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Executives

Charles F. McBride - Vice President, Investor Relations

Murray D. Martin - President, Chief Executive Officer, Director

Bruce P. Nolop - Chief Financial Officer, Executive Vice President

Analysts

Jay Vleeschhouwer - Merrill Lynch

Matt Troy - Citigroup

Caroline Sabbagha - Lehman Brothers

Shannon Cross - Cross Research

Josh Golden - J.P. Morgan

Chris Whitmore - Deutsche Bank

Vincent Lim - Goldman Sachs

Pitney Bowes Inc. (PBI) Q3 2007 Earnings Call October 29, 2007 5:00 PM ET

Operator

Good afternoon and welcome to the Pitney Bowes third quarter 2007 earnings conference call. (Operator Instructions) I would now like to introduce your speakers for today’s conference call: Mr. Murray Martin, President and Chief Executive Officer; Mr. Bruce Nolop, 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 F. McBride

Thank you and good afternoon. Let me remind you that you can find today’s earnings press release and the attached schedules on our website at www.pb.com/investorrelations. The forward-looking statements contained in this presentation involve risks and uncertainties and are subject to change based on various important factors, including changes in international or national political or economic conditions, timely development and acceptance of new products, timing of potential acquisitions, mergers, or restructurings, getting product approval, successful entry into new markets, changes in interest rates and changes in postal regulations, as more fully outlined in the company’s Form 10-K annual report filed with the Securities and Exchange Commission.

Additionally, if there are any non-GAAP measures discussed during the call, such as adjusted earnings per share, earnings before interest and taxes, EBIT, free cash flow, and organic revenue, there will be a reconciliation of those measures to GAAP measures located again at our website at www.pb.com/investorrelations.

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

Murray D. Martin

Good afternoon. Thank you for joining us for the announcement of our third quarter earnings. I will start with a broad overview of what affected our performance and Bruce will follow with some additional perspectives on our quarterly results and on our guidance for the fourth quarter. I will then conclude with a brief discussion of our action steps for the near future and then open the lines for your questions.

During the quarter, our revenue grew 5% compared with our previous guidance of 8% to 11%. Our adjusted earnings per share from continuing operations was $0.63 compared with $0.66 in the third quarter of 2006. This was below our guidance of $0.70 to $0.74.

Our GAAP earnings per share from continuing operations was $0.58 compared with $0.64 for the same period last year. This is the first time in 28 quarters that we have performed below earnings expectations. We are disappointed in this performance and I will talk about the factors which led to these results.

But before I do that, I want to make certain that we do not lose site of the positive trends we continued to see during the quarter. Our enhanced management focus on free cash flow has delivered one of our strongest quarters ever, as we generated $239 million during the quarter.

Also, as we saw last quarter, the software segment continues to be one of our growth leaders. The ongoing demand for our array of solutions highlights software’s growing importance in helping customers optimize their Mailstream investments.

During the quarter, we combined Group 1 and MapInfo into one organization, bringing together our expertise in locations and addresses, and laying the foundation for us to become the most comprehensive provider of customer information for marketing and business transactions.

Earlier this year, we named Mark Cattini, former CEO of MapInfo, as head of our marketing services group. Since that time, we have begun leveraging the synergies and increasing linkages between our software and our marketing services group. This powerful combination enables us to add value to customer operations earlier in the Mailstream lifecycle.

Our mail services segment also had a very strong performance, as we experienced growth in both pre-sort and cross-border mail services. The recent increase in work sharing discounts available to large mailers is an example of the benefits made possible by U.S. postal reform.

We are continuing to build out our network of services in the U.S. and are looking at opportunities to expand internationally.

During the quarter, we also achieved good growth in payment solutions and Asia-Pacific continued its strong momentum with excellent growth across all product lines. However, these positive results were offset by more challenging conditions than we anticipated in four areas.

First, we experienced an unfavorable impact due to weakness in certain sectors of the economy, in particular financial services. We are seeing lower sales of equipment and software, lower supplies orders, and slow-downs in transaction volumes handled by management services.

Second, we had lower-than-expected revenue in our U.S. mailing segment. After the exceptionally strong second quarter performance, we planned to return to more normalized levels of growth in September. We now believe that the lower sales were related not only to the spillover effects due to the rate case, but also the wind-down of meter migration.

Third, in our international mailing segment, delays in market liberalization in some countries and the issues related to changing requirements from deregulation in others has contributed to market confusion and lower product placements. In the U.K., as an example, strike conditions at Royal Mail created uncertainty, affecting postal services and reducing sales. In France, a regulatory change in the method of meter rentals is causing both delayed purchasing decisions and increased selling and marketing costs.

Additionally, our profit margins in Europe continued to be adversely impacted by ongoing investments in sales and marketing channels. And the transformation of our back-office operation has continued to produce higher-than-anticipated expenses this year.

Fourth, while our management services revenue was helped by strong written business from prior quarters, the third quarter results were affected by continued weak performance in the legal solutions vertical. We also experienced unanticipated delays in new business in the government solutions vertical as the postal service postponed any additional outsourcing activity while it works through the review of the new regulations that resulted from postal reform.

Bruce will now provide some additional information concerning our financial results.

Bruce P. Nolop

Our revenue for the quarter was $1.5 billion, which was a 5% increase from a year earlier. Foreign currency contributed about 2% and acquisitions contributed about 4%. Therefore, excluding the impact of acquisitions and currency, our revenue declined by 1%.

Our revenue overall in the U.S. grew by 2% while our revenue outside the U.S. grew by 13%, although this was primarily due to currency translation.

Our earnings before interest and taxes, or EBIT, declined by 2% during the quarter to $278 million. Our EBIT margin for the quarter was 18.4%, which was lower than the prior year’s margin of 19.8%. But on an organic basis, our EBIT margin was 19.2%. The decline in our EBIT margin was due primarily to mix, as we had a lower average gross margin and a higher selling and marketing expense ratio. However, on an organic basis, our general and administrative expense ratio actually declined by 20 basis points.

If we add back depreciation and amortization, our EBITDA for the quarter was $374 million, which was very close to the $377 million of EBITDA in last year’s third quarter.

Our adjusted earnings per share for the quarter was $0.63 per diluted share, which compares with $0.66 for the same period last year. Much of the year-over-year decline in our adjusted earnings per share was due to higher interest expense. The higher interest expense reflects higher levels of debt outstanding but also last year, we had interest income on a large cash balance that resulted from the capital services divestiture. This cash balance contributed about $5 million of interest income to last year’s third quarter results.

Our GAAP earnings per share for the quarter was $0.58. This included a $0.02 charge for aligning the MapInfo accounting with our procedures for software. In addition, we had two non-cash adjustments -- a $4 million net decrease in our deferred taxes, primarily due to recent changes in German tax laws, and a $4 million pretax expense for the impairment of certain intangible assets in legal solutions.

Our effective tax rate on adjusted earnings for the year is now expected to be 34.10%. This is a slight decline from the 34.25% that we estimated last quarter.

Our shares outstanding this quarter were approximately 1% below what they were in last year’s third quarter.

Our cash flow from operations for the quarter was $290 million. Our free cash flow was $239 million, and there are three things to note about our strong free cash flow. First, we are seeing the benefits of increased management attention on working capital and generated about $57 million of cash from working capital during the quarter. Second, our capital expenditures were $22 million below the level of depreciation and amortization. And finally, we had lower additions to finance receivables, which is a function of lower sales of equipment.

We now have generated $550 million of free cash flow year-to-date, and given this strong performance, we are increasing our annual guidance to $625 million to $675 million from our previous estimate of $550 million to $625 million.

During the quarter, we used $72 million of our cash to pay dividends to shareholders and we also repurchased $105 million of stock. We acquired 2.3 million shares during the quarter. Year-to-date, we have returned $497 million to our shareholders through dividends and share repurchases.

Our total debt as of September 30th was $4.9 billion. About 79% of this debt is fixed rate and 21% is floating rate.

As we look to the fourth quarter, we are expecting a continuation of the trends that we saw this quarter. We are forecasting revenue growth in a range of 6% to 9%, and for the full year, we expect revenue growth in a range of 6% to 8%.

For the fourth quarter, we are forecasting adjusted earnings per share of $0.67 to $0.71, which compares with $0.77 for last year. On a GAAP basis, we are forecasting fourth quarter earnings per share of $0.66 to $0.70, which compares with $0.73 last year.

Our guidance for full year adjusted earnings per share is $2.67 to $2.71. Our GAAP earnings forecast is $2.59 to $2.63.

So that concludes my remarks and now Murray will provide more insight about our plans going forward.

Murray D. Martin

We do not believe that this year’s results are indicative of the growth and the value inherent in our Mailstream portfolio. As a result, we plan to accelerate some of our action plans to ensure better performance going forward.

First, we are looking at ways to accelerate our infrastructure improvements to lower our costs and deliver a better customer experience. Second, we are planning to accelerate the transition strategies for our mailing products in the U.S., Canada and Europe, in light of the dynamic market conditions resulting from the end of meter migration in North America, postal reform in the U.S., and market liberalization in Europe.

Our mailing business is central to our equation for delivering shareholder value. Our goal is to ensure that this business delivers consistent earnings and cash flow even in the midst of increasing complexity within our markets.

Third, we must improve our operating performance in Europe. As a first step at the end of the quarter, we appointed Neil Metviner as President of our mailing segment in Europe. Neil joined the company in 2000 and has successfully transformed our global small business operations by creatively expanding our market reach to over 1 million small business customers while lowering our cost structure. I have a great deal of confidence in his ability to make an immediate and positive impact.

Earlier in the quarter, we also appointed Ian Davidson as head of production mail in Europe. I believe that Ian’s experience and market knowledge will enhance our focus on production mail opportunities and lead to improved profitability.

Overall, we are examining all aspects of our operations and our investment strategies to ensure that we will deliver enhanced value to our shareholders. I want to assure you that we will move swiftly to take appropriate actions for the current market conditions.

We plan to hold a special investor call on Thursday, November the 15th, to discuss our action plans with you.

Now, we’ll take your questions.

Charles F. McBride

Operator, can you open up the lines for questions, please?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jay Vleeschhouwer with Merrill Lynch. Please go ahead.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Murray, you mentioned that the benefits from postal reform in the U.S. earlier in the year turned out to be temporary, concentrated in the second quarter. And that was notwithstanding years of anticipation of these reforms and how it would benefit the business, so the question is why do you think it was so brief or concentrated? And the next time such reforms occur in Europe or elsewhere, is it reasonable to assume that the benefit would again prove to be relatively temporary?

The second question concerns the strength you are seeing in mail services. Is there any reason to believe that in pre-sort or any other part of that business, that the current growth, which I assume is volume driven, could prove to be temporary?

Murray D. Martin

Thanks, Jay. First of all, on postal reform, there are long-term benefits to postal reform and it really starts with market stabilization and the benefits that the entire market will receive from having a solid postal environment.

Now, as we look at the benefits of postal reform, the first is we are seeing and expect to continue to see positive benefits in our mail services segment. We don’t see these as temporary benefits. The discount offered to mailers is very good and the co-mingling of mail enables them to receive those discounts. So we would expect more and more customers to look at how they can co-mingle their mail to receive those discounts, and we see that as a positive going forward.

As to your question on the second quarter, the second quarter actually created a slight anomaly which was the introduction of shape-based rating. That was not really something that was part of postal reform or anticipated in postal reform. It was something the postal service put in and it brought forward business but we don’t see it as having a long-term negative effect. It changed the timing of when revenue will be recognized.

We do believe that the other elements in postal reform and market liberalization around the world will have long-term positive effects, although we will see occasional anomalies.

Jay Vleeschhouwer - Merrill Lynch

In the software business, you mentioned that you’ve combined MapInfo and Group 1. Do you foresee the benefit, or do you anticipate similar structural changes across any of the other business units? Or is this unique to the software business?

And a couple of things you mentioned at the analyst meeting earlier in the year were first that the composition of the business now would likely lead to more “variability” -- your word at the time. I assume what you are seeing goes beyond some of the revenue mix variability that you anticipated earlier in the year, and you also talked about accelerated product development, if there’s something you could say on that.

Murray D. Martin

First of all, let me touch back and I’ll try and remember the question, and if I don’t get it all, pop back.

On Group 1 and MapInfo, the consolidation of that has brought together our software capabilities around addressing and location intelligence and we see that as enhancing the segment substantially. And having that synergy we believe will be of long-term benefits to our customers and to the entire Mailstream. The ability to be more precise in determining an address also will enhance marketing and trans-promo as it begins to expand and people look to take transactions to promotional mail. So we see that as having a continuing effect.

At the same time, we are looking at and examining all portions of our business to see which items fit best together to provide us the most synergistic benefits and the best results, not only for our customers but return as well.

One of those is in U.S. mailing, where we have brought together small business and our mid-sized business and put them together so that we have one end-to-end view of the customer and we have a way of seeing the customer from small to large. That has allowed us to bring the infrastructure together in one place so that we can deal with the customer experience while we at the same time look at reducing the cost of delivering an enhanced experience. So we are continuing to look at all pieces of the business to see what synergies are available, not just from a cost side but from a customer experience as well.

As to products, we are continuing to focus on certain areas of products that we believe will give us a good return. We are doing that in our software segment, which you are seeing some of the results of today. We’ve been doing that in our DMT space as we’ve become the clear market leader in technology and advanced productivity systems around the world, and we have done it historically in our mailing business, where we have a fleet now of units that can upgrade their rates capability as the postal service makes change. And this is one of the major things in postal reform -- the post is going to want more flexibility on rates and we have a large fleet that is easily adaptable, and this is significantly different than others in the market.

We will look at how we can enhance this to take advantage of many of the new functionality that the postal service will be rolling out over the next 12 to 24 months to enhance the value for our customers.

Operator

And our next question comes from the line of Matt Troy with Citigroup. Please go ahead.

Matt Troy - Citigroup

A question; given a quarter that was very un-Pitney like, I know it’s difficult for you on that end, certainly for everyone on this end, I was just curious -- when did you first get a sense that the quarter was structurally beneath your expectations? Why weren’t you able to update investors sooner, given the magnitude of the miss? And I realize this could be just a perfect storm of several items coming together, but I wanted to get a directional sense of the items you listed, what were the major drivers of the shortfall? Were some more impactful than others? When did you get a sense that this quarter and your outlook for 4Q would be structurally beneath that which you previously articulated?

Murray D. Martin

Matt, as I mentioned, and as we’ve discussed, the results for a quarter tend to come in in the last week, in the last days, and that’s particularly true of our software business and of our lease trade-up business. And this is when we had expected to see a positive swing going forward.

Now, we saw at that point that there were some challenges. We still expected to be towards the bottom end of the range, but we did not expect to be where we have come out. I think you were exactly correct in the -- all of these items coming together at one time.

To give you an idea as to your question about are some more than others, basically the first three represented about 90% and they are about evenly split at about 30% each. That, just to reiterate, that was about 30% that was defined around the weakness that we saw in the economy and we did not expect those results to show up as they did, particularly in the finance sector, where we had some shutdowns of procurement that occurred at the end of the quarter.

Secondly, the U.S. mailing segment, that was about 30% and as I mentioned, we expected that to arrive at the end of the month of September, and international was about 30% and then the PBMS was about 10%.

Matt Troy - Citigroup

Okay. If I could maybe ask, and I’m sure you’ll share in greater details your plans at the November call, but some of the actions you spoke of in reaction to what you are seeing now in this business were internal facing. I was just curious, from a longer term perspective, the concern would be that you build these better technologies and these better services and this better hardware to accommodate for a much more dynamic requirement in a post-postal reform era. How do we get comfortable that you are going to be able to be compensated from your customers for that investment, in light of the current quarter results and some of the weakness? That ultimately, you will get an adequate return, you will be able to seek price -- what are some of the external facing strategies you are pursuing to make sure that you can recoup this investment to make your technology and product more valuable and viable?

Murray D. Martin

Well, I think there are a number of things there. Number one, as I was discussing, in software, we have combined assets to ensure that we can enhance the customer experience which delivers significantly more value. I was just with a customer this week and we were going over the results of the analysis of their mail with the new tools that are coming available and there were millions of dollars of benefit for that particular customer. And that customer was saying can you look at the rest of my facilities to see how much more benefit we can get?

So I believe that as these new technologies roll out, they are measurable and clearly definable benefits for the customer that will justify the expense.

As we move into the more traditional mailing products, the postal service is expanding through the balance of this year and 2008 full-face scanning and they will be putting in the ability to read the barcodes off the meters and this will then enable us to really take advantage of special services that have had limited capability up until now and that will provide an expanding benefit from our customers.

So I really believe that these two areas will make a significant difference for us and we have built these products so that they have got some upgradeability in the field to handle variances that the postal service has.

I think those are the items that will really generate the maximum potential benefit and we are quite confident that our customers will realize measurable benefit.

Matt Troy - Citigroup

And will they pay for it?

Murray D. Martin

Yes, we believe they’ll pay for it. The customer I was with the other day, I said to him so there’s a lot of money here on the table. What about the price? And he said “the ROI is more than sufficient”, so as an example from a customer, he saw no issues on the ROI that was presented.

Matt Troy - Citigroup

Last question, in terms of the share repurchase program, could you just give us an update in terms of, Bruce, where you are with that and in light of what the stock is going to do in the morning, might you be opportunistic in seeking expanded authorization from the board? What kind of capacity do you have there?

Bruce P. Nolop

We’ve, as of end of quarter, bought in $280 million worth of stock and we are going to be looking at whether to increase the authorization. But that’s something that we will look at between now and November 15th and we will update you about what our plans are in that regard.

Matt Troy - Citigroup

Did you have though a number in terms of remaining capacity yet unused?

Bruce P. Nolop

Authorization is $160 million.

Matt Troy - Citigroup

Of which you’ve used how much?

Bruce P. Nolop

No, that’s how much is remaining.

Matt Troy - Citigroup

Okay. All right. Thank you.

Bruce P. Nolop

We have current authority and the question is whether to increase that.

Matt Troy - Citigroup

Okay. Thank you.

Operator

And our next question comes from the line of Carol Sabbagha with Lehman Brothers. Please go ahead.

Caroline Sabbagha - Lehman Brothers

Thank you. I just wanted to get, delve a little bit deeper into what happened with the U.S. mailings. There’s still a bit of a disconnect for me. Starting off just with the three reasons you gave for the miss in the quarter, and one was economic and what you saw in the financial services sector, my understanding with where you were most exposed to that was in management services, but it didn’t seem like the top line in that business was that impacted. So where would you attribute that 30% impact to -- was it management services or elsewhere in the organization?

Bruce P. Nolop

Carol, it would be largely outside of management services, and it would show up in areas like supplies orders. We also think on the mailing side that it affects equipment and in particular, production mail, which is the large equipment, and then software. So it’s roughly -- if we had to characterize it, Carol, we’d say maybe half was equipment, 25% supplies, and 25% software.

Caroline Sabbagha - Lehman Brothers

Okay, and the half in equipment, you would say mostly in production equipment or also in mailing equipment?

Bruce P. Nolop

Both. And the other thing I would mention too, Carol, is it didn’t affect revenue but we did have some incremental costs related to the financial services sector, particularly in the mortgage area. We had a couple million dollars of write-offs related to that sector.

Caroline Sabbagha - Lehman Brothers

And those would have shown up in PBMS -- in management services?

Bruce P. Nolop

No, they’d show up in U.S. mailing.

Caroline Sabbagha - Lehman Brothers

In U.S. mailing, okay.

Bruce P. Nolop

Yes, so that’s what I’m saying, that mailing is more diversified than management services, but it still has a very large presence in that sector.

Caroline Sabbagha - Lehman Brothers

And if you looked at U.S. mailing and you looked at the revenue, 3% down, what part -- what did equipment sales do within U.S. mailing and what did the other components, if you can just give us a general feel? Because I would have thought that 75% to 80% would be recurring, so it shouldn’t see wild swings like this.

Bruce P. Nolop

No, in the U.S. mailing segment, it’s the swing numbers, it would show up as the equipment sales and they were clearly off. In contrast, second quarter they were significantly up, so just on a quarter-by-quarter swing, and then you also see it in the rental line as well. And then you see it in international mailing as well.

Caroline Sabbagha - Lehman Brothers

And then --

Bruce P. Nolop

The other point is that supplies is something that you do see effects from the economy and just the amount of postage volume that’s flowing through, but even more importantly, just people sometimes postpone the replenishment of supplies.

Caroline Sabbagha - Lehman Brothers

Although your supplies number looked pretty good. Maybe not as strong as the first half, but nothing --

Bruce P. Nolop

I would say if you broke it down between international and U.S., you would have seen that international was very strong in supplies but U.S. was down considerably quarter over quarter.

Caroline Sabbagha - Lehman Brothers

Okay, and then you I think, Murray, mentioned when you were talking about U.S. mailing that you thought the end-of-meter migration had an impact. Is that right and did --

Murray D. Martin

Yes. If I could just touch on meter migration, we’ve got about 49,000 meters left in migration between 2007 and 2008, and what we have seen, which was really a surprise to us, is the migration rate on meters has dropped by about 50%. So customers that we would expect to migrate are migrating at about half the speed that we expected them to, which says they are pushing out towards the end of migration and what we are now expecting is that customers that would normally have upgraded later earlier are saying “I’ve got until the end of 2008, beginning of 2009. I have no urgency to move forward” and that would be both in the owned and in the leased fleet. The owned in particular is definitely in delay from where they were.

So we expect we will only see about half of the volume between now and the end of ’08 that we had expected.

Caroline Sabbagha - Lehman Brothers

In the last migration cycle, I think what happened after migration was over was that revenues came under pressure because a lot of new equipment orders were pulled in during migration. Is that something that happened here? This one was stretched out a lot longer and it seemed like people migrated during their natural lease terms.

Murray D. Martin

I think there are two things there. One is the second quarter, if we talk about the second quarter and what happened is people were in one of two positions. They either had equipment nearing the end of lease, which they traded out prematurely to get the new equipment. That created a pull-forward and it therefore lowered the trade-up potential over the following periods.

The second item is people that added components to their existing piece of equipment and this allowed them to take advantage of the pricing in proportion, but they then, as they are nearing the end of their lease, where they would normally trade up pre the end of their lease, are now staying longer in the lease because they did have an equipment upgrade. And this was something we had not considered as we had looked at the upgrade cycle, is that those people would also shift their repurchase to a later point in time. This was also a major piece.

So there’s the migration effect that I was talking about, which is at a slower rate, but then you have the second quarter effect, which pulled forward and shifted some of the timing. As those pieces of equipment come to end of lease, they will still be in a renewal cycle.

The other thing that we’ve analyzed over the last week is as we’ve gotten deeper into the lease cycles, we can see what the potential opportunity is for upgrade and we can now more clearly see what has been pulled forward and what is available in the coming years. And we will talk to you in more detail about that as we confirm it on our November the 15th call.

Caroline Sabbagha - Lehman Brothers

And how quickly do you think, given all the information that you have, how quickly do you think the U.S. mailing can get back on track to call it low single digit, flattish low single digit growth?

Murray D. Martin

We are forecasting through the fourth quarter that the current conditions will still be there and then on our November 15th call, we will give you the 2008 looking forward as to exactly where we see not just U.S. mailing but all of the different components of the business.

Caroline Sabbagha - Lehman Brothers

And then, one last quick question; your revenue guidance for fourth quarter is within sort of what we had been forecasting, but obviously the EPS is much below. Is it that maybe we were off in the components of what was growing? Maybe we had U.S. mailing -- is it just the product mix that is causing that I guess is the question.

Bruce P. Nolop

I think it’s almost all mix, I’m guessing, in what the difference is, and also too that you have more of the revenue growth probably from currency and acquisitions than you originally thought. So that’s made a difference.

For example, we bought a company called Asterion, which you may have seen, which is going to add to our revenue but -- so overall, I mean, we’re looking fourth quarter organically to be roughly flat and so that’s probably the difference between the --

Caroline Sabbagha - Lehman Brothers

Okay. Thank you very much.

Operator

(Operator Instructions) And next we’ll go to the line of Shannon Cross with Cross Research. Please go ahead.

Shannon Cross - Cross Research

Good afternoon. A couple of questions; the first one, looking at the issues that are hitting you from a revenue standpoint, Bruce, can you talk a little bit -- I mean, the first concern everybody is going to have in looking at this obviously is the economy. And I’m just curious as to how much, when you look at it, is truly the economy weakness in FMB, pull-back of lease renewals, all of that, and how much do you think is -- I don’t know, one-time or more related to the mail meter migration -- just any more clarity you can give on that I think would be helpful. Because I know I got several comments and questions from clients right after they saw the numbers as to --

Bruce P. Nolop

Sure. I would say this -- as we’ve always noted, two things; one is that we are generally resistant to the economy but we are not immune, and just to reiterate what Murray said, is that we estimate that perhaps 30% of the shortfall was attributable to the economy, so it’s still -- it’s a significant item but it’s not the majority.

And secondly is we tend to be not a leading indicator but a coincident indicator, and we really saw the impact toward the end of the quarter. We didn’t see it through the first two months. And at that time, we were seeing a few things but nothing that would indicate the kind of economic decline.

And we’re just, again, being a coincident company and in some ways a barometer of what the economy is doing, we see it continuing and we are forecasting the fourth quarter to have that slower results.

And as I mentioned, we are seeing it in a lot of ways but some of the places that we look particularly, such as large equipment orders, we’re seeing the companies are clearly watching their procurement and in many cases shutting down new proposals. So again, we can’t be a long-term forecaster, but we will tell you right now we are definitely seeing the effects in the economy in our business and it is at least having the 30% of our shortfall effect through the fourth quarter, and probably greater on a percentage basis fourth quarter than third, and that’s why you may see even some widening compared to what we did year over year.

Shannon Cross - Cross Research

And then, can you talk a bit about your international EBIT margins, pressures you’ve seen there? You know, ways that maybe you can address them going forward? I’m sure a lot of this will come out in November but just anymore clarity you can give us on the weakness in international EBIT?

Murray D. Martin

There are two things in international and I break the international numbers as basically 50-50. About half of the miss in international has to do with the uncertainty and the delays in the postal liberalization and the effect of the strike by Royal Mail in the U.K., which is our largest volume area and the highest margin in Europe.

So that’s sort of one half. On the other side, I think half of it is clearly operational. It is up to us to get it fixed and take that cost out. It’s cost that we did not anticipate and we expect it to be gone by now, and it is not. And that had to do with our outsourcing of back offices across Europe and that included our order to cash component. And we have not seen those benefits realized as expected in totality. We are seeing the benefit but we are carrying increased expense to ensure that the benefits get there, so to me it nets out as we aren’t seeing the benefit. We have put actions in place that will get us there but I’m very disappointed in our lack of being able to deliver that on time.

I think that will change the markets, the margin that you’re referring to significantly as that clears itself out.

Shannon Cross - Cross Research

Okay, and then just, not to beat this to death but I’m just curious, Bruce, if you could talk a little bit about supplies. You talked about it being under pressure in the U.S. Just from a -- maybe if you look back over the last several quarters trend-wise, because again, I think it does have to go back to the number of transactions and how much people are using their mail [meter], which ultimately gets back to the economy, can you talk a little bit about trends you’ve seen in terms of supplies growth? And then, if there’s been any change since the end of the quarter -- looking for a silver lining here.

Bruce P. Nolop

Sure. In terms of supplies, they have been growing organically at double digits. Now, in the U.S., that would be low single digits. And that is something that was just a change that occurred relatively quickly, so in other words, it was not a gradual change. It was really a step function between second and third quarter.

We don’t see any change to that and it’s related primarily in our mailing line, not the new supply area. So it is -- some effect due to postage but we believe that the economy clearly is affecting that as well.

Shannon Cross - Cross Research

Okay, great. Well, thank you very much.

Operator

And next we’ll go to the line of Josh Golden with J.P. Morgan. Please go ahead.

Josh Golden - J.P. Morgan

Good evening. A question for you regarding the balance sheet; given what the share price may do and the future outlook that you are forecasting, could you talk to me about the integrity of the balance sheet? Are you willing to leverage it up? What type of share repurchases are you willing to do? Are you willing to take on additional debt to defend the share price?

Bruce P. Nolop

I would say that we do anticipate that we will have an opportunity to buy in shares at what we believe will be an attractive price. And we will be looking at what kind of strategies make sense. Again, we have authorization now and we’ll be looking at it.

But one thing I would say is our cash flow remains very strong, and so the fact that we’ve increased our guidance for free cash flow indicates that we can buy in more shares without having an impact on the credit ratios and balance sheet.

Josh Golden - J.P. Morgan

Are there any type of credit ratios that you are looking to target within a range?

Bruce P. Nolop

The ratio that we look at that tends to have the most legitimacy to the ratings agencies is EBITDA to debt, or debt to EBITDA to reverse it, and we look at it at roughly three times, and that what equates to the rating agencies look at a more complex formula that separates out our finance receivables. But that tends to be our rule of thumb, three times.

The other thing is we tend to look at returning cash to shareholders to the extent we get free cash flow. And if you look at what we’ve done over the last five years, we’ve returned all of our cash to shareholders, either as dividends or share repurchase. And we have done that without jeopardizing the basic credit statistics. In other words, even though we’ve added debt to finance acquisitions, that ratio of debt-to-EBITDA has been very solid during that period.

Josh Golden - J.P. Morgan

Sure, that’s fair enough. So it is reasonable to assume that there won’t be in the future much of a deviation outside of that three times debt-to-EBITDA?

Bruce P. Nolop

All I can say is that that’s the current targets, and as Murray said, we’re going to be looking at strategies that make sense to deliver shareholder value. I don’t want to rule anything out but as of today, that is our intent.

Josh Golden - J.P. Morgan

Thank you.

Operator

And our next question comes from the line of Chris Whitmore with Deutsche Bank. Please go ahead.

Chris Whitmore - Deutsche Bank

Thanks very much. I wanted to get a little more clarity on the weakness you’re seeing in the U.S. capital spending environment. How much of that was isolated within the financial vertical versus other end markets? Could you provide any color beyond what you’re seeing in financials?

Bruce P. Nolop

I would say that in our case, that we are seeing it mostly in the financial services vertical and there are a few others that had impact. For example, retail, people that are exposed to the home market, that would be another area. But it just wasn’t enough of a factor to quantify for you, but I would say that in general, Pitney Bowes is very diversified across the economy and that’s one of our strengths.

But on the other hand, again, we’re not immune so as you see weakness in different sectors of the economy, that will affect our sales line and our incremental revenue as opposed to our base revenue.

Chris Whitmore - Deutsche Bank

How much is the large financials, or the U.S. financials as a percentage of total revenue currently?

Bruce P. Nolop

We estimate that overall for our revenue, it’s roughly 25% of our revenue would come from financial services industry.

Chris Whitmore - Deutsche Bank

Secondly, your business model has been shifting a bit from rental related revenue to supplies related revenue, and this quarter suggests the supplies line is a bit more sensitive to the economy than perhaps the rental line. So has the company’s cyclicality changed at all as the business has shifted more to a supplies base recurring revenue stream as opposed to a rental base model?

Bruce P. Nolop

There’s a slight change in the model towards supplies, but keep in mind that much of the supplies is really related to the basic postage meter, so in many ways it will be relatively constant, although you do have these quarter-over-quarter issues.

And I’d say that the business model, if you are looking for how it’s changing, it’s probably more toward software as a percent of revenue has come in, and even there though that we’re really emphasizing a maintenance stream as well as the sales stream.

Chris Whitmore - Deutsche Bank

Last question; it looks like receivables were up over 20% year on year. You mentioned the organic business --

Bruce P. Nolop

Right. On an organic basis -- yeah, they were a source of cash. They were actually -- we generated cash from receivables, so what you are seeing is really two things, primarily; currency and then the addition of acquisition.

Chris Whitmore - Deutsche Bank

Have you seen any changes in bad debt expense or delinquencies?

Bruce P. Nolop

Well, as I mentioned, we definitely saw it related to the mortgage industry and we are generally though looking at bad debt, the trend has been favorable and we’ve not seen anything that would contradict what has been a very favorable trend.

Chris Whitmore - Deutsche Bank

Okay. Thanks a lot.

Operator

Next we’ll go to the line of Vincent Lim with Goldman Sachs. Please go ahead.

Vincent Lim - Goldman Sachs

This is Vincent on behalf of Julio. I think most of my questions have been answered; just one really quick follow-up question regarding the financial services vertical. Since you brought up mortgage was one area of weakness that you saw, is there any other pocket within the financial services vertical, whether it’s commercial banks, broker dealers, capital markets, that you can point us to?

Murray D. Martin

I’d say no. When we talk about it, it’s just more general across it and I think it’s hard to pinpoint but we have exposure to all of the large financial institutions. So just think about people that do large amounts of mailings.

Vincent Lim - Goldman Sachs

Got it. Thanks.

Operator

And our final question in queue comes from the line of Matt Troy with Citigroup. Please go ahead.

Matt Troy - Citigroup

I think I’m done. Thanks.

Operator

(Operator Instructions) And there are no additional questions at this time.

Murray D. Martin

Thank you all for your questions and spending the time with us this evening. As I said earlier, we are looking to and will always continue to be focused on enhancing return to our shareholders. Over the last 50 years, we’ve delivered over 12.5% total return to our shareholders and we intend to continue that trend into the long-term.

We look forward to discussing with you on November the 15th more specific actions that we’ll be taking to enhance our value. Thank you and have a good evening.

Operator

Ladies and gentlemen, that does conclude your conference for today. If you wish to access the replay system, it will be available starting today at 8:30 through November 12th at midnight. You may access the AT&T teleconference replay system at any time by dialing 800-475-6701 and entering the access code 888763. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844. The access code is 888763.

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Source: Pitney Bowes Q3 2007 Earnings Call Transcript
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