of the guidance? You're lowering revenue, it sounds like margins are tracking better than you had expected. Is that sort of where the offset comes from? And to what extent might sort of Volly be tracking a little bit, I guess, less of the headwind than you expected. You kept the range, the range is the same, but I guess it's only a $0.01 sort of impact this quarter. And then how does the Dallas warehouse completely kind of fit into the guidance?

Murray Martin

Sure. Just to sort of reiterate on the guidance. The only thing that we changed our guidance is the revenue growth outlook, and that came down 2 percentage points. Because of the margin performance we've seen to date, we have kept our adjusted earnings per share guidance range the same. So we are pleased with the margin performance of the business to date. We think because of the fire, which has impacted us particularly in the first 2 quarters. Now that we have our new facility up and running, it should be a much less of an impact in the third quarter and should be really a nonissue in the fourth quarter in terms of impact. But obviously, the first half impact is reflected in our overall revenue and then certainly, the broader economic outlook. So the key is the revenue guidance has come down a bit but the earnings guidance remains the same. As far as Volley is concerned, we remain, I think on track to be within the $0.05 to $0.10 range on a full year basis. The penny is what it rounds to obviously, the dollars can vary a bit from quarter-to-quarter based on the level of activity.

Ananda Baruah - Brean Murray, Carret & Co., LLC

Okay. And it sounds like, Mike, you have baked into the guidance that you will get sort of the least potentially, get the sort of the $0.68 impactfully from the Dallas warehouse situation?

Michael Monahan

That's correct. The $0.05 is already reflected in our reported adjusted earnings through the first half, but we anticipate at this point, to get that recovery.

Ananda Baruah - Brean Murray, Carret & Co., LLC

Okay, great. And then just if I could, can you just give us a sense of what you've seen from, I guess, customer activity the last 4 to 6 weeks both in SMB and in the Enterprise, both U.S. and Europe, with sort of the economic news? It's been underwhelming and then just sort of the concerns that sort of -- they're sort of overwhelming everybody from what growth might sort of -- kind of might be in the second half of the year. Any kind of detail there would be great.

Murray Martin

Sure. What we -- we've seen the SMB market to be fairly steady at a lower level than what we had expected. So it hasn't really swung a lot. We had anticipated that it would recover and it has remained more similar to last year than we had expected. So I think we're seeing that as -- at a lower rate, the smaller businesses are not investing in new but the renewal continues to stay there. As to the enterprise space, you'll see in our results that both Software and the Production Mail, which are the large ticket items, continue to perform well and it's sort of broad-based. It's a little irregular from period to period as you look at different countries. But with the broad distribution we see, Europe will be hit good or certain countries in Europe, then Canada, then Asia then the U.S. So we saw strong deliveries in the second quarter. But then, we had strong written business in a number of the areas as well. So we are seeing not that big a variance in our large accounts. And I think, I would go back to, as you recall, back in '08 and '09, was there was a lot of things postponed and delayed and so the refreshes are continuing. When you get into the other areas of Enterprise, which are volume related, our services business, mail services continues to be strong. We see a little bit of a shift in volume related in the management services business around print volume, which is down period to period. But in general, I'd say we've been fairly well on target in the enterprise space and then as we saw through the first 2 quarters, a little lighter in the SMB. And I wouldn't say any dramatic change that we've seen in that space. It's been pretty stable.

Ananda Baruah - Brean Murray, Carret & Co., LLC

That's helpful. I guess just one last follow for me sort of as it sets in. Any comments about linearity through the quarter both in SMB and Enterprise? And I guess, maybe it sounds like you're saying SMB is a bit softer than Enterprise for you. Is this something you saw? I mean, I know the SMB indicators began to turnover as we got into the quarter. Was it really coincident with that and just over the last 2 to 4 weeks, have you seen any change in business though from your customers in either side of your business?

Michael Monahan

I don't think that we've seen certainly, measurable change in behavior. I think obviously, the events in the last few days, we'll see how that affects people going forward. But the SMB business tends to be kind of a fairly continuous selling process and it's a very localized type of selling process. Whereas the Enterprise side, as Murray indicated, there tends to be a replacement cycle we are seeing some particularly in the Production Mail side, some take-up in the new color printing, which is contributing to that as well. But obviously, it's something we'll stay close to.

Operator

We have a question from Shannon Cross with Cross Research.

Shannon Cross - Weeden & Co., LP

My first question is with regards to lease extensions. Can you just talk a little bit about the dynamics? Has anything changed or is that sort of a continuation of what you've seen in prior quarters?

Michael Monahan

It is a continuation. I think it's relatively consistent with what we saw the first quarter. I think our preference would have been to see that come down a little bit more. So perhaps, it's one place where we're seeing some of the hesitation on the part of small- and mid-sized businesses. But obviously, the important part is to continue the relationship with them and these are very valuable transactions as you see as reflected in the improvement in the equipment sales margin. So they're good transactions but we hope to see more uptake of new equipment as we go forward in the second half.

Shannon Cross - Weeden & Co., LP

And is it still sort of a 2-year extension?

Michael Monahan

Generally, they can be 2 to 4 year and they probably average on the longer side than the shorter side.

Shannon Cross - Weeden & Co., LP

And then can you talk a little bit about in terms of the cash flow. You had very strong cash flow, you noted timing of tax payment this quarter. How are you thinking about cash flow for the full year? Because it seems like you're very much well on track to make at least, certainly the high -- well, low end and pretty comfortably, the high end of your cash flow. So is there something we should sort of think about in the next couple of quarters?

Michael Monahan

Sure, as far as the tax payments are concerned, we did have some tax benefits related to our pension contributions that we made in the quarter. So there's an effect in there for that. But to your point, we feel good about the cash flow right now and we're probably trending towards -- more towards the higher end of our range. And we think it should be again another good, strong cash flow year.

Shannon Cross - Weeden & Co., LP

Okay. And then just sort of a follow-up to cash flow is, on the capital structure, I think you're -- I can't remember the exact number, 74% something like that in terms of fixed this point? How are you thinking about the capital structure? Use of cash clearly remains -- dividends and share repurchase. But just any more color you can give on sort of how you're thinking about it especially from a debt standpoint.

Michael Monahan

Yes. From a debt standpoint, obviously, at the end of the quarter, we didn't have any commercial paper outstanding. That tends to fluctuate during the period. But at the end of the period, we were able to eliminate that. We don't have any debt coming due until September of next year. So we're kind of locked. It really wouldn't cost effective to buy that out early. So we're kind of set on that. So we will have free cash flow to obviously reinvest in the business. We will spend about $100 million in cash this year on principally severance payments, related to our strategic transformation program. So that's one other use as well. I think the good news is going forward in 2012, as we see some of those programs come to conclusion, that usage going forward should be somewhat less. As we get into 2012, we'll look at our refinancing or pay-down options, related to the debt that's maturing in 12.

Shannon Cross - Weeden & Co., LP

Okay, great. And then my final question for Murray. Can you talk a little bit about what's going on with the U.S. postal service in terms of the closures? I think they've announced about 11% of the locations, if I remember a number, are closing. Just any opportunities that might be there for Pitney or any concerns? How we should sort of think about some of the restructuring that's been going on in the postal service and then how it might impact your company?

Murray Martin

Well, first of all, I think that any restructuring in the postal service that enhances their economic structure is a positive not only for us but for the industry. Secondly, when it comes to these very small post offices, it really has no effect to our basic delivery of mail. The people there still get there delivery, it's strictly an access site. And what they're actually doing is providing alternate access. So when they close a physical facility, they actually, in many cases, are providing more access points around of that facility than there was in the post office. That actually, as you rightly alluded, could provide us with opportunities when it comes to self-service, since we do supply kiosks. And also, if there are smaller sites that open to services, post offices, it would open the potential for meter activity as well. So we don't see it as a negative but we see more opportunity there than there would be in the current form.

Operator

We have a question from Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank AG

I wanted to follow-up a little on the improvement you saw in recurring revenue stream. It looked like most of the improvement was driven by supplies. I was hoping you could flush out the trend you're seeing in supplies? And talk to the sustainability of growth in supplies, given the ongoing trends that we're seeing in mail volumes.

Michael Monahan

Sure. So supplies really has 3 components to it. Our traditional mail ink for postage meters, there's other third-party supplies that we provide and then the newest stream of supplies that we have are related to our intelligent printers. And as we begin to build the base of those printers, which are high-speed, high-volume, color inkjet printing engines that we partner with HP to market to high-volume mail producers. That will build a new revenue stream for us. So some of the moderation is the fact that we're seeing more stability in our traditional mail inks and then the growth in some of these other supply categories. The other thing I'd note about some of the other elements of recurring revenues. In terms of growth in our businesses overall, we saw good growth in Canada from an equipment standpoint. We had positive growth in Europe from an equipment standpoint. And that's translated into improvement in our financing revenue as well. In fact in Europe, it was flat year-over-year. So we are seeing in a number of markets that the impact of sales improvements do end up filtering through to the recurring revenues. So those are some of the key drivers.

Chris Whitmore - Deutsche Bank AG

Should we expect the supplies line to grow in the back half of the year?

Michael Monahan

That's certainly a possibility. It depends on certainly the mix of business we do. The IntelliJet ink streams will build as we build an install base, but we have seen moderation in the mail inks. So that's certainly a possibility in the back half.

Chris Whitmore - Deutsche Bank AG

Okay. And in terms of the sales of equipment placements and I'm thinking about meter specifically, can you talk about the mix trend you're seeing in terms of those shipments? Are you seeing that mix improve or deteriorate? And maybe can you comment on pricing in the competitive environment as well?

Murray Martin

I think what -- Chris, it's Murray. We're seeing the high end continuing, the mid and high end continuing to be positive. The lower end meter space where you have some people that are less to do very low volume, that is susceptible in this type of market. But in the mid to upper, it's certainly doing pretty well. When it comes to our price realization, we're continuing, as you can see in our margins, to see continued realization of price. So I think margins in the industry are holding fairly well.

Chris Whitmore - Deutsche Bank AG

Okay. So the -- sometimes your competitors talk about some market share gains, you don't seem to be seeing any pressure on your market share, is that correct?

Murray Martin

Market share fluctuates a little bit by region, by month, by quarter. So we see gains in market share in some places period to period and maybe a minus here or there. Overall, we see market share as relatively flat on a global basis.

Chris Whitmore - Deutsche Bank AG

Okay. And my last question is also on guidance. The range in the back half of the year is about 20% or so on the EPS line. It seems unusually large. Does that reflect greater uncertainty around the back half of this year or maybe you can give us a little more color on why such wide guidance range?

Michael Monahan

I think it's more a matter of just maintaining our annual outlook as opposed to getting into a particular quarter guidance or whatever. So I wouldn't read anything more into it than we've just maintained our annual guidance for the first half.

Operator

We have a question from Charles Riggle [ph], a private investor.

Unknown Speaker

Many of the analyst out there are suggesting that your dividends may be reduced or eliminated but from what I've heard, it appears your free cash flow will more than cover adequately any dividend though matching previous dividend declarations. Am I correct there?

Michael Monahan

We have a long history of generating very solid free cash flow. Our guidance for this year projects solid free cash flow and we have a track record of increasing our dividend for 29 consecutive years, that's been an important part of the total mix of return to shareholders and...

Unknown Speaker

That's what keeps me in there.

Michael Monahan

It what keeps me in there too. And so obviously, we think we're in a good position to continue to support the dividend.

Operator

We have a question from Hale Holden with Barclays Capital.

Hale Holden - Barclays Capital

Just very quickly on the Volly, assuming it's adopted at your highest expectation. Isn't it kind of that's core cannibalistic to your core mail stream as we shift more billing electronic mail over the web? Doesn't it reduce the volume that you push through the bigger service centers?

Michael Monahan

Yes. Volly would actually provide a shift. So today, there -- we would estimate about 10% it's digital, that we don't participate in and as we look forward over the next decade, we believe there will be some shift and what Volly does is it puts us in a position to capture that shift, as well as capture the shift from high-volume mail that we do not deliver today. So when you look at our Production Mail equipment, we have a global share of less than 50%. So that would provide us an opportunity to take all of that digital as well. So we also, when we look at the shift from physical to digital to Volly, we would not expect that people will go to 100% digital. So there's going to be a long tail on hybrid regardless of what the range of transition might be and people will continue to need to produce physical mail. Also, you have the standard mail side of the business, which does not substitute into digital. And it is continuing to show positive growth over an extended time period. So we see that sort of mail continuing to be there. And what this does is it really keeps us in more of the end-to-end process. So we really go from the origination of the mail and all of the software tools there to the location of where it goes whether it's physical or digital, and then the demographic and psychographics around that for enhancing the value of that communication to help people deliver more value to their customers and to find new customers. So we see it, yes, there will be some cannibalization, but we also see incremental opportunity in that the total end-to-end process.

Hale Holden - Barclays Capital

So if we assume [indiscernible] is going to happen and that you want to be able to control the transition sort of from physical to digital. Obviously, there's some -- there's always risk in any transition that another competitor comes in. Who would you kind of wind up as your main competitors when you're pitching Volly to customers?

Murray Martin

Well, today, it's very difficult to identify a major competitors. In the U.S. for example, in transaction mail, we participate in 74% of the transaction mail and so there's no one else that's close to dealing with that, with the customer base. So we're involved with those customers in creating the physical and we believe it places us in a fairly unique position from those long-term relationships and considering that those customers will continue to have to produce physical. So to have a solution that delivers in a hybrid form, both physical and digital and allows you to manage it as one process is a significant advantage that anyone new coming in would struggle with.

Hale Holden - Barclays Capital

And then I guess it's my final one is, how do you -- how are you asking your customers to pay for Volly? Is it sort of getting Volly into larger contracts right now as an add-on so that you can maintain a relationship with the transition or is there a separate charge for it?

Murray Martin

Well, when you think about the delivery of physical mail piece, you have the production of the mail piece, which we participate in. You have the paper, the envelope and the postage, are sort of the segments of that. We only participate in a small portion. So the cost to deliver would be less than the total cost of physical but we would participate in more -- in a bigger portion of that than we do today.

Michael Monahan

And it would free to the consumer to access it.

Operator

We have a follow-up from Ananda Baruah with Brean Murray

Ananda Baruah - Brean Murray, Carret & Co., LLC

Mike, could you maybe just walk us through what the different pieces of the, I guess, of the incremental operating margins strength is? I'm assuming it's a little bit better than what your expectations were the last quarter. How much of it is mix? How much of it is maybe cost saves? Ahead of schedule? How much of it is other stuff? And can you actually give us sort of like a year-to-date update on cost synergies realized?

Michael Monahan

Yes, in terms of -- let me address the 2 parts in order. I think the best way to look at where you've seen the improvement is to look at our gross profit. We increased that year-over-year. In fact, our gross profit this year was the best second quarter gross profit since 2008. So what we've been able to do is really shift the mix of our revenue and yet, still maintain strong margins in the business. Within those margins are reflected some of the benefits of the transformation initiatives that we put underway, in terms of how we service our product, the cost of the product. A lot of our procurement activities are baked into that. And then there's obviously some benefits in our SG&A expenses as well. In terms of seeing reduced cost there on a constant-currency basis, our absolute levels of SG&A expenses are coming down. Year-to-date, we've probably seen about $80 million of incremental benefits from transformation and roughly $200 million, I think at the end of last year. We talked $120 million of savings through the end of 2010 in the program. So roughly, about $200 million of benefits in the program. One of the things I'd emphasize though is that those benefits are captured in the numbers but more importantly, we've created more variable cost. Meaning, we've outsourced the number of functions, we've used more SaaS-based solutions as supposed to capitalizing a lot of big software or equipment. We've reduced the number of physical locations and those things allow us more flexibility as we go forward to continue to adjust cost without incurring severance and other things that might normally come with changing priorities in the business. So I think, we've created some additional flexibility from that standpoint.

Ananda Baruah - Brean Murray, Carret & Co., LLC

Okay. That's helpful. And then, I guess, in terms of thinking about how to -- I mean, for 2012 modeling purposes, what's the -- a prudent way for us to think about what the incremental investment for Volly and other things could be? Should we just sort of say, hey it might be the same, and just leave it at that for now. I guess, that gives us like a little -- the hedges are under a little bit. And could you maybe talk about what the levers could be that might push it either stronger or softer than kind of what it is this year?

Michael Monahan

Sure. The investments that we're making in Volly this year are really driven by 2 things that Murray touched on earlier. One is then the basic development of the product and the refinement of that and the market research around that to really understand consumer preferences, biller's needs and those types of things. And the second -- and build the -- build out the infrastructure support and things needed for it. The second is to begin the selling process to engage mailers and then to onboard them with the technology to enable them to be able to deliver digitally into Volly. The variable cost, as we go forward in 2012, will really be around marketing expense. And that will be driven by how much we market directly versus market through participating billers. Perhaps, as they encourage their customers to choose the way that they want to deliver or receive digitally. So we'll learn our way into that a little bit more as we engage with the mailers and understand their marketing plans and develop our own marketing plans and get to the consumer experience on that. So at this point, I think assuming the same as this year is probably a safe thing to do. Obviously, we'll have better insight when we give 2012 guidance.

Ananda Baruah - Brean Murray, Carret & Co., LLC

Okay, that's helpful. And just one last one for me and then I'll get off again, is -- I guess, just on the buyback, you -- the $50 million was, I think was 1/3 of what you had going into the quarter on the authorization. I mean, last quarter you talked about taking up to 6 quarters to ease all things. So with the stock where it is now, I mean, I know it's sort of the whole market's down. But I guess just with the stock where it is now, can you just update us your thinking on sort of the stock buyback generally? And just sort of philosophically how stock buyback fits into how you guys are thinking about using this capital right now?

Michael Monahan

Yes. Stock buyback has always been a variable for us in terms of what priorities we have around cash utilization or capital utilization. When we increase the authorization of the $150 million, we said it would be over 12 to 18 months or 4 to 6 quarters. Obviously, we've begun to do some of that already. With the stock price down, obviously, it's going to be one of the things that we consider as we move into the second half as options to deploy excess cash.

Operator

There are no further questions. Please continue.

Murray Martin

Thank you. I'd just like to, in conclusion, summarize a number of things that we've covered. First, there are 3 positive trends that we saw during the quarter that underscored our progress in laying the foundation for long-term growth and profitability. They were: continued growth in equipment and Software sales led by high-speed inserting and Connect+; the combined recurring SMB revenue stream of supplies, rentals and financing that declined at a lesser rate than both the prior quarter and prior-year; the improvement in EBIT margin particularly in SMB and our Software business, despite the unsettled economic environment.

We also continued to reap the benefits, as Mike touched on, of our strategic transformation actions, which has significantly increased the variable portion of our cost structure and allowed us to reinvest in our business. During the quarter, we also expanded our new cloud-based SMB products and there is more to come for both the SMB and Enterprise customers. Our progress with Volly continues to be on track for a phased consumer rollout. In the last 90 days, we trained 50 of our existing reps and we have currently signed agreements with large third-party mailers, representing over 1,500 companies that send out billions of pieces of mail. So we see that as on track and we look forward to the coming year as we look to where Volly could go as it rolls forward. Thank you.

Operator

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