PBI

Business Context and Reporting Period

Company: Pitney Bowes Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Pitney Bowes is the world's largest provider of mail processing equipment and integrated mail solutions. The company operates in two primary business groups: Mailstream Solutions (equipment, supplies, software) and Mailstream Services (management, mail, and marketing services). In 2006, the company completed the sale of its Capital Services external financing business and Imagistics lease portfolio, which are reported as discontinued operations.

Key Financial Metrics

Note: Net Income for 2006 was significantly reduced by a $460 million loss from discontinued operations, primarily due to the sale of Capital Services and related tax settlements.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 7% to $5.73 billion, driven by growth in supplies, financing, software, and mail services. Acquisitions contributed 2% to revenue growth.
• Profitability: Income from continuing operations rose 20% to $566 million. Earnings Before Interest and Taxes (EBIT) increased 8% to $1.37 billion.
• Discontinued Operations: The company recorded a net loss of $460 million from discontinued operations in 2006, compared to income of $35 million in 2005. This was driven by a $445 million loss on the sale of Capital Services and a $41 million tax charge related to an IRS settlement.
• Cash Flow: Operating cash flow turned negative at $(287) million, a sharp decline from $530 million in 2005. This was primarily due to a $1.1 billion payment to the IRS to settle tax disputes and fund the sale of Capital Services.
• Equity Reduction: Stockholders' equity decreased by approximately $665 million, largely due to the adoption of SFAS 158 (pension accounting), which reduced equity by $297 million, and the impact of discontinued operations.

Guidance, Outlook, and Risks

Outlook: Management anticipates solid financial results for 2007. The company expects a changing mix of product sales with a greater percentage of revenue from smaller, fully featured systems. The passage of the Postal Accountability and Enhancement Act is viewed as a positive catalyst for industry growth.

Key Risks and Contingencies:

• Legal Proceedings: The company is a defendant in a patent infringement suit by Ricoh Company, Ltd. While Pitney Bowes prevailed at trial (patents found invalid), Ricoh is expected to appeal. Additionally, the subsidiary Imagitas faces nine class-action lawsuits alleging violations of the Drivers Privacy Protection Act (DPPA).
• Postal Regulations: Revenue is heavily dependent on USPS and foreign postal regulations. Changes in postal rates, processes, or the decline of physical mail volumes pose significant risks.
• Tax Matters: The company settled outstanding tax audit issues with the IRS for years through 2000, resulting in a $1.1 billion payment. Future changes in tax reserves or laws could materially impact results.
• Market Risk: Exposure to foreign currency fluctuations and interest rate changes, though managed through hedging strategies.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by analyzing "Income from Continuing Operations" ($566M) rather than "Net Income" ($105M), as the latter is distorted by one-time divestiture losses.
• Cash Flow Recovery: Monitor the recovery of operating cash flow in 2007, given the massive $1.1 billion IRS payment and negative operating cash flow in 2006.
• Legal Outcomes: Track the status of the Ricoh patent appeal and the Imagitas DPPA class-action lawsuits for potential future liabilities.
• Dividend Sustainability: Confirm the company's ability to maintain its dividend (increased to $0.33/share in Q1 2007) amidst reduced equity and cash flow volatility.
• Segment Performance: Review the growth trajectory of the Mailstream Services segment, which saw EBIT grow 48% in 2006, as a key driver of future profitability.