ITEM 1 - BUSINESS
Our company was incorporated in the state of Delaware on April 23, 1920, as the Pitney Bowes Postage Meter Company. Today, we are a provider of leading-edge global, integrated mail and document management solutions for organizations of all sizes.
Pitney Bowes Inc. and its subsidiaries (which we refer to in this Form 10-K as us, we, our or the company) operate in three reportable segments: Global Mailing, Enterprise Solutions and Capital Services. We operate both inside and outside the United States. Our financial information concerning revenue, operating profit and identifiable assets, by reportable segment and geographic area, appears on pages 71 to 73 of this Form 10-K.
For more information about us, our products, services and solutions, visit www.pitneybowes.com. Also, our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K will be made available free of charge through the Investor Relations section of our website as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission.
Global Mailing
Our Global Mailing segment includes worldwide revenue and related expenses from the rental of postage meters and the sale, rental and financing of mailing equipment, including mail finishing and software-based mail creation equipment. We also include in this segment, software-based shipping, transportation and logistics systems, related supplies and services, presort mail services, postal payment solutions and supply chain solutions such as order management and fulfillment support. We sell, rent or finance our products. We sell our supplies and services. Some of our products are sold through dealers outside the United States.
Products in this segment include postage meters, mailing machines, address hygiene software, manifest systems, letter and parcel scales, mail openers, mailroom furniture, folders, paper handling equipment, shipping equipment, software-based shipping and logistics systems, presort machines and postal payment solutions.
Enterprise Solutions
Our Enterprise Solutions segment comprises two divisions - Pitney Bowes Management Services (PBMS) and Document Messaging Technologies (DMT). In this segment, we sell, rent or finance our products, while we sell supplies and services.
PBMS includes revenue and related expenses from facilities management contracts for advanced mailing, secure mail services, reprographic, document management and other high-value services. PBMS offers a variety of business support services to our customers to manage copy, reprographic and mail centers, facsimile, electronic printing and imaging services, and records management. PBMS is a major provider of on- and off-site services which helps our customers manage the creation, processing, storage, retrieval, distribution and tracking of documents and messages in both paper and digital form.
DMT includes revenue and related expenses from the sale, service and financing of high speed, software-enabled production mail systems, sorting equipment, incoming mail systems, electronic statement, billing and payment solutions, and mailing software.
We include our internal financial services operations in both the Global Mailing and Enterprise Solutions segments. The internal financial services operations provide lease financing for our products in the U.S., Canada, the United Kingdom, Germany, France, Norway, Ireland, Australia, Austria, Spain, Italy, Switzerland and Sweden.
Capital Services
Our Capital Services segment consists of external financing for non-Pitney Bowes equipment, including the strategic financing of third-party equipment. It comprises primarily asset and fee-based income generated by financing or arranging transactions of critical large-ticket customer assets.
In January 2003, we announced that we would stop active pursuit of, and growth in, long-term Capital Services financing transactions, including long-term financing of postal and related equipment. We will continue to provide lease financing for our products through our internal financing operations.
In the past, we have directly financed or arranged financing for commercial and non-commercial aircraft, real estate, over-the-road trucks and trailers, locomotives, railcars, rail and bus facilities, office equipment and high-technology equipment such as data processing and communications equipment.
Support Services
We maintain extensive field service organizations in the U.S. and some other countries to provide support services to customers who have rented, leased or purchased equipment. These support services, which are usually in the form of annual maintenance contracts, accounted for approximately 13 percent of revenue in 2002, 2001 and 2000.
Marketing
Our products and services are marketed through an extensive network of offices in the U.S. and through a number of our subsidiaries and independent distributors and dealers in many countries throughout the world. We also use direct marketing, outbound telemarketing and the Internet. We sell to a variety of business, governmental, institutional and other organizations. We believe we have a broad base of customers, and we are not dependent upon any one customer or type of customer for a significant part of our business. We do not have significant backlog or seasonality relating to our businesses.
Credit Policies
We establish credit approval limits and procedures at regional, divisional, subsidiary and corporate levels based on the credit quality of the customer and the type of product or service provided. In addition, we utilize an Automatic Approval Program (“AAP”) for certain leases within the internal financing divisions. The AAP program is designed to facilitate low dollar transactions by utilizing historical payment patterns and losses realized for customers with common credit characteristics. The program dictates the criteria under which we will accept a customer without performing a more detailed credit investigation. The AAP considers criteria such as maximum equipment cost, a customer’s time in business and current payment experience with our internal financing division.
We base our credit decisions primarily on a customer’s financial strength, and, in the case of our Capital Services programs, we also consider collateral values.
Credit Experience
In 2002, the U.S. airline industry experienced a rapid deterioration in business conditions. For a further discussion of our aircraft leasing investments, please refer to Capital Services on page 23.
Excluding aircraft leasing investments, the percentage of receivables over 30 days delinquent was 7.4 percent at December 31, 2002, 8.1 percent at December 31, 2001 and 7.5 percent at December 31, 2000 of which the percentage relating to financial services was 53 percent, 58 percent and 60 percent at December 31, 2002, 2001 and 2000, respectively.
We have charged against the allowance for doubtful accounts losses of $13.7 million, $10.3 million and $11.6 million in 2002, 2001 and 2000, respectively. Charges against the allowance for credit losses on finance receivables were $66.3 million, $50.4 million and $65.8 million in 2002, 2001 and 2000, respectively.
Operations Outside the United States
Our manufacturing operations outside the U.S. are in the United Kingdom, France and Germany.
Competition
Historically, we have been a leading supplier of products and services in our business segments, particularly postage meters and mailing machines. Our meter base and our continued ability to place meters in key markets is a significant contributor to our current and future revenue and profitability. However, all of our segments face strong competition from a number of companies. In particular, we face competition in many countries for new placements from several postage meter and mailing machine suppliers, and our mailing systems products face competition from products and services offered as alternative means of message communications. PBMS, a major provider of business support services and document management to the corporate, financial services, and professional services markets, competes against national, regional and local firms specializing in facilities and document management. We believe that our long experience and reputation for product quality, and our sales and support service organizations are important factors in influencing customer choices with respect to our products and services.
The financing business is highly competitive with aggressive rate competition. Leasing companies, commercial finance companies, commercial banks and other financial institutions compete, in varying degrees, in the several markets in which our finance operations do business. Our competitors range from very large, diversified financial institutions to many small, specialized firms. In view of the market fragmentation and absence of any dominant competitors, we believe that it is not possible to provide a meaningful description of our finance operations’ competitive position in these markets.
Research and Development/Patents
We have research and development programs that are directed toward developing new products and service methods. Our expenditures on research and development totaled $141.3 million, $133.1 million and $120.5 million in 2002, 2001 and 2000, respectively.
As a result of our research and development efforts, we have been awarded a number of patents with respect to several of our existing and planned products. However, we believe our businesses are not materially dependent on any one patent or any group of related patents. We also believe our businesses are not materially dependent on any one license or any group of related licenses.
Material Supplies
We believe we have adequate sources for most parts and materials for our products that we manufacture. However, these products rely to an increasing extent on microelectronic components, and temporary shortages of these components have occurred from time to time due to the demands by many users of such components. However, we do not expect these temporary shortages to have a material adverse impact on our business.
Regulatory Matters
We are subject to the U.S. Postal Service’s regulations and those of foreign postal authorities, related to product specifications and business practices. From time to time, we will work with these governing bodies to help in the enhancement and growth of mail and the mail channel. See Legal and Regulatory Matters in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Form 10-K.
Employee Relations
At December 31, 2002, we employed 25,188 persons in the U.S. and 7,942 persons outside the U.S. We believe that employee relations are satisfactory. The large majority of our employees are not represented by any labor union. Our management follows the policy of keeping employees informed of decisions, and encourages and implements employee suggestions whenever practicable.
ITEM 2
ITEM 2 - PROPERTIES
Our World Headquarters and certain other office and manufacturing facilities are located in Stamford, Connecticut. We have additional office facilities located in Shelton, Connecticut. We maintain research and development operations at a corporate engineering and technology center in Shelton, Connecticut. A sales and service training center is located near Atlanta, Georgia. We believe that our current manufacturing, administrative and sales office properties are adequate for the needs of all of our operations.
In 2002, we announced that we are reviewing options for real estate realignment, including alternative sites for our World Headquarters office, in order to better meet our long-term needs. We are continuing to review the alternatives and have made no decisions to date.
Global Mailing
Global Mailing products are manufactured in a number of plants principally in Connecticut, as well as in Harlow, England; Friedberg, Germany; Lyon, France and St. Denis, France. Most of these facilities are owned by the company. At December 31, 2002, there were 151 sales, support services and finance offices, substantially all of which are leased, located throughout the U.S. and in a number of other countries.
Enterprise Solutions
Our Document Messaging Technologies business is headquartered in Danbury, Connecticut. We lease twelve facilities located throughout the U.S. Our Management Services business is headquartered in Stamford, Connecticut and leases 40 facilities located throughout the U.S. and in Canada, England, Belgium, Denmark, France, Germany, Norway, Netherlands and Sweden.
Our headquarters of our financing operations within the U.S. is located in Shelton, Connecticut. Offices of our financing operations outside the U.S. are maintained in Mississauga, Ontario, Canada; Harlow, England; Heppenheim, Germany; Paris, France; Oslo, Norway; Dublin, Ireland; French’s Forest, Australia; Vienna, Austria; Effretikon, Switzerland; Milan, Italy; Barcelona, Spain; and Stockholm, Sweden.
Capital Services
Our wholly-owned subsidiary, Pitney Bowes Credit Corporation (PBCC), leases an executive and administrative office in Shelton, Connecticut, which is owned by Pitney Bowes Inc. There are eight leased regional and district sales offices located throughout the U.S.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
In the ordinary course of normal business, we are routinely defendants in or parties to a number of pending and threatened legal actions including proceedings purportedly brought on behalf of classes of claimants. These may involve litigation by or against us relating to, among other things:
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contractual rights under vendor, insurance or other contracts
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intellectual property or patent rights
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equipment, service, payment or other disputes with customers
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disputes with employees
Included among these cases are two patent actions, one with Stamps.com and one with Ricoh Company, Ltd. in which allegations of infringement have been made against our DM SeriesTM of products. In addition, we are defendants in several state court actions relating to a program PBCC offers to some of its leasing customers to replace the leased equipment if it is lost, stolen or destroyed. Of the current actions, three are purportedly brought on behalf of state-based classes of customers and the others are brought on behalf of individual customers. No court has ruled on whether or not the cases may proceed on a class basis. We have previously prevailed at the summary judgment stage in two similar litigations, including one federal court decision affirmed by the United States Court of Appeals for the Fifth Circuit.
In those cases where we are the defendant, plaintiffs may seek to recover large and sometimes unspecified amounts of damages or other types of relief and some matters may remain unresolved for several years. Although we cannot predict the outcome of such matters, based on current knowledge, management does not believe that the ultimate outcome of the litigations referred to in this section will have a material adverse effect on our financial position, results of operations or cash flows. However, if the plaintiffs do prevail, the result may have a material effect on our financial position, future results of operations or cash flows. See Legal and Regulatory Matters in Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Legal Settlements, net section under Special Items in Item 7 of this Form 10-K.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our shareholders during the three months ended December 31, 2002.
Executive Officers of the Registrant
* Ms. Moss resigned her position for family related reasons, effective February 2003. Michele Coleman Mayes joined the company effective February 2003 as Senior Vice President and General Counsel. Prior to joining the company, Ms. Mayes was Vice President - Legal, Assistant Secretary and Corporate Officer of Colgate-Palmolive Company. Ms. Mayes also served as Vice President and Deputy General Counsel - International and Corporate as well as Vice President of Human Resources and Legal for Colgate North America. Prior to joining Colgate-Palmolive Company, Ms. Mayes also held various legal positions at Unisys Corporation.
There is no family relationship among the above officers, all of whom have served in various corporate, division or subsidiary positions with the company for at least the past five years except G.E. Buoncontri, L.A. Jimenez, M. Mayes and B.P. Nolop.
Mr. Buoncontri was formerly the Vice President, Information Technology and Chief Information Officer of Novartis Pharmaceuticals Corp. (merger of Sandoz and Ciba Geigy). Prior to the merger, he also served as the Vice President, Information Systems and Chief Information Officer for Sandoz Pharmaceuticals Company. Mr. Buoncontri also served as Vice President, Information Management Services and Chief Information Officer of Asea Brown Boveri, Inc.
Mr. Jimenez joined the company from Arthur D. Little, an international management consulting company, with over 25 years of experience. Mr. Jimenez was appointed worldwide practice leader for postal organizations in 1990, Corporate Vice President in 1991, and served most recently on the firm’s global board for telecommunications and media and as Manager of the Latin American practice.
Mr. Nolop joined the company from Wasserstein Perella & Co., an investment bank and one of Pitney Bowes’ financial advisors, where he had served as managing director since 1993. Prior to joining Wasserstein Perella & Co., Mr. Nolop held senior positions with Goldman Sachs & Co., Kimberly-Clark Corporation and Morgan Stanley & Co.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDERS’ MATTERS
Pitney Bowes common stock is traded under the symbol “PBI”. The principal market is the New York Stock Exchange. The stock is also traded on the Chicago, Philadelphia, Boston, Pacific and Cincinnati stock exchanges. At December 31, 2002, the company had 27,418 common stockholders of record.
Stock Information
Dividends per common share
Quarterly price ranges of common stock
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following tables summarize selected financial data for the company, and should be read in conjunction with the more detailed consolidated financial statements and related notes thereto included under Item 8 of this Form 10-K.
Summary of Selected Financial Data
(Dollars in thousands, except per share amounts)
Note: The sum of the earnings per share amounts may not equal the totals due to rounding.
Free cash flow is defined as net cash provided by operating activities less net investment in fixed assets. See reconciliation on page 32. Free cash flow, earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation and amortization (EBITDA) are not presented as an alternative measure of operating results or cash flow from operations, as determined in accordance with generally accepted accounting principles, but are presented because we believe they are widely accepted indicators of our ability to incur and service debt. EBIT and EBITDA do not give effect to cash used for debt service requirements and capital expenditures and thus do not reflect funds available for reinvestment, dividends or other discretionary uses. In addition, free cash flow, EBIT and EBITDA as presented in this summary schedule may not be comparable to similarly titled measures reported by other companies.
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We continue to build on the core activities that support our strong competitive position in integrated mail and document management solutions.
We operate in three reportable segments: Global Mailing, Enterprise Solutions and Capital Services.
Our Global Mailing segment includes worldwide revenue and related expenses from the rental of postage meters and the sale, rental and financing of mailing equipment, including mail finishing and software-based mail creation equipment. We also include in this segment software-based shipping, transportation and logistics systems, related supplies and services, presort mail services, postal payment solutions and supply chain solutions such as order management and fulfillment support.
Our Enterprise Solutions segment comprises Pitney Bowes Management Services (PBMS) and Document Messaging Technologies (DMT). PBMS includes revenue and related expenses from facilities management contracts for advanced mailing, reprographic, document management and other high-value services. DMT includes revenue and related expenses from the sale, service and financing of high speed, software-enabled production mail systems, sortation equipment, incoming mail systems, electronic statement, billing and payment solutions, and mailing software.
Our Capital Services segment consists of external financing for non-Pitney Bowes equipment, including the strategic financing of third-party equipment. It comprises primarily asset and fee-based income generated by financing or arranging transactions of critical large-ticket customer assets. In January 2003, we announced that we would stop active pursuit of, and growth in, long-term Capital Services financing transactions, including long-term financing for postal and related equipment. We will continue to provide lease financing for our products through our internal financing operations.
During 2002, we completed the acquisition of PSI Group, Inc. (PSI), the nation’s largest mail presort company with operating centers across the U.S. This increased our presence in the domestic market for mail-related services.
During 2001, we completed several acquisitions that increased our presence in both domestic and international markets and that we believe will better position the company for long-term growth and enhanced shareholder value. These acquisitions included the following:
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Secap SA (Secap), a mailing systems company based in France.
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Danka Services International (DSI), a provider of on- and off-site document management services in the U.S. and Europe.
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Bell & Howell’s International Mail and Messaging Technologies (MMT) business in Europe, Africa, the Middle East and Asia.
On December 3, 2001, we completed the spin-off of our office systems business to stockholders as an independent, publicly-traded company under the name of Imagistics International Inc. (IGI). On that date, we paid a special stock dividend of IGI common stock to our common shareholders. Through this special dividend, we distributed 100% of the shares of IGI stock to common shareholders of the company. The historical carrying amount of the IGI net assets distributed to our shareholders on the spin-off date has been recorded as a stock dividend of $311.7 million. We have segregated the operating results of IGI and reported them as discontinued operations in the Consolidated Statements of Income. In connection with the spin-off, we recorded a loss of approximately $26.0 million (net of taxes of $12.2 million) for the year ended December 31, 2001. See Note 12 to the consolidated financial statements.
On January 14, 2000, we sold Atlantic Mortgage & Investment Corporation (AMIC), a wholly-owned subsidiary of the company, to ABN AMRO North America. In connection with this transaction, we recorded a gain of $12.5 million (net of taxes of $7.4 million) for the year ended December 31, 2002. This gain resulted from the favorable resolution of certain contingent liabilities recorded at the time of sale. See Note 12 to the consolidated financial statements.
On October 30, 1998, Colonial Pacific Leasing Corporation (CPLC), a wholly-owned subsidiary of the company, transferred the operations, employees and substantially all assets related to its broker-oriented external financing business to General Electric Capital Corporation, a subsidiary of the General Electric Company. In connection with this transaction, we recorded a gain of $25.5 million (net of taxes of $15.0 million) for the year ended December 31, 2002. This gain resulted from the favorable resolution of certain contingent liabilities recorded at the time of sale. See Note 12 to the consolidated financial statements.
Critical Accounting Policies
We have identified the policies below as critical to our business operations and to the understanding of our results of operations. We discuss the impact and any associated risks on our results of operations related to these policies throughout Management’s Discussion and Analysis of Financial Conditions and Results of Operations. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the consolidated financial statements.
The preparation of our financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates include, but are not limited to customer cancellations, bad debts, inventories, investments, useful lives of long-lived assets, intangible assets, income taxes, financing operations, warranty obligations, restructuring, pensions and other postretirement benefits, and contingencies and litigation. Our actual results could differ from those estimates.
Revenue recognition
We derive our revenue from the following sources:
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sales;
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business services;
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rentals and financing; and
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support services
In accordance with generally accepted accounting principles, we recognize revenue from these sources as follows:
Sales revenue
Sales of equipment
We sell equipment to our customers, as well as to distributors and dealers (re-sellers) throughout the world. Revenue from these sales is recognized upon the transfer of title, which is at the point of shipment. We do not offer any rights of return or stock balancing rights.
Our sales revenue from customized equipment and software-enabled mail creation equipment and shipping products is generally recognized when installed.
Sales of supplies
Revenue related to supplies is recognized at the point of title transfer, which is upon shipment.
Software licenses and integration services
We recognize revenue related to off-the-shelf software licenses upon transfer of title, which is upon shipment. We recognize revenue from software requiring integration services at the point of customer acceptance.
Business services revenue
Business services
Business services revenue includes revenue from PBMS and PSI.
Management services, which includes outsourcing of mailrooms, copy centers, or other document management functions, are typically annual or longer contracts that contain a monthly service fee and in many cases a “click” charge based on the number of copies made, machines in use, etc. Revenue is recognized over the term of the agreement, based on monthly service charges, with the exception of the “click” charges, which are recognized as incurred.
Presort mail services include the preparation, sortation and aggregation of mail to earn postal discounts and expedite delivery for our customers. Revenue is recognized over the term of the agreement as earned.
Rentals revenue
Product rentals
We rent equipment to our customers, primarily postage meters, mailing equipment and shipping systems under short-term rental agreements, generally for periods of three months to three years. We invoice in advance the charges for equipment rental. We defer the billed revenue and include it initially in advance billings. Rental revenue is recognized on a straight-line basis over the term of the rental agreement.
Financing revenue
Product financing arrangements
We provide lease financing of our products in the U.S. and outside the U.S. through sales-type leases.
When a sales-type lease is consummated, we record the gross finance receivable, unearned income and the estimated residual value of the leased equipment. Unearned income represents the excess of the gross finance receivable plus the estimated residual value over the sales price of the equipment. We recognize the equipment sale at the inception of the lease. We recognize unearned income as earned using the interest method over the term of the transaction. Earned income is included in rentals and financing revenue in the Consolidated Statements of Income.
Capital Services revenue
We provide financing for non-Pitney Bowes equipment through direct financing leases and leveraged leases.
When a direct financing lease is consummated, we record the gross finance receivable, unearned income and the estimated residual value of the leased equipment. Unearned income represents the excess of the gross receivable plus the estimated residual value over the cost of the equipment. We account for initial direct costs incurred in consummating a transaction as part of the investment in the lease and appropriately amortize these costs using the interest method over the term of the lease. We recognize unearned income as earned using the interest method over the term of the transaction. Earned income is included in financing revenue in the Consolidated Statements of Income.
From time to time, we sell selected finance assets. We follow Statement of Financial Accounting Standards (FAS) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” when accounting for our sale of finance assets. We recognize all assets obtained or liabilities incurred in consideration as proceeds of the sale and recognize any gain or loss on the sale in earnings.
Our investment in leveraged leases consists of rentals receivable net of principal and interest on the related nonrecourse debt, estimated residual value of the leased property and unearned income. We recognize the unearned income as leveraged lease revenue over the lease term. Earned income is included in financing revenue in the Consolidated Statement of Income.
Support services revenue
Equipment maintenance agreements
We provide support services to our customers primarily through extended maintenance contracts. Revenue related to these agreements is recognized on a straight-line basis over the term of the agreement.
Multiple element arrangements
Certain of our transactions are consummated at the same time. The usual form of this transaction involves the sale or lease of equipment, a cancelable meter rental and/or a cancelable equipment maintenance agreement.
In these cases, fair value of the various elements is determined by using the “residual method.” In applying this method, the fair values of any meter rental or equipment maintenance agreement are determined to be equivalent to the price charged in a standalone or renewal transaction. Any remaining consideration is allocated to the value of the equipment.
Allowance for doubtful accounts
We estimate our accounts receivable risks and provide allowances for doubtful accounts accordingly. We believe that our credit risk for accounts receivable is limited because of the large number of our customers and the relatively small account balances for most of our customers. Also, our customers are dispersed across different businesses and geographic areas. We believe that our allowance for doubtful accounts is sufficient.
We evaluate the adequacy of the allowance for doubtful accounts on a periodic basis. Our evaluation includes historical loss experience, adverse situations that may affect a customer’s ability to repay, and prevailing economic conditions. We make adjustments to our allowance if the evaluation of allowance requirements differs from the actual aggregate reserve. This evaluation is inherently subjective because our estimates may be revised as more information becomes available.
Allowance for credit losses
We estimate our finance receivables risks and provide allowances for credit losses accordingly. Our financial services businesses establish credit approval limits based on the credit quality of the customer and the type of equipment financed. We charge finance receivables through the allowance for credit losses after collection efforts are exhausted and we deem the account uncollectible. Our financial services businesses base credit decisions primarily on a customer’s financial strength. We believe that our concentration of credit risk for finance receivables in our internal financing division is limited because of our large number of customers, small account balances and customer geographic and industry diversification. In addition, in our Capital Services programs, we may also consider collateral values.
Our general policy for finance receivables contractually past due for over 90 to 120 days is to discontinue revenue recognition. We resume revenue recognition when payments reduce the account to 60 days or less past due. In our Capital Services programs, we discontinue revenue recognition as soon as it is apparent that the obligor will not be making payments in accordance with lease terms, such as in the event of bankruptcy. Otherwise, we discontinue revenue recognition when accounts are over 90 days past due.
We evaluate the adequacy of allowance for credit losses on a periodic basis. Our evaluation includes historical loss experience, the nature and volume of our portfolios, adverse situations that may affect a customer’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. We make adjustments to our allowance for credit losses if the evaluation of reserve requirements differs from the actual aggregate reserve. This evaluation is inherently subjective because our estimates may be revised as more information becomes available.
Accounting for income taxes
When we prepare our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We record this amount as a provision for our taxes in accordance with FAS No. 109, “Accounting for Income Taxes.” This process requires us to make the following assessments:
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we estimate our actual current tax liability in each jurisdiction.
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we estimate our temporary differences resulting from differing treatment of items, such as lease revenue and related depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we include within our Consolidated Balance Sheet.
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we then assess the likelihood that our deferred tax assets will be recovered from future taxable income and if we believe that recovery is not likely, we establish a valuation allowance.
At any time, our provision for taxes could be impacted by changes in tax law and interpretations by governments or courts.
Long-lived assets
Long-lived assets include:
Property, plant and equipment
We state property, plant and equipment at cost. We depreciate property, plant and equipment principally using the straight-line method over estimated useful lives: machinery and equipment principally three to 15 years and buildings up to 50 years. We capitalize major improvements which add to productive capacity or extend the life of an asset and we charge to expense as incurred repairs and maintenance. We depreciate rental equipment on the straight-line method over appropriate periods, principally three to ten years. Changes in regulatory provisions or technology may impact the useful lives of these assets. We depreciate other depreciable assets using either the straight-line method or accelerated methods. We amortize properties leased under capital leases on a straight-line basis over the primary lease terms.
We capitalize certain costs of internally developed software. These costs include purchased materials and services, payroll and payroll related costs and interest costs. We amortize internally developed software on a straight-line basis over the estimated useful life, which is principally three to ten years.
We do not capitalize software development costs related to software to be sold, leased, or otherwise marketed due to the fact that the period between establishment and testing of a working model and the general availability of our software has historically been short and the related software development costs qualifying for capitalization in accordance with FAS No. 86 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” have been insignificant.
Goodwill
Goodwill represents the excess of cost over the value of net tangible and other intangible assets acquired in business combinations. Goodwill acquired under business combinations completed prior to June 30, 2001 has been amortized, through December 31, 2001, using the straight-line method over its estimated useful life, principally 40 years. Goodwill acquired under business combinations completed after June 30, 2001 has not been amortized.
Other intangible assets
Intangible assets with finite lives, acquired under business combinations, are amortized using the straight-line method over estimated useful lives, principally five to 15 years.
Impairment review
Periodically, we assess the carrying value of our long-lived and intangible assets. Our assessment involves comparing the carrying value of the asset on our Consolidated Balance Sheet to the cash flows we expect to generate in the future by that asset. We forecast the cash flows based on our assessment of our business. If the expected cash flows are less than the asset’s carrying value, we record an impairment charge on that asset.
We believe that we have no impairment to our assets as of December 31, 2002. However, future events and circumstances, some of which are described below, may result in an impairment charge:
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changes in postal regulations governing the types of meters allowable for use. However, recent regulations were issued in November 2001, and therefore we do not expect new regulations for the foreseeable future.
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new technological developments that provide significantly enhanced benefits over current digital technology
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significant negative economic or industry trends
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changes in our business strategy that alter the expected usage of the related assets
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significant increase or decrease in our cost of capital
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future terrorist or other actions that significantly impact the volume of mail
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future economic results that are below our expectations used in the current assessments.
Special Items
Diluted earnings per share from continuing operations were $1.81, $2.08 and $2.18 for the years ended December 31, 2002, 2001 and 2000, respectively. Diluted earnings per share in 2002 included Capital Services charges of 56 cents per diluted share, related to a write-down of our investments in commercial passenger aircraft leasing and to increase our provision for credit losses primarily related to the rapid deterioration of the U.S. airline industry. Diluted earnings per share in 2001 included a charge of 68 cents per diluted share related to assets associated with our non-networked mailing technology, a charge of 30 cents per diluted share related to restructuring initiatives and a net gain of 82 cents per diluted share from legal settlements. Diluted earnings per share in 2000 includes a charge of 4 cents per diluted share related to restructuring initiatives and a gain of 5 cents per diluted share related to state tax law changes. Excluding the impact of these special items, diluted earnings per share from continuing operations was $2.37, $2.25 and $2.17 for the years ended December 31, 2002, 2001 and 2000, respectively.
A discussion of these items is as follows:
Capital Services charges
In 2002, we recorded a non-cash pre-tax charge of approximately $213 million, to write down our investments in commercial passenger aircraft leases primarily with US Airways Group, Inc. (US Airways) and United Air Lines (United) and to increase our provision for credit losses primarily related to commercial passenger aircraft leasing investments in the U.S. The charge was composed of the following:
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A write-down of U.S. aircraft lease receivables and residuals of approximately $110 million
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Additional credit loss reserves related to U.S. aircraft lease investments of approximately $82 million
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Other costs related to our aircraft leasing investments of approximately $1 million; and
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Additional credit loss reserves related to non-aircraft Capital Services investments of approximately $20 million.
The decision of US Airways and United to file for bankruptcy exacerbated an already difficult environment in the airline industry. As a result of the rapid deterioration of the U.S. airline industry as well as our revised Capital Services strategy, we recorded a charge of
approximately $82 million to increase our provision for credit losses related to our aircraft leasing investments in the U.S. As a result of these events, combined with both the deteriorating financial condition in various other industries and the change in our Capital Services strategy, we also recorded a charge of approximately $20 million to increase our provision for credit losses related to non-aircraft leasing investments, including investments in the telecommunications industry.
A further breakdown of the charge related to aircraft lease investments by individual airline is presented on page 24.
Meter transition
In 2001, we adopted a formal plan to transition to the next generation of networked mailing technology. The information capture and exchange, made possible by advanced technology, turns the postage meter into an “intelligent” terminal that networks the mailer to postal and carrier information and systems. This two-way information architecture, in turn, enables convenient access to and delivery of value-added services such as tracking, delivery confirmation and rate information. The adoption of this plan was facilitated by our expanded access to technology and our ability to move to networked products combined with our expectations that the U.S. and postal services around the world will continue to encourage the migration of mailing systems to networked digital technologies. In connection with this plan, we recorded non-cash pre-tax charges of $268.3 million for the year ended December 31, 2001, related to assets associated with our non-networked mailing technology. We have segregated these charges in the Consolidated Statement of Income for the year ended December 31, 2001. In November 2001, postal regulations were issued, consistent with our meter transition plan, defining the meter migration process and timing. See Regulatory Matters.
Restructuring charges
In 2001, we adopted a formal restructuring plan to implement a common, streamlined business infrastructure across the corporation as a result of our decisions to spin off our office systems business and align our mailing business on a global basis, as well as cost saving opportunities resulting from strategic acquisitions and partnerships, and additional benefits attained from the consolidation of our information technology organization and enterprise-wide resource planning initiatives. In connection with this plan, we recorded pre-tax restructuring charges of $149.3 million in 2001, of which $116.1 million was related to continuing operations and the remaining $33.2 million was related to discontinued operations. We have segregated the restructuring charges related to continuing operations in the Consolidated Statement of Income for the year ended December 31, 2001. The restructuring charges related to discontinued operations are included in discontinued operations in the Consolidated Statement of Income for the year ended December 31, 2001.
In 2000, we recorded a pre-tax charge of approximately $19 million related to the consolidation of information technology staff and infrastructure. We have segregated this charge in the Consolidated Statement of Income for the year ended December 31, 2000.
Legal settlements, net
In 2001, the company and Hewlett-Packard announced that they had reached an agreement resolving a lawsuit filed by us in 1995. The lawsuit arose out of a dispute over print technology patents. Under the terms of the agreement, the companies resolved all pending patent litigation without admission of infringement and we received $400 million in cash and ten year supply and technology agreements. We recorded the cash payment, net of legal fees and related expenses of $37.8 million, as other income in the Consolidated Statement of Income for the year ended December 31, 2001.
In 2001, we recorded a pre-tax charge of approximately $24 million associated with the settlement of a lawsuit related to lease upgrade pricing in the early to mid-1990s. The $24 million charge relates to the following settlement costs: award certificates to be provided to members of the class for purchase of office products through the Pitney Bowes supply line and the cost of legal fees and related expenses of $8.3 million. We included this charge in other income in the Consolidated Statement of Income for the year ended December 31, 2001.
State tax benefits
In 2000, we recorded a one-time tax benefit of $12 million related primarily to state tax law changes.
The following table reconciles GAAP to Proforma income from continuing operations for the years ended December 31, 2002, 2001 and 2000, respectively:
Results of Continuing Operations 2002 Compared to 2001
In 2002, our revenue increased 7%, income from continuing operations decreased 15% and diluted earnings per share from continuing operations decreased 13% to $1.81 compared with $2.08 for 2001. Excluding special items in both periods, as identified on page 14, income from continuing operations increased 3% and diluted earnings per share from continuing operations increased 5% to $2.37 compared with $2.25 for 2001. Excluding the acquisitions of PSI, Secap, DSI, and MMT, our revenue increased 1%. These acquisitions increased our operating profit, but including related financing costs, did not materially affect earnings either on a per share or aggregate basis.
Revenue
The following table shows revenue in 2002 and 2001 by segment:
Total Messaging Solutions revenue grew 8% over the prior year. The revenue increase came from growth in the Global Mailing and Enterprise Solutions segments of 6% and 12%, respectively, over 2001. Approximately 77% of our total revenue in 2002 is recurring revenue, which we believe is a continuing good indicator of potential repeat business.
Excluding the acquisitions of PSI, Secap and MMT, Global Mailing revenue increased 2%. Global Mailing revenue in the U.S. benefited from the placement of new digital mailing systems and the demand for our mail creation and distribution solutions products. Our new DM Series™ of digital mailing systems featuring IntellilinkTM technology has experienced strong customer satisfaction. Within the Global Mailing segment, international mailing revenue grew 17 percent, driven by revenue from the acquisition of Secap, improved revenue trends in the U.K. and Canada and the favorable impact of foreign currency. Excluding revenue from the acquisition of Secap and the favorable impact of foreign currency, international mailing revenue grew 2%. This revenue growth was achieved despite lower revenue in Germany and several other European countries, where demand has been slower for mailing equipment in a post meter migration environment, and where the company has not yet launched its new DM SeriesTM.
Enterprise Solutions revenue growth of 12% over the prior year was driven by a 19% increase at PBMS primarily as a result of the acquisition of DSI. Excluding the acquisition of DSI, PBMS revenue grew 4%. PBMS continues to improve its competitive position and generate strong growth in new written business, particularly in the higher value document management services, but this growth was partially offset by the continued contraction of large enterprise accounts, especially in the financial services and legal sectors. DMT revenue decreased 7% over the prior year as businesses continue to delay large capital spending decisions, which in turn slowed worldwide demand for our high speed, software-enabled production mail equipment and mail processing software.
Capital Services revenue decreased 6% due to our previously stated strategy to concentrate on fee-based income opportunities.
Operating profit
The following table shows operating profit in 2002 and 2001:
Operating profit grew 4% over the prior year which reflected contributions from the acquisitions, as well as our continuing emphasis on reducing costs and controlling operating expenses. Operating profit grew 4% in the Global Mailing segment and 7% in the Enterprise Solutions segment.
Global Mailing operating profit grew 4% supported by revenue growth and the effect of our continued emphasis on reducing costs and controlling operating expenses. Operating profit was adversely affected by moderating customer orders and upgrades due to the continuing weak economy and a shift to lower margin products and services.
The operating profit growth in our Enterprise Solutions segment came from 11% operating profit growth at PBMS offset by a 5% operating profit decrease at DMT. The operating profit growth at PBMS was supported by strong revenue growth. Operating profit was adversely affected by costs associated with acquiring new accounts, and investments in product technology and infrastructure, especially in Europe. DMT’s operating profit decline was driven by slower placements of high margin equipment, an increase in lower margin service revenue and continued investment in new product development.
Operating profit increased 4% in the Capital Services segment due primarily to the decline in interest rates.
The following table shows revenue in 2002 and 2001 by source of revenue:
Sales revenue remained flat in 2002. Sales growth was adversely affected by the continued slowdown of the global economy which has resulted in moderating customer orders and upgrades at Global Mailing and DMT. Additionally, sales growth was adversely affected by our focus on rentals revenue, which should provide a more stable revenue stream over time.
Business services revenue includes revenue from PBMS and PSI. Business Services revenue increased 23% due mainly to the acquisitions of DSI and PSI. Excluding the acquisition, business services revenue grew 3% due to growth in new written business. Revenue growth at PBMS was adversely affected by the continued contraction of large enterprise accounts, especially in the financial services and legal sectors.
Rentals revenue increased 6% primarily due to strong placements of our stand-alone meters and new digital meters. At December 31, 2002, digital meters represented approximately 58% of our U.S. meter base, up from 50% in 2001 and electronic meters represented approximately 42% of our U.S. meter base. We no longer place mechanical meters, which is in line with USPS guidelines. As previously mentioned, in 2001 we adopted a formal plan to transition to the next generation of networked mailing technology. See Legal and Regulatory Matters. We do not expect this transition to have a material adverse impact on rentals revenue.
Financing revenue remained flat. Financing revenue growth was adversely affected by our strategies to reduce our exposure to our Capital Services segment. In total, we financed 52% and 54% of all sales in 2002 and 2001, respectively.
Support services revenue increased 9% in 2002. Despite competitive pricing pressures, Global Mailing achieved a strong increase in support services revenue due to a larger population of equipment maintenance agreements and the impact of acquisitions in 2002. DMT had growth in support services revenue due to an increased service contract base and on-site contracts. Ongoing support services revenue continues to be partially dependent on equipment sales levels.
Costs and Expenses
The following table shows cost of sales as a percentage of sales revenue in 2002 and 2001:
Cost of sales, as a percentage of sales revenue, decreased primarily due to a favorable product mix at our U.S. and international mailing businesses including margin improvements from the launch of our DM seriesTM of digital mailing systems.
The following table shows cost of business services as a percentage of business services revenue in 2002 and 2001:
Cost of business services revenue, as a percentage of business services revenue, increased slightly, primarily due to costs associated with acquiring new management services accounts that have not yet generated a full year of revenue.
The following table shows cost of rentals as a percentage of rentals revenue in 2002 and 2001:
Cost of rentals, as a percentage of rentals revenue, increased compared with 2001, as a result of higher depreciation costs. We expect this ratio to continue to increase in 2003 due to the timing of our customers’ transition to digital meters.
The following table shows cost of financing as a percentage of financing revenue in 2002 and 2001:
Cost of financing, as a percentage of financing revenue, decreased compared with 2001, due primarily to the lower mix of Capital Services revenue.
Selling, service and administrative expenses
The following table shows selling, service and administrative expenses as a percentage of total revenue in 2002 and 2001:
Selling, service and administrative expenses were 33.6% of total revenue in 2002 compared with 33.2% in 2001. The increase in this ratio was primarily due to the higher mix of support services revenue and costs associated with investments in infrastructure and growth initiatives.
Research and development expenses
The following table shows our research and development expenses in 2002 and 2001:
Research and development expenses increased 6% in 2002 to $141 million, reflecting continued investment in developing new technologies and enhancing features for all our products. The 2002 increase represents expenditures for digital document delivery systems, new digital meters and mailing machines, billing and statement software, distribution and logistics software, advanced inserting equipment and mail sorting equipment. We expect similar levels of investment in research and development in 2003.
Net interest expense
The following table shows our net interest expense in 2002 and 2001:
Net interest expense decreased due to lower average interest rates during 2002 compared with 2001. This decrease was partially offset by higher average borrowings associated with our investment in leasing and rental products, acquisitions, dividends, and our stock repurchase program. Our variable and fixed rate debt mix, after adjusting for the effect of interest rate swaps, was 32% and 68%, respectively, at December 31, 2002. Based on current borrowing levels, a 25 basis point change in interest rates would impact annual interest expense by approximately $3 million to $4 million.
Effective tax rate
The following table shows the effective tax rate in 2002 and 2001:
Excluding special items, the effective tax rate was 31.3% in 2002 compared with 31.6% in 2001, reflecting continued tax benefits from leasing and financing activities. The tax rate is also favorably affected by our international expansion and our continued investment in developing new technologies. Our provision for taxes could be affected by tax law changes and interpretations by governments or courts. We expect our effective tax rate to increase as we implement our Capital Services strategy outlined on page 23.
Income from continuing operations decreased 15% and diluted earnings per share from continuing operations decreased 13% in 2002. Excluding special items in 2002 and 2001, income from continuing operations increased 3% and diluted earnings per share from continuing operations increased 5% in 2002. The increase in diluted earnings per share outperformed the increase in income from continuing operations due to the company’s share repurchase program. During the year, we repurchased 7.9 million shares, approximately 3% of the average common and potential common shares outstanding at the end of 2001. Excluding special items in 2002 and 2001, income from continuing operations as a percentage of revenue decreased to 13.0% in 2002 from 13.5% in 2001 due primarily to the higher mix of lower-margin revenue.
Results of Continuing Operations 2001 Compared to 2000
In 2001, revenue increased 6%, income from continuing operations decreased 9% and diluted earnings per share from continuing operations decreased 5% to $2.08 compared with $2.18 for 2000. Excluding special items in both periods, income from continuing operations decreased 1% and diluted earnings per share from continuing operations increased 3% to $2.25 compared with $2.17 for 2000. Excluding the acquisitions of Secap, DSI, and MMT, revenue increased 1%. These acquisitions did not materially affect earnings either on a per share or an aggregate basis.
Revenue
The following table shows revenue in 2001 and 2000 by segment:
Total Messaging Solutions revenue grew 6% over the prior year. The revenue increase came from growth in the Global Mailing and Enterprise Solutions segments of 1% and 26%, respectively, over 2000. Approximately 75% of our total revenue in 2001 is recurring revenue, which we believe is a continuing good indicator of potential repeat business.
Excluding the acquisitions of Secap and MMT, Global Mailing revenue decreased 2%. Global Mailing revenue growth, particularly in the U.S. was adversely affected by moderating customer orders and upgrades due to the slow economic environment, especially for shipping and system related products. Within the Global Mailing segment, international mailing revenue grew at a strong pace, fueled by revenue from the recent acquisitions of Secap and MMT plus continued strong demand for mailing products in Europe. However, revenue was also adversely impacted by weaker performance in the U.K. and Canada, as both countries were affected by slowing economic activity and a lull in those countries’ meter migration programs.
Enterprise Solutions revenue growth was driven by a 34% increase at PBMS as a result of higher volume in the core business and the acquisition of DSI. Excluding the acquisition of DSI, Enterprise Solutions revenue grew 11%. DMT revenue increased 5% over the prior year; however, our performance continues to be affected by a worldwide slowdown in capital spending, which has caused many of our customers to delay purchases of higher-margin customized inserting systems.
Capital Services revenue increased 2% primarily due to higher revenue associated with the strategic financing of equipment for posts around the world.
Operating profit
The following table shows operating profit in 2001 and 2000:
Operating profit grew 3% over the prior year, which reflected contributions from acquisitions. Operating profit grew 2% in the Global Mailing segment and 6% in the Enterprise Solutions segment.
The operating profit growth in the Global Mailing segment came from improved profit margins at Pitney Bowes Small Business Solutions (SBS). Operating profit growth was moderated by the events of September 11, 2001 and the continued slowdown of the economy. This was particularly true for higher volume mail creation and shipping products. The acquisitions of Secap SA and MMT did not materially impact Global Mailing operating profit.
The operating profit growth in our Enterprise Solutions segment came from double-digit operating profit growth at PBMS. Excluding the acquisition of DSI, Enterprise Solutions operating profit decreased 11%. Enterprise Solutions’ operating profit was negatively affected by lower operating profit at DMT, due to higher expenses associated with the introduction and marketing of new products and lower placements of higher margin customized production mail equipment as a result of the slowdown in worldwide capital spending.
Operating profit increased 11% in the Capital Services segment due primarily to the higher revenue and the previously stated strategic shift to concentrate on fee-based income opportunities.
The following table shows revenue in 2001 and 2000 by source of revenue:
Sales revenue increased 3% in 2001 due mainly to the acquisitions of Secap and MMT. Excluding these acquisitions, sales declined 1%. Sales growth was moderated as a result of the contraction and downsizing of operations of some of our customers resulting in reduced demand for some of our higher value mailing products. The negative impact of foreign currency reduced sales growth by slightly more than 1%. U.S. and U.K. Mailing Systems’ sales decreased due to softness in the high-end shipping and mail creation product lines as the economy and slower customer decision-making process for the higher-value, more complex products adversely impacted growth.
Business services revenue increased 35% in 2001 due mainly to the acquisition of DSI and higher volume in the core business. Excluding this acquisition, revenue grew 13%. Revenue growth was moderated as a result of the contraction and downsizing of operations of some of our customers resulting in reduced demand for some of our outsourcing services. The negative impact of foreign currency reduced services revenue growth by slightly less than 1%. Increases in value-added services to both new and existing customers, as part of the company’s strategy of pursuing profitable growth, stimulated revenue growth at PBMS.
Rental revenue decreased 6% primarily due to the slowing economy and consolidation of facilities by some of our customers, which has resulted in fewer than usual upgrades to our larger systems meters. We continue to experience good placements of our stand-alone and new digital meters. At December 31, 2001, electronic meters represented approximately 50% of our U.S. meter base and digital meters represented approximately 50% of our U.S. meter base, up from 44% in 2000. We no longer place mechanical meters, which is in line with USPS guidelines. As previously mentioned, in 2001 we adopted a formal plan to transition to the next generation of networked mailing technology. See Regulatory and Legal Matters.
Financing revenue increased 1% driven by higher revenue associated with the strategic financing of equipment for postal authorities around the world. Financing revenue growth was moderated by our strategy to reduce our asset-based financing in our Capital Services segment, through asset sales in 2001 and prior years. In total, we financed 54% and 55% of all sales in 2001 and 2000, respectively.
Support services revenue increased 9% in 2001. Despite competitive pricing pressures, U.S. and International Mailing had increased support services revenue due to a larger population of extended maintenance contracts, higher chargeable service calls and billed labor hours in 2001 and the acquisition of MMT. DMT had double-digit growth in support services revenue due to an increased service contract base and on-site contracts. Ongoing support services revenue continues to be partially dependent on equipment sales levels.
Costs and Expenses
The following table shows cost of sales as a percentage of sales revenue in 2001 and 2000:
Cost of sales, as a percentage of sales revenue, increased due to unfavorable product mix at our U.S. and international mailing businesses; in particular, our DMT customers delayed purchases of higher-margin customized inserting systems.
The following table shows cost of business services revenue as a percentage of business services revenue in 2001 and 2000:
Cost of business services revenue, as a percentage of business services revenue, decreased primarily due to the acquisition of DSI and improved margins from value added services for existing clients.
The following table shows cost of rentals as a percentage of rentals revenue in 2001 and 2000:
Cost of rentals, as a percentage of rentals revenue, improved 2 percentage points, due to lower costs and related depreciation at U.S. Mailing and SBS.
The following table shows cost of financing as a percentage of financing revenue in 2001 and 2000:
Cost of financing, as a percentage of financing revenue, increased .4 percentage points, due to higher costs associated with new business initiatives.
Selling, service and administrative expenses
The following table shows selling, service and administrative expenses as a percentage of total revenue in 2001 and 2000:
Selling, service and administrative expenses were 33.2% of total revenue in 2001 compared with 33.5% in 2000. The improvement in this ratio resulted from continued emphasis on controlling our expenses. The ratio was favorably affected by our successful Enterprise-Wide Resource Planning (ERP) initiative and by our restructuring initiatives. The improvement in this ratio was partially offset by costs associated with investments in acquisition and growth initiatives and the higher mix of support services revenue.
Research and development expenses
The following table shows our research and development expenses in 2001 and 2000:
Research and development expenses increased 10% in 2001 to $133 million reflecting continued investment in developing new technologies and enhancing features for all our products. The 2001 increase represents expenditures for digital document delivery systems, new digital meters and mailing machines, personal computer metering technology, advanced inserting equipment, and new and advanced features for production mail equipment and high volume incoming mail sorting equipment.
Net interest expense
The following table shows our net interest expense in 2001 and 2000:
Net interest expense decreased due to lower average interest rates during 2001 compared to 2000 associated with borrowings to fund the company’s investment in leasing and rental products, acquisitions, dividends and our stock repurchase program. Our variable and fixed rate debt mix, after adjusting for the effect of interest rate swaps, was 42% and 58%, respectively, at December 31, 2001. Based on current borrowing levels, a 25 basis point change in interest rates would affect annual interest expense by approximately $3 million to $4 million.
Effective tax rate
The following table shows the effective tax rate in 2001 and 2000:
Excluding the impact of special items in 2001, the effective tax rate was 31.6% in 2001 compared to 31.4% in 2000, reflecting continued tax benefits from leasing and financing activities. The tax rate was favorably affected by leasing investments and international expansion. The company’s provision for taxes could be affected by tax law changes and interpretations by governments or courts.
Income from continuing operations decreased 9% and diluted earnings per share from continuing operations decreased 5% in 2001. Excluding special items in both periods, income from continuing operations decreased 1% and diluted earnings per share from continuing operations increased 3% in 2001. The increase in diluted earnings per share outperformed the decrease in income from continuing operations due to the company’s share repurchase program, under which 7.8 million shares, approximately 3% of the average common and potential common shares outstanding at the end of 2000, were repurchased in 2001. Excluding special items in both periods, income from continuing operations as a percentage of revenue decreased to 13.5% in 2001 from 14.5% in 2000 due primarily to the higher mix of lower-margin revenue.
Capital Services
Capital Services strategy
In 2002, we took a number of strategic actions to transition our Capital Services business and reduce our overall exposure to long-term external financing assets. First, we liquidated about $225 million of financing assets primarily related to assets held for sale. Second, we began a strategic analysis of our existing portfolio to develop the best disposition strategy. Finally, we decided to stop active pursuit of, and growth in, long-term Capital Services financing transactions, including long-term postal financing. We will continue to provide lease financing for our products through our internal financing operations. We believe that these actions will further position us for growth and maintain our financial flexibility.
As a result of these actions and the Capital Services charges discussed below, we estimate a reduction in 2003 earnings of approximately 6 cents per diluted share. Additionally, the higher tax rate expected from lower Capital Services investments is estimated to reduce earnings by an incremental 2 to 3 cents per diluted share in 2003.
Capital Services charges
In 2002, we recorded a non-cash pre-tax charge of approximately $213 million, to write down our investments in commercial passenger aircraft leases primarily with US Airways and United and to increase our provision for credit losses primarily related to aircraft leasing investments in the U.S. See page 14 for a further breakdown of this charge.
Investment in commercial passenger and cargo aircraft leasing transactions
At December 31, 2002, our net investment in commercial passenger and cargo aircraft leasing transactions was $344.4 million, which is composed of transactions with U.S. and foreign airlines of $62.0 million and $282.4 million, respectively. This portfolio is diversified across 13 airlines and 30 aircraft and is financed through investments in leveraged lease transactions, direct financing lease transactions and through our equity investment in PBG Capital Partners LLC (PBG). Risk of loss under these transactions is primarily related to: (1) the inability of the airline to make underlying lease payments; (2) our inability to generate sufficient cash flows either through the sale of the aircraft or secondary lease transactions to recover our net investment; and/or (3) in the case of the leveraged lease portfolio, the absence of an equity defeasance or other third party credit arrangements. Approximately 35% of our remaining net investment in commercial passenger and cargo aircraft leasing investments is further secured by approximately $120 million of equity defeasance accounts or third party credit arrangements.
At December 31, 2002, our net investment in commercial passenger and cargo aircraft leasing transactions was composed of the following:
(A)
Our investment in commercial passenger aircraft leasing transactions with United included four aircraft leased to United and one aircraft leased to a wholly-owned regional carrier subsidiary of United, for a total investment of approximately $72 million. In December 2002, United filed for protection under Chapter 11 of the U.S. Bankruptcy Code. We are currently in discussions with United as to whether we will continue leasing these aircraft to them post-bankruptcy at reduced lease rates. Based on the expected outcome of these negotiations and the continued deterioration of the U.S. airline industry, we recorded a charge of approximately $54 million to write down lease receivables and residuals to reflect the estimated cumulative loss of future cash flows over the next nine years.
(B)
Prior to these charges and an exchange transaction as discussed below, our investment in commercial passenger aircraft leasing transactions with US Airways included four aircraft for a total investment of approximately $60 million. In August 2002, US Airways filed for protection under Chapter 11 of the U.S. Bankruptcy Code. To eliminate our exposure to US Airways, in December 2002, we exchanged the four aircraft leased to US Airways, which were then valued at approximately $9 million and paid approximately $11 million in cash for a leased aircraft operated by Federal Express. We recorded a charge of approximately $51 million as a result of this transaction
(C)
We recorded a charge of approximately $5 million to write down lease residuals on leases with Delta Airlines based on an assessment of the underlying leases and aircraft.
The write-down of lease receivables and residuals of $110 million and additional credit loss reserves of $82 million include $31 million and $70 million, respectively, related to aircraft financed through our equity investment in PBG.
Capital Services portfolio
Our investment in Capital Services lease related assets included in our Consolidated Balance Sheet was composed of the following:
Our investment in leveraged lease assets consists of the following:
•
The $1.6 billion is the amount that is on our Consolidated Balance Sheet.
•
Rental receivables represent total lease payments from our customers over the remaining term of the leveraged leases.
•
Residual value represents the value of the property anticipated at the end of the leveraged lease terms and is based on independent appraisals. We regularly review the recorded residual value to ensure it is appropriate.
•
Principal and interest on nonrecourse loans represent amounts due to unrelated third parties from our customers over the remaining term of the leveraged leases. The nonrecourse loans are secured by the lessees’ rental obligations and the leased property. If a lessee defaults and if the amounts realized from the sale of these assets are insufficient, we have no obligation to make any payments due on these nonrecourse loans to the unrelated third parties. Accordingly, we are required by generally accepted accounting principles to subtract the principal and interest over the remaining term of the nonrecourse loans from our rental receivables and residual value. At December 31, 2002, the principal balances on the nonrecourse loans totaled $3.6 billion and the related interest payments over the remaining terms of the leases totaled $3.3 billion.
•
Unearned income represents our future financing income that will be earned over the remaining term of the leases.
The $1.6 billion investment in leveraged leases on our Consolidated Balance Sheet is diversified across the following types of assets:
•
$340.1 million related to commercial real estate facilities, with original lease terms ranging from 17 to 25 years.
•
$307.1 million for postal equipment with international postal authorities, with original lease terms ranging from 16 to 24 years.
•
$303.1 million related to locomotives and railcars, with original lease terms ranging from 20 to 40 years.
•
$302.4 million related to nine commercial passenger and cargo aircraft, with original lease terms ranging from 23 to 25 years.
•
$132.5 million for telecommunications equipment, with original lease terms ranging from 14 to 16 years.
•
$131.3 million for rail and bus facilities with original lease terms ranging from 27 to 37 years.
•
$43.4 million for shipping and handling equipment with an original lease term of 24 years.
Our leveraged lease investment in telecommunications equipment represents leases to three highly rated international telecommunication entities. Approximately 86 percent of this portfolio is further secured by equity defeasance accounts or other third party credit arrangements. Additionally, our leveraged lease investment in commercial real estate facilities includes approximately $84 million related to leases of corporate facilities to four U.S. telecommunication entities, of which $69 million is with lessees that are highly rated. In addition, as part of our Capital Services charges discussed on page 23, we increased our provision for credit losses related to our investment in the telecommunications industry.
Overall, approximately 48 percent of our $1.6 billion leveraged lease portfolio is further secured by equity defeasance accounts or other third party credit arrangements. In addition, approximately 17 percent of the remaining leveraged lease portfolio represents leases to highly rated government related organizations which have guarantees or supplemental credit enhancements upon the occurrence of certain events.
Finance receivables are composed of the following:
(Dollars in millions)
We expect to phase out our assets held for sale portfolio by the end of 2003. Our Consolidated Statements of Income includes financing revenue of $32.6 million and $33.8 million for the years ended December 31, 2002 and 2001, respectively, attributable to our assets held for sale portfolio.
Other assets represent our 50% equity interest in PBG. See Off-Balance Sheet Items for a further discussion of our equity interest in PBG. Our net investment in PBG was reduced by a write-down of aircraft lease receivables of approximately $31 million and additional provisions for credit losses of approximately $70 million related to aircraft lease investments in the U.S. See Capital Services charges.
Off-Balance Sheet Items
Finance receivables sales
As part of our Capital Services programs, we have, from time-to-time sold, through securitizations, net finance receivables with limited recourse. In these transactions, we have surrendered control over the transferred assets in accordance with paragraph 9 of FAS No. 140 and received a cash payment from the transferee. Specifically, the finance receivables were sold to a bankruptcy remote limited liability company. At the time of sale, we obtained legal counsel’s opinion that the assets were isolated and that the sale qualified as a true sale at law. Under the terms of the sale, the transferee has the right to pledge or exchange the assets it received. There are no conditions that both constrain the transferee from taking advantage of its right to pledge or exchange and provide more than a trivial benefit to the transferor. We do not maintain effective control over the transferred assets.
We have accounted for these transactions as a sale recognizing assets obtained and liabilities incurred in consideration as proceeds of the sale. Any resulting gain or loss was recognized in income at the time of sale. The maximum risk of loss in these transactions arises from the possible non-performance of lessees to meet the terms of their contracts. We believe adequate provisions for losses have been established for receivables sold which may become uncollectible and for which we have recourse obligation, in accordance with paragraph 113 of FAS No. 140.
In selective cases, when we have sold net finance receivables, we entered into guarantee contracts with varying amounts of recourse in privately-placed transactions with unrelated third-party investors. The uncollected principal balance of receivables sold and guarantee contracts totaled $183.0 million and $181.2 million at December 31, 2002 and 2001, respectively. In accordance with generally accepted accounting principles, we do not record these amounts as liabilities on our Consolidated Balance Sheet.
Our maximum risk of loss on these net finance receivables and guarantee contracts arises from the possible non-performance of lessees to meet the terms of their contracts and from changes in the value of the underlying equipment. These contracts are secured by the underlying equipment value, and supported by the creditworthiness of our customers. At December 31, 2002, the underlying equipment value exceeded the sum of the uncollected principal balance of receivables sold and the guarantee contracts. As part of our review of our risk exposure, we believe we have made adequate provision for sold receivables and guarantee contracts which may not be collectible. See Notes 18, 20 and 22 to the consolidated financial statements. We do not depend on these types of transactions to fund our leasing investments. We selectively use these transactions when the overall economic impact on us is more favorable than debt.
Equity interest
During 1997, we formed PBG with GATX Corporation (GATX) for the purpose of financing and managing certain leasing related assets existing at that time. We contributed assets to PBG and maintain a 50% interest. We account for our investment in PBG under the equity method. Our maximum exposure is our investment of $61 million on our Consolidated Balance Sheet at December 31, 2002. PBG’s total assets and liabilities at December 31, 2002 are $379 million and $239 million, respectively. In accordance with generally accepted accounting principles, we do not record these assets and liabilities on our Consolidated Balance Sheet.
State and local government financing
We have originated tax-exempt secured loans to state and local governments and have sold certificates of interest in these loans. Generally, we recognize revenue for the fees we receive upon the sale of these certificates. These transactions however, may require us to buy back certificates if interest rates rise significantly. Our maximum risk of loss arises because we may be required to buy back certificates and resell them to other third parties at below our cost. We have structured these transactions so that even in a rising interest rate environment, our losses would be minimal. We have further minimized any risk of non-performance on the state and local government loans by obtaining credit guarantees of these loans from a highly-rated nationally recognized insurance company. Certificates outstanding at December 31, 2002 and 2001 were $216.8 million and $263.7 million, respectively, which represent our maximum exposure to state and local government financing. In accordance with generally accepted accounting principles, we do not record these certificates as assets or liabilities on our Consolidated Balance Sheet.
Our potential requirement to buy back certificates is based on movements of the Bond Market Association (BMA) Municipal Index. Our weighted average coupon rate on the underlying secured loans is approximately 4.96%. The current market rate per the BMA Index is 1.08% on January 3, 2003. We pay a premium over the BMA Index in the range of 25 to 40 basis points. We would be required to buy back certificates if rates rise by approximately 350 basis points. We have periodically entered into a fixed rate contract with investors whereby we lock in a fixed rate for a fixed period, generally 13 months. This insulates our interest rate risk for that set period of time. We recognized net pre-tax gains/(losses) after expenses of $2.5 million, $8.1 million and $(.7) million in 2002, 2001 and 2000, respectively.
Restructuring Charges
In January 2003, we announced that we will undertake restructuring initiatives related to realigned infrastructure requirements and reduced manufacturing needs for digital equipment. We expect that the pre-tax cost of these restructuring initiatives will be about $160 million over a two-year period as the various initiatives take effect.
In 2001, we adopted a formal restructuring plan to implement a common, streamlined business infrastructure across the corporation as a result of our decisions to spin off our office systems business and align our mailing business on a global basis, as well as cost saving opportunities resulting from strategic acquisitions and partnerships, and additional benefits attained from the consolidation of our IT organization and ERP initiatives. In connection with this plan, we recorded pre-tax restructuring charges of $149.3 million in 2001, of which $116.1 million was related to continuing operations and the remaining $33.2 million was related to discontinued operations. The restructuring charges related to continuing operations have been segregated in the Consolidated Statements of Income for the year ended December 31, 2001. The restructuring charges related to discontinued operations have been reported in discontinued operations in the Consolidated Statement of Income for the year ended December 31, 2001. See Note 13 to the consolidated financial statements.
The restructuring charges related to continuing operations are composed of:
All restructuring charges, except for the asset impairments, will result in cash outflows. The severance and benefit costs relate to a reduction in workforce of approximately 1,500 employees worldwide which was initiated in 2001 and was substantially completed at December 31, 2002. The workforce reductions relate to actions across several of our businesses resulting from infrastructure and process improvements and our continuing efforts to streamline operations, and include managerial, professional, clerical and technical roles. Approximately 80% of our workforce reductions are in the U.S. The majority of the international workforce reductions are in Europe. None of the reductions will impact our sales coverage. At December 31, 2002, 1,529 employees were separated under these initiatives and approximately $73.6 million of severance and benefit costs were paid. Asset impairments relate primarily to the disposal or abandonment of certain hardware and software applications, resulting from the alignment of our mailing business on a global basis and ERP initiatives. Other exit costs relate primarily to lease termination costs, non-cancelable lease payments, and other costs associated with business activities that have been exited and the consolidation of excess facilities.
The restructuring charges related to discontinued operations are composed of:
The severance and benefit costs relate to a reduction in workforce of approximately 25 employees. The asset impairments relate primarily to an impairment of residual values, in connection with leases of copier equipment, and the write-down of certain facsimile and copier equipment, resulting from the spin-off of our office systems business. Other exit costs relate primarily to incremental costs associated with cancellation and separation of facility occupancy leases that are shared between the company and IGI.
Accrued restructuring charges at December 31, 2002 consist of the following:
(Dollars in millions)
This restructuring plan was substantially completed at December 31, 2002. The restructuring charges are expected to continue to increase our operating efficiency and effectiveness in 2003 and beyond while enhancing growth, primarily as a result of reduced personnel-related expenses. We achieved pre-tax savings in operating expenses of approximately $50 million in 2002 from these restructuring initiatives.
In 2000, we recorded a pre-tax charge of approximately $19 million related to the consolidation of information technology staff and infrastructure. This initiative was focused on creating an efficient global organization and technology platform to leverage the benefits of our ERP and e-business initiatives. The majority of the initiatives and cash outflows relating to this consolidation were completed by December 31, 2001.
Meter Transition
In 2001, we adopted a formal plan to transition to the next generation of networked mailing technology. The information capture and exchange, made possible by advanced technology, turns the postage meter into an “intelligent” terminal that networks the mailer to postal and carrier information and systems. This two-way information architecture, in turn, enables convenient access to and delivery of value-added services such as tracking, delivery confirmation and rate information. The adoption of this plan was facilitated by our expanded access to technology and our ability to move to networked products combined with our expectations that the U.S. and postal services around the world will continue to encourage the migration of mailing systems to networked digital technologies. As a result of this plan, certain electronic meter rental assets and related equipment will not be placed back in service. In addition, certain leased equipment will either not be remarketed or will result in lower realization at end of lease as a result of the introduction of new technology. In connection with this plan, we recorded non-cash pre-tax charges of $268.3 million for the year ended December 31, 2001, related to assets associated with our non-networked mailing technology. In November 2001, postal regulations were issued, consistent with our meter transition plan, defining the meter migration process and timing. See Legal and Regulatory Matters.
The charges related to the meter transition plan are composed of:
Acquisitions
In August 2002, we acquired PSI Group, Inc. (PSI) for approximately $127 million in cash and $39 million in debt assumed. PSI, the nation’s largest mail presort company, prepares, sorts and aggregates mail to earn postal discounts and expedite delivery for its customers. See Note 15 to the consolidated financial statements.
In October 2001, we acquired Secap SA, for approximately Euros 220 million ($206 million) in cash. Secap offers a range of mail processing and paper handling equipment, supplies and technology for low- to mid-volume mailers. Secap holds more than 30% of the postage meter market share in France.
In June 2001, we acquired DSI. The final purchase price, following post closing adjustments, was $285.5 million in cash. DSI provides on- and off-site document management services, including the management of central reprographic departments, the placement and maintenance of photocopiers, print-on-demand operations and document archiving and retrieval services.
In June 2001, we acquired the MMT business in Europe, Africa, the Middle East and Asia. The final purchase price, following post closing adjustments, was $44 million in cash. MMT markets and services high-end mail processing, sorting and service-related products through a network of distributors and direct operations.
We accounted for the acquisitions of PSI, Secap, DSI and MMT under the purchase method and accordingly, the operating results of these acquisitions have been included in our consolidated financial statements since the date of acquisition. The acquisitions of PSI, Secap, DSI and MMT did not materially affect income from continuing operations for the years ended December 31, 2002 and 2001, respectively. See Note 15 to the consolidated financial statements.
During 2002 and 2001, we also completed several smaller acquisitions including the remaining 43% ownership interest of MailCode Inc. in 2002, the acquisition of Alysis Technologies Inc. in 2001, a leading provider of digital document delivery solutions, the acquisition of some of our international dealerships and acquisitions of presort businesses. The cost of these acquisitions was in the aggregate less than $50 million in each year. These acquisitions did not have a material impact on our financial results either individually or on an aggregate basis.
Accounting Changes
In 1998, FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” amended in 2000 by FAS No. 138, was issued. FAS No. 133 requires that an entity recognize all derivative instruments as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Changes in the fair value of those instruments will be reflected as gains or losses. The accounting for the gains or losses depends on the intended use of the derivative and the resulting designation. The company adopted the provisions of FAS No. 133 in the first quarter of 2001. The company uses derivatives to reduce the volatility in earnings and cash flows associated with the impact of interest rate changes and foreign currency fluctuations due to its investing and funding activities and its operations in different foreign currencies. Derivatives designated as cash flow hedges include primarily foreign exchange contracts and interest rate swaps related to variable-rate debt. Derivatives designated as fair value hedges include primarily interest rate swaps related to fixed-rate debt. The adoption of FAS No. 133 has resulted in an after-tax reduction to accumulated other comprehensive income of $7.0 million for the year ended December 31, 2001, including a one-time cumulative effect of accounting change which reduced accumulated other comprehensive income by approximately $9.2 million in the first quarter of 2001. The adoption of FAS No. 133 has also affected assets and liabilities recorded on the Consolidated Balance Sheet.
In 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements,” summarizing certain guidance in applying generally accepted accounting principles to revenue recognition in financial statements. The company adopted the provisions of SAB No. 101 in the fourth quarter of 2000, retroactive to January 1, 2000. The adoption of SAB No. 101 resulted in a one-time cumulative after-tax reduction in net income of $4.7 million (net of taxes of approximately $3.1 million) in the first quarter of 2000. The reduction to net income was primarily attributable to the deferral of sales recognition of software-enabled mail creation equipment and shipping products prior to installation. See Note 1 to the consolidated financial statements.
In 2000, FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” was issued, replacing FAS No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” FAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral, as well as requiring certain additional disclosures. However, it carries over most of the provisions contained in FAS No. 125. FAS No. 140 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. However, it was effective for the recognition and reclassification of collateral and for disclosures relating to those transactions for the year ended December 31, 2000. The adoption of this standard did not have a material impact on the company.
In July 2001, FAS No. 141, “Business Combinations” and FAS No. 142, “Goodwill and Other Intangible Assets” were issued requiring business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and refining the criteria for recording intangible assets separate from goodwill. Recorded goodwill and intangibles are evaluated against this new criterion and result in certain intangibles being included in goodwill, or alternatively, amounts initially recorded as goodwill
may be separately identified and recognized apart from goodwill. FAS No. 142 requires the use of a nonamortization approach to account for purchased goodwill and indefinite-lived intangibles. Under a nonamortization approach, goodwill and indefinite lived intangibles are not amortized into results of operations, but instead are reviewed for impairment and charged against results of operations only in the periods in which the recorded value of goodwill and indefinite-lived intangibles is more than its fair value. The company has adopted the provisions of each statement, which apply to business combinations completed after June 30, 2001. The adoption of these accounting standards did not materially impact results of operations for the year ended December 31, 2001. The provisions of each statement, which apply to goodwill and intangible assets acquired prior to June 30, 2001 were adopted by the company on January 1, 2002. The adoption of these standards reduced the amortization of intangible assets commencing January 1, 2002 by approximately 2 cents per diluted share. Goodwill is reviewed for impairment on an annual basis or as circumstances warrant.
In August 2001, FAS No. 143, “Accounting for Asset Retirement Obligations” was issued, amending FAS No. 19, “Financial Accounting and Reporting by Oil and Gas Producing Companies,” and applies to all entities. FAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS No. 143 is effective January 1, 2003 for the company. We do not expect this statement to have a material impact on our financial position, results of operations or cash flows.
In August 2001, FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” was issued, replacing FAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and portions of Accounting Principles Board (APB) Opinion 30, “Reporting the Results of Operations.” FAS No. 144 provides a single accounting model for long-lived assets to be disposed of and changes the criteria that would have to be met to classify an asset as held-for-sale. FAS No. 144 retains the requirement of APB Opinion 30, to report discontinued operations separately from continuing operations and extends that reporting to separate components of an entity. FAS No. 144 is effective January 1, 2002 for the company. The adoption of this statement did not materially impact our financial position, results of operations or cash flows.
In September 2001, the Financial Accounting Standards Board’s Emerging Issues Task Force (EITF) reached a consensus on Issue 01-10, “Accounting for the Impact of the Terrorist Attacks of September 11, 2001.” EITF 01-10 provides guidance for accounting for the effects of the events of September 11, 2001 in financial statements. The company believes it is in compliance with this consensus in all material respects.
In April 2002, FAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Correction,” was issued. Under FAS No. 145, gains and losses related to the extinguishment of debt should no longer be segregated on the income statement as extraordinary items. Instead, such gains and losses should be included as a component of income from continuing operations. The provisions of FAS No. 145 are effective for fiscal years beginning after May 15, 2002 with early adoption encouraged. We do not believe that this statement will have a material impact on our financial position, results of operations or cash flows.
In July 2002, FAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” was issued. This statement nullifies EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” FAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of FAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002. Early adoption is encouraged. We are currently evaluating the impact of this statement.
In November 2002, the Financial Accounting Standards Board issued FASB Interpretation (FIN) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies the requirements of FAS No. 5, “Accounting for Contingencies,” relating to a guarantor’s accounting for and disclosure of, the issuance of certain types of guarantees. FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations does not apply to product warranties or to guarantees accounted for as derivatives. The recognition provisions of FIN No. 45 are effective for the company beginning January 1, 2003. We do not believe that this interpretation will have a material impact on our financial position, results of operations or cash flows. See Note 18 to the consolidated financial statements.
In December 2002, FAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” which amends FAS No. 123, “Accounting for Stock-Based Compensation,” was issued. FAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and requires more prominent and more frequent disclosures in the financial statements of the effects of stock-based compensation. The provisions of FAS No. 148 are effective for fiscal years ending after December 15, 2002. See Note 1 to the consolidated financial statements.
In January 2003, the Financial Accounting Standards Board issued FIN No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. We are currently evaluating the provisions of FIN No. 46 including the impact, if any, on our equity investment in PBG. We do not believe that the adoption of these provisions will have a material impact on our financial position, results of operations or cash flows.
Liquidity and Capital Resources
Our ratio of current assets to current liabilities declined to .76 to 1 at December 31, 2002 compared with .83 to 1 at December 31, 2001. The decrease in this ratio was primarily due to the substitution of long-term debt for short-term.
To manage interest rate risk, we use a balanced mix of debt maturities, variable and fixed rate debt and interest rate swap agreements. In 2002, we received $95 million in cash associated with the termination of four swap agreements. As a result of these transactions, our fixed to floating percentages increased to 68% and 32%, respectively at December 31, 2002 compared to 60% and 40%, respectively at December 31, 2001.
Our cash and cash equivalents increased to $315.2 million at December 31, 2002 from $231.6 million at December 31, 2001. The increase resulted primarily from $502.6 million provided by operating activities, offset in part by $300.9 million and $122.8 million used in investing and financing activities, respectively. Net cash of $502.6 million provided by operating activities consisted primarily of net income adjusted for non cash items, and the increase in deferred taxes on income, partially offset by our pension plan investment of $338.6 million, changes in working capital and our investment in internal finance receivables. Net cash used in working capital resulted primarily from increases in inventory to support new product introductions. Net cash of $300.9 million used in investing activities consisted primarily of acquisitions, investments in fixed assets and leveraged leases, partially offset by Capital Services asset sales and reserve account deposits. Net cash of $122.8 million used in financing activities consisted primarily of stock repurchases, dividends paid to stockholders and payments on long-term obligations partially offset by net proceeds from long-term obligations.
In 2002, we made year-end contributions of approximately $305 million and $34 million to our U.S. and U.K. pension plans, respectively. We expect these additional investments to significantly offset the impact of changes to actuarial assumptions and loss experience. Based on historical results and future projections, we concluded that a reduction to the long-term return on asset assumption to 8.50% in 2003 was warranted. Additionally, we have lowered the discount rate to 6.75% and adopted a new mortality table. We expect that 2003 incremental pension costs attributable to these assumption changes, net of the impact of the pension plan contributions, will be approximately 2 cents per diluted share.
Excluding special items and discontinued operations in both periods, the ratio of EBIT to interest was 5.6x and 5.4x and the ratio of EBITDA to interest was 7.1x and 6.7x for the years ended December 31, 2002 and 2001, respectively. The ratio of total debt to total debt and stockholders’ equity was 82.3% at December 31, 2002, versus 79.7% at December 31, 2001. Including the preferred stockholders’ equity in a subsidiary company as debt, the ratio of total debt to total debt and stockholders’ equity was 83.4% at December 31, 2002 compared to 81.0% at December 31, 2001. The increase in this ratio was driven primarily by debt related to acquisitions and the $300 million repurchase of 7.9 million shares of common stock. We generated $277.7 million of free cash flow (defined as cash from operations less capital expenditures) which partially offset the increase in this ratio. Excluding the cash flow impacts of the pension plan investment and payments related primarily to restructuring initiatives, free cash flow was $682.0 million in 2002. See reconciliation below.
In 2000, we sold our PitneyWorksSM Business RewardsSM Visa® and Business Visa® card operations, including credit card receivables of approximately $322 million, to US Bank, a division of US Bancorp. The proceeds from the sale were used for general corporate purposes, including the repayment of commercial paper, financing acquisitions and the repurchase of company stock. The sale included standard representations and warranties with regard to the underlying assets and also included an indemnification provision whereby we would potentially reimburse US Bank if credit losses in the portfolio exceeded agreed-upon levels.
In 2001, we terminated a related co-branded credit card program arrangement with US Bank that the parties entered into at the time of the sale of the portfolio. As part of that termination, we were relieved of any on-going liability for indemnification for credit losses. As a result, we have no ongoing liability to US Bancorp related to credit losses in the portfolio or any contingent liability related to the sale, and hence, there is no future impact on our liquidity or capital resources.
In November 2002, our Board of Directors authorized the repurchase of up to $300 million of our common stock over the next 12 to 24 months.
The following table reconciles GAAP net cash provided by operating activities to proforma free cash flow from continuing operations for the years ended December 31, 2002, 2001 and 2000, respectively:
Financings and Capitalization
On December 31, 2002, $1.4 billion remained available under the shelf registration statement filed in October 2001 with the SEC, permitting issuances of up to $2 billion in debt securities, preferred stock and depositary shares.
In September 2002, we issued $400 million of unsecured fixed rate notes maturing in October 2012. These notes bear interest at an annual rate of 4.625% and pay interest semi-annually beginning April 2003. The proceeds from these notes were used for general corporate purposes, including the repayment of commercial paper in anticipation of 2003 debt maturities.
In February 2002, we completed an offering of Euros 250 million of senior unsecured notes. These notes bear interest at a floating rate of EURIBOR plus 20 basis points, set two Euro business days preceding the quarterly interest payment dates and mature in August 2003. The notes are listed on the Luxembourg Stock Exchange and have been designated as a hedge of Euro denominated assets held by the company. The proceeds from these notes were used for general corporate purposes including repaying commercial paper, financing acquisitions and the repurchase of company stock.
In August 2001, we issued $350 million of unsecured fixed rate notes maturing in August 2008. These notes bear interest at an annual rate of 5.75% and pay interest semi-annually beginning February 15, 2002. The proceeds from these notes were used for general corporate purposes, including the repayment of commercial paper.
In July 2001, we issued four non-recourse promissory notes totaling $111.5 million in connection with four lease transactions. The promissory notes are all due in monthly installments over 194 months at an interest rate of 7.24%. In September 2001, we sold our interest in two of the lease transactions and transferred the obligation on two of the non-recourse promissory notes totaling $55.3 million in principal balance. In December 2002, we sold our interest in one of the leasing transactions and transferred the obligation on one non-recourse promissory note outstanding at December 31, 2001 with a total principal balance of $25.6 million.
In April 2001, we issued the remaining $300 million of notes available under a prior shelf registration, permitting issuances of up to $500 million in debt securities (including medium-term notes) with a minimum maturity of nine months. These unsecured notes bear annual interest at 5.875% and mature in May 2006. The proceeds were used for general corporate purposes, including the repayment of commercial paper, financing acquisitions and the repurchase of company stock.
In December 2000, we issued $100 million of unsecured floating rate notes maturing in April 2002 and $100 million of unsecured floating rate notes maturing June 2004, available under the medium-term note program. These notes bear interest at floating rates of LIBOR plus five basis points and 25 basis points, respectively, set as of the quarterly interest payment dates. The proceeds from these notes were used for general corporate purposes, including the repayment of commercial paper.
In March 2000, we issued $43.3 million senior notes maturing 2002 through 2012. The proceeds from these notes which have an interest rate of 7.515% were used to pay down commercial paper.
In April 2000, we issued a total of $134 million of secured floating rate senior notes. The notes mature in 2003 and bear interest at 7.443%. The proceeds from these notes were used for general corporate purposes, including the repayment of short-term debt.
At December 31, 2002, we had unused lines of credit and revolving credit facilities of $1.5 billion in the U.S. and $14.6 million outside the U.S., largely supporting commercial paper debt.
We believe our financing needs for the next 12 months can be met with cash generated internally, money from existing credit agreements, debt issued under new and existing shelf registration statements and existing commercial and medium-term note programs. Information on debt maturities is presented in Note 5 to the consolidated financial statements.
In February 2003, we sold 6.45% Preferred Stock in a subsidiary of Pitney Bowes Credit Corporation to an outside institutional investor for approximately A$191 million ($110 million). As part of this transaction, we agreed to repurchase the stock in 10 years. Additionally, we entered into a cross currency interest rate swap with the same institutional investor, effectively converting the obligation to a $110 million note that bears interest at a floating rate of approximately LIBOR minus 50 basis points. This note will be recorded as long-term debt in our Consolidated Balance Sheet. The proceeds from this transaction will be used for general corporate purposes which may include repaying commercial paper, financing acquisitions and the repurchase of company stock.
Total financial services assets decreased to $6.2 billion at December 31, 2002, down 4.2% from $6.4 billion in 2001. To fund finance assets, borrowings were $3.0 billion in 2002 and $3.2 billion in 2001. Approximately $596 million and $419 million in cash was generated from the sale of finance assets in 2002 and 2001, respectively. We used the proceeds to pay down debt, repurchase shares and fund new business investments, and invest in our pension plans.
The following summarizes our contractual obligations at December 31, 2002, and the effect that such obligations are expected to have on our liquidity and cash flow in future periods:
Capital Investment
During 2002, net investments in fixed assets included net additions of $154 million to property, plant and equipment and $71 million of rental equipment and related inventories, compared with $132 million and $124 million, respectively, in 2001. These additions included expenditures for normal plant and manufacturing equipment. In the case of rental equipment, the additions included the production of postage meters and the purchase of facsimile and copier equipment related to the discontinued operations of IGI in 2001. Excluding IGI, during 2001, net additions to property, plant and equipment were $119 million and rental equipment was $68 million.
We expect net investments in fixed assets in 2003, relating to continuing operations, to be slightly higher than the prior year. These investments will also be affected by the timing of our customers’ transition to digital meters. At December 31, 2002, commitments for the acquisition of property, plant and equipment reflected plant and manufacturing equipment improvements as well as rental equipment for new and replacement programs.
Legal and Regulatory Matters
Legal
In the ordinary course of normal business, we are routinely defendants in or parties to a number of pending and threatened legal actions including proceedings purportedly brought on behalf of classes of claimants. These may involve litigation by or against us relating to, among other things:
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contractual rights under vendor, insurance or other contracts
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intellectual property or patent rights
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equipment, service, payment or other disputes with customers
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disputes with employees
In those cases where we are the defendants, plaintiffs may seek to recover large and sometimes unspecified amounts of damages or other types of relief and some matters may remain unresolved for several years. Although we cannot predict the outcome of such matters, based on current knowledge, management does not believe that the ultimate outcome of the litigations referred to in this section will have a material adverse effect on our financial position, results of operations or cash flows. However, if the plaintiffs do prevail, the result may have a material effect on our financial position, future results of operations or cash flows. See Legal Settlements, net in Special Items.
USPS meter transition
In 2000, the USPS issued a schedule for the phaseout of manually reset electronic meters in the U.S. as follows:
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As of February 1, 2000, new placements of manually reset electronic meters were no longer permitted.
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The current users of manually reset electronic meters could continue to use these meters for the term of their rental and lease agreements. Leases or rentals due to expire in 2000 could be extended to December 31, 2001.
On November 15, 2001, the USPS issued a rule as follows:
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New placements of non-digital meters without the “timeout” feature that enables the meters to be automatically disabled, if not reset within a specified time period are no longer permitted after December 31, 2002. These meters must be off the market by December 31, 2006.
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New placements of non-digital meters with a “timeout” feature are no longer permitted after June 30, 2004. These meters must be off the market by December 31, 2008.
We adopted a formal plan in the second quarter of 2001 to transition to the next generation of networked mailing technology. See Note 14 to the consolidated financial statements.
USPS Information Based Indicia Program (IBIP)
In May 1995, the USPS publicly announced its concept of its IBIP for future postage evidencing devices. As initially stated by the USPS, the purpose of the program was to develop a new standard for future digital postage evidencing devices which would significantly enhance postal revenue security and support expanded USPS value-added services to mailers. The program would consist of the development of four separate specifications: (i) the Indicium specification; (ii) a Postal Security Device specification; (iii) a Host specification; and (iv) a Vendor Infrastructure specification. During the period from May 1995 through December 31, 2002, we submitted extensive comments to a series of proposed IBIP specifications issued by the USPS, including comments on the IBI Performance Criteria.
Other regulatory matters
In June 2002, we received an examination report from the Internal Revenue Service (IRS) showing proposed income tax adjustments for the 1992 to 1994 tax years. The total additional tax proposed by the IRS for the 1992 through 1994 tax years is about $24 million. In August 2002, we filed a protest with the IRS to challenge most of the proposed deficiencies asserted by the IRS. We believe that we have meritorious defenses to those deficiencies and that the ultimate outcome will not result in a material effect on our results of operations, financial position or cash flows. However, if the IRS prevails on its asserted deficiencies, additional tax may be due for 1995 and future tax years, which could materially affect our future results of operations, financial position or cash flows. At any time, our provision for taxes could be affected by changes in tax law and interpretations by governments or courts.
In June 1999, we were served with a Civil Investigative Demand (CID) from the U.S. Justice Department’s Antitrust Division. A CID is a tool used by the Antitrust Division for gathering information and documents. The company believes that the Justice Department may have been reviewing the company’s efforts to protect its intellectual property rights. We believe we have complied fully with the antitrust laws and cooperated fully with the department’s investigation. In February 2002, the Justice Department advised us that it has decided to close this investigation with no further action.
Effects of Inflation and Foreign Exchange
Inflation, although moderate in recent years, continues to affect worldwide economies and the way companies operate. It increases labor costs and operating expenses, and raises costs associated with replacement of fixed assets such as rental equipment. Despite these growing costs and the USPS meter migration initiatives, we have generally been able to maintain profit margins through productivity and efficiency improvements, continual review of both manufacturing capacity and operating expense levels, and, to an extent, price increases.
Although not affecting income, translation gains of $38 million were recorded in 2002 resulting from the stronger British pound and Euro as compared to the U.S. dollar. Deferred translation losses of $9 million and $46 million were realized in 2001 and 2000, respectively. These translation losses resulted principally from weaker Canadian dollar, British pound and Euro currencies as compared to the U.S. dollar during those years.
The results of our international operations are subject to currency fluctuations. We enter into foreign exchange contracts primarily to minimize our risk of loss from such fluctuations. Exchange rates can impact settlement of our intercompany receivables and payables that result from transfers of finished goods inventories between our affiliates in different countries, and intercompany loans.
At December 31, 2002, we had approximately $636 million of foreign exchange contracts outstanding, most of which mature in 2003, to buy or sell various currencies. Risks arise from the possible non-performance by counterparties in meeting the terms of their contracts and from movements in securities values, interest and/or exchange rates. However, we do not anticipate non-performance by the counterparties as they are composed of a number of major international financial institutions. Maximum risk of loss on these contracts is limited to the amount of the difference between the spot rate at the date of the contract delivery and the contracted rate.
Dividend Policy
Our Board of Directors has a policy to pay a cash dividend on common stock each quarter. In setting dividend payments, our board considers the dividend rate in relation to the company’s recent and projected earnings and our capital investment opportunities and requirements. We have paid a dividend each year since 1934.
Forward-Looking Statements
We want to caution readers that any forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 in this Form 10-K, other reports or press releases or made by our management involve risks and uncertainties which may change based on various important factors. These forward-looking statements are those which talk about the company’s or management’s current expectations as to the future and include, but are not limited to, statements about the amounts, timing and results of possible restructuring charges and future earnings. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” and similar expressions may identify such forward-looking statements. Some of the factors which could cause future financial performance to differ materially from the expectations as expressed in any forward-looking statement made by or on our behalf include:
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changes in international or national political conditions, including any terrorist attacks
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negative developments in economic conditions, including adverse impacts on customer demand
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changes in postal regulations
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timely development and acceptance of new products
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success in gaining product approval in new markets where regulatory approval is required
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successful entry into new markets
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mailers’ utilization of alternative means of communication or competitors’ products
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the company’s success at managing customer credit risk, including risks associated with commercial passenger and cargo aircraft leasing transactions
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changes in interest rates
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foreign currency fluctuations
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timing and execution of the restructuring plan
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timing and execution of the meter transition plan
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regulatory approvals and satisfaction of other conditions to consummation of any acquisitions and integration of recent acquisitions
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impact on mail volume resulting from current concerns over the use of the mail for transmitting harmful biological agents
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third-party suppliers’ ability to provide product components
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negative income tax adjustments for prior audit years and changes in tax laws or regulations
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terms and timing of actions to reduce exposures and disposal of assets in Capital Services segment
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continuing developments in the U.S. and foreign airline industry
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changes in pension and retiree medical costs.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate changes and foreign currency fluctuations due to our investing and funding activities and our operations in different foreign currencies.
Our objectives in managing our exposure to interest rate changes are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve our objectives, we use a balanced mix of debt maturities and variable and fixed rate debt together with interest rate swaps.
Our objective in managing our exposure to foreign currency fluctuations is to reduce the volatility in earnings and cash flows associated with the effect of foreign exchange rate changes on transactions that are denominated in foreign currencies. Accordingly, we enter into various contracts, which change in value as foreign exchange rates change, to protect the value of external and intercompany transactions.
The principal currencies hedged are the British pound, Canadian dollar and Euro.
We employ established policies and procedures governing the use of financial instruments to manage our exposure to such risks. We do not enter into foreign currency or interest rate transactions for speculative purposes. The gains and losses on these contracts offset changes in the value of the related exposures.
We utilize a “Value-at-Risk” (VaR) model to determine the maximum potential loss in fair value from changes in market conditions. The VaR model utilizes a “variance/co-variance” approach and assumes normal market conditions, a 95% confidence level and a one-day holding period. The model includes all of our debt and all interest rate and foreign exchange derivative contracts. The model excludes anticipated transactions, firm commitments, and receivables and accounts payable denominated in foreign currencies, which certain of these instruments are intended to hedge.
The VaR model is a risk analysis tool and does not purport to represent actual losses in fair value that will be incurred by us, nor does it consider the potential effect of favorable changes in market factors.
During 2002, our maximum potential one-day loss in fair value of our exposure to foreign exchange rates and interest rates, using the variance/co-variance technique described above, was not material.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Statements of Income
(Dollars in thousands, except per share data)
Note: The sum of the earnings per share amounts may not equal the totals above due to rounding.
See notes, pages 41 through
Consolidated Balance Sheets
(Dollars in thousands, except share data)
See notes, pages 41 through 75
Consolidated Statements of Cash Flows
(Dollars in thousands)
See notes, pages 41 through 75
Consolidated Statements of Stockholders’ Equity
(Dollars in thousands, except per share data)
See notes, pages 41 through 75
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data or as otherwise indicated)
1. Summary of significant accounting policies
Consolidation
The consolidated financial statements include the accounts of Pitney Bowes Inc. and all of its subsidiaries (the company). All significant intercompany transactions have been eliminated.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Cash equivalents, short-term investments and accounts receivable
Cash equivalents include short-term, highly liquid investments with a maturity of three months or less from the date of acquisition. The company places its temporary cash and short-term investments with financial institutions and limits the amount of credit exposure with any one company. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers and relatively small account balances within the majority of the company’s customer base, and their dispersion across different businesses and geographic areas.
Inventory valuation
Inventories are valued at the lower of cost or market. Cost is determined on the last-in, first-out (LIFO) basis for most U.S. inventories, and on the first-in, first-out (FIFO) basis for most non-U.S. inventories.
Fixed assets and depreciation
Property, plant and equipment are stated at cost and depreciated principally using the straight-line method over estimated useful lives: machinery and equipment principally three to 15 years and buildings up to 50 years. Major improvements which add to productive capacity or extend the life of an asset are capitalized while repairs and maintenance are charged to expense as incurred. Rental equipment is depreciated on the straight-line method over estimated useful lives, principally three to ten years. Other depreciable assets are depreciated using either the straight-line method or accelerated methods. Properties leased under capital leases are amortized on a straight-line basis over the primary lease terms.
Capitalized computer software costs
The company capitalizes certain costs of internally developed software. Capitalized costs include purchased materials and services, payroll and payroll related costs and interest costs. The cost of internally developed software is amortized on a straight-line basis over the estimated useful life which is, principally three to ten years.
The company does not capitalize software development costs related to software to be sold, leased, or otherwise marketed due to the fact that the period between establishment and testing of a working model and the general availability of the software has historically been short and the related software development costs qualifying for capitalization in accordance with Financial Accounting Standards (FAS) No. 86 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” have been insignificant.
Rental arrangements and advance billings
The company rents equipment to its customers, primarily postage meters, mailing equipment and shipping systems under short-term rental agreements, generally for periods of three months to three years. Charges for equipment rental and maintenance contracts are billed in advance; the related revenue is included in advance billings and recorded as revenue on a straight-line basis over the rental period. Ancillary rental and other finance income is recognized as earned.
Allowance for credit losses
The company estimates its finance receivables risks and provides allowances for credit losses accordingly. The company’s financial services businesses establish credit approval limits based on the credit quality of the customer and the type of equipment financed. The company charges finance receivables through the allowance for credit losses after collection efforts are exhausted and the company deems the account uncollectible. The company’s financial services businesses base credit decisions primarily on a customer’s financial strength and, particularly in its Capital Services programs, the company may also consider collateral values. The company believes that its concentration of credit risk for finance receivables in its internal financing division is limited because of its large number of customers, small account balances and customer geographic and industry diversification. In addition, in the company’s Capital Services programs, it may also consider collateral values.
The company’s general policy for finance receivables contractually past due for over 90 to 120 days is to discontinue revenue recognition. The company resumes revenue recognition when payments reduce the account to 60 days or less past due. In its Capital Services programs, the company discontinues revenue recognition as soon as it is apparent that the obligor will not be making payments in accordance with lease terms, such as in the event of bankruptcy. Otherwise, the company discontinues revenue recognition when accounts are over 90 days past due.
The company evaluates the adequacy of allowance for credit losses on a periodic basis. The company’s evaluation includes historical loss experience, the nature and volume of our portfolios, adverse situations that may affect a customer’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The company makes adjustments to its allowance for credit losses if the evaluation of reserve requirements differs from the actual aggregate reserve. This evaluation is inherently subjective and estimates may be revised as more information becomes available.
Allowance for doubtful accounts
The company estimates its accounts receivable risks and provides allowances for doubtful accounts accordingly. The company believes that its credit risk for accounts receivable is limited because of its large number of customers and the relatively small account balances for most of its customers. Also, the company’s customers are dispersed across different business and geographic areas. The company evaluates the adequacy of the allowance for doubtful accounts on a periodic basis. The evaluation includes historical loss experience, adverse situations that may affect a customer’s ability to repay, and prevailing economic conditions. The company makes adjustments to its allowance if the evaluation of allowance requirements differs from the actual aggregate reserve. This evaluation is inherently subjective and estimates may be revised as more information becomes available.
Business combinations, goodwill and other intangible assets
In July 2001, FAS No. 141, “Business Combinations” and FAS No. 142, “Goodwill and Other Intangible Assets” were issued requiring business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and refining the criteria for recording intangible assets separate from goodwill. FAS No. 142 requires the use of a nonamortization approach to account for purchased goodwill and indefinite-lived intangibles. Under a nonamortization approach, goodwill and indefinite-lived intangibles will not be amortized into results of operations, but instead would be reviewed for impairment and charged against results of operations only in the periods in which the recorded value of goodwill and indefinite-lived intangibles is more than its fair value. The company has adopted the provisions of each statement, which apply to business combinations completed after June 30, 2001. The adoption of these accounting standards did not materially impact results of operations for the year ended December 31, 2001. On January 1, 2002, the company adopted the provisions of each statement, which apply to goodwill and intangible assets acquired prior to June 30, 2001. The adoption of these standards reduced the amortization of intangible assets commencing January 1, 2002 by approximately 2 cents per diluted share. Goodwill is reviewed for impairment on an annual basis or as circumstances warrant.
Goodwill represents the excess of cost over the value of net tangible and other intangible assets acquired in business combinations. Goodwill acquired under business combinations completed prior to June 30, 2001 has been amortized through December 31, 2001, using the straight-line method over its estimated useful life, principally 40 years. Goodwill acquired under business combinations completed after June 30, 2001 has not been amortized. Intangible assets with finite lives, acquired under business combinations, are amortized using the straight-line method over estimated useful lives, principally five to 15 years.
Impairment review
Long-lived assets, including goodwill and other intangible assets have been reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable. If such a change in circumstances occurs, the related estimated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition, are compared to the carrying amount. If the sum of the expected cash flows is less than the carrying amount, the company records an impairment loss. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset.
In August 2001, FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” was issued, replacing FAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” FAS No. 144 provides a single accounting model for long-lived assets to be disposed of and changes the criteria that would have to be met to classify an asset as held-for-sale. The adoption of FAS No. 144 was effective January 1, 2002 for the company and did not materially impact the company’s results of operations, cash flows or financial position.
Revenue
In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements,” summarizing certain guidance in applying generally accepted accounting principles to revenue recognition in financial statements. The company adopted the provisions of SAB No. 101 in the fourth quarter of 2000, retroactive to January 1, 2000. The adoption of SAB No. 101 resulted in a one-time cumulative after-tax reduction in net income of $4.7 million (net of taxes of approximately $3.1 million) in the first quarter of 2000. The reduction to net income was primarily attributable to the deferral of sales of software-enabled mail creation equipment and shipping products until installation. The change in accounting
had no material impact on quarterly results, and as a result, quarterly information was not restated. The pro forma effect of retroactive application of this new method of accounting did not materially affect the results of operations for the year ended December 31, 2000.
The company derives its revenue from the following sources:
•
sales;
•
business services;
•
rentals and financing; and
•
support services
In accordance with generally accepted accounting principles, the company recognizes revenue from these sources as follows:
Sales revenue
Sales of equipment
The company sells equipment to its customers, as well as to distributors and dealers (re-sellers) throughout the world. The company recognizes revenue from these sales upon the transfer of title, which is at the point of shipment. The company does not offer any rights of return or stock balancing rights.
The company’s sales revenue from customized equipment and software-enabled mail creation equipment and shipping product, is generally recognized when installed.
Sales of supplies
Revenue related to supplies is recognized at the point of title transfer, which is upon shipment.
Software licenses and integration services
The company recognizes revenue related to off-the-shelf software licenses upon transfer of title, which is upon shipment. The company recognizes revenue from software requiring integration services at the point of customer acceptance.
Business services revenue
Business services
Business services revenue includes revenue from management services and presort mail services.
Management services, which includes outsourcing of mailrooms, copy centers, or other document management functions, are typically annual or longer contracts that contain a monthly service fee and in many cases a “click” charge based on the number of copies made, machines in use, etc. Revenue is recognized over the term of the agreement, based on monthly service charges, with the exception of the “click” charges, which are recognized as incurred.
Presort mail services include the preparation, sortation and aggregation of mail to earn postal discounts and expedite delivery for customers. Revenue is recognized over the term of the agreement as earned.
Rentals revenue
Product rentals
The company rents equipment to its customers, primarily postage meters, mailing equipment and shipping systems under short-term rental agreements, generally for periods of three months to three years. The company invoices in advance the charges for equipment rental. The company defers the billed revenue and includes it initially in advance billings. Rental revenue is recognized on a straight-line basis over the term of the rental agreement.
Financing revenue
Product financing arrangements
The company provides lease financing of its products in the U.S. and outside the U.S. through sales-type leases.
When a sales-type lease is consummated, the company records the gross finance receivable, unearned income and the estimated residual value of the leased equipment. Unearned income represents the excess of the gross finance receivable plus the estimated
residual value over the sales price of the equipment. The company recognizes the equipment sale at the inception of the lease. The company recognizes unearned income as earned using the interest method over the term of the transaction. Earned income is included in rentals and financing revenue in the Consolidated Statements of Income.
Capital Services revenue
The company provides financing for non-Pitney Bowes equipment through direct financing leases and leveraged leases.
When a direct financing lease is consummated, the company records the gross finance receivable, unearned income and the estimated residual value of the leased equipment. Unearned income represents the excess of the gross receivable plus the estimated residual value over the cost of the equipment. The company accounts for initial direct costs incurred in consummating a transaction as part of the investment in the lease and appropriately amortize using the interest method over the term of the lease. The company recognizes unearned income as earned using the interest method over the term of the transaction. Earned income is included in rentals and financing revenue in the Consolidated Statements of Income.
From time to time, the company sells selected finance assets. The company follows FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” when accounting for its sale of finance assets. The company recognizes all assets obtained or liabilities incurred in consideration as proceeds of the sale and recognizes any gain or loss on the sale in earnings.
The company’s investment in leveraged leases consists of rentals receivable net of principal and interest on the related nonrecourse debt, estimated residual value of the leased property and unearned income. At lease inception, unearned income represents the excess of rentals receivable, net of that portion of the rental applicable to principal and interest on the nonrecourse debt, plus the estimated residual value of the leased property over the company’s investment in the transaction. The company recognizes the unearned income as leveraged lease revenue over the lease term. Earned income is included in rentals and financing revenue in the Consolidated Statement of Income.
Support services revenue
Equipment maintenance agreements
The company provides support services to its customers primarily through extended maintenance contracts. Revenue related to these agreements is recognized on a straight-line basis over the term of the agreement.
Multiple element arrangements
Certain of the company’s transactions are consummated at the same time. The usual form of this transaction involves the sale or lease of equipment, a cancelable meter rental and/or a cancelable equipment maintenance agreement.
In these cases, fair value of the various elements is determined by using the “residual method.” In applying the method, the fair values of any meter rental or equipment maintenance agreement is determined to be equivalent to the price charged in a standalone or renewal transaction. Any remaining consideration is allocated to the value of the equipment.
Costs and expenses
Operating expenses of field sales and service offices are included in selling, service and administrative expenses because no meaningful allocation of such expenses to cost of sales, rentals and financing or support services is practicable.
Income taxes
The deferred tax provision is determined under the liability method. Deferred tax assets and liabilities are recognized based on differences between the book and tax bases of assets and liabilities using currently enacted tax rates. The provision for income taxes is the sum of the amount of income tax paid or payable for the year as determined by applying the provisions of enacted tax laws to the taxable income for that year and the net change during the year in the company’s deferred tax assets and liabilities.
Deferred taxes on income result principally from the excess of tax over book depreciation, recognition of lease income and gross profits on sales to finance subsidiaries and is reduced for expenses not currently recognized for tax purposes.
For tax purposes, income from leases is recognized under the operating method and represents the difference between gross rentals billed and depreciation expense.
It has not been necessary to provide for income taxes on $308 million of cumulative undistributed earnings of subsidiaries outside the U.S. These earnings will be either indefinitely reinvested or remitted substantially free of additional tax. Determination of the liability that would result in the event all of these earnings were remitted to the U.S. is not practicable. It is estimated, however, that withholding taxes on such remittances would approximate $11 million.
Nonpension postretirement benefits and postemployment benefits
It is the company’s practice to fund amounts for nonpension postretirement and postemployment benefits as benefits become due. See Note 11 to the consolidated financial statements.
Earnings per share
Basic earnings per share is based on the weighted average number of common shares outstanding during the year, whereas diluted earnings per share also gives effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares include preference stock, preferred stock and stock option and purchase plan shares.
Accounting for stock-based compensation
In December 2002, FAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” which amends FAS No. 123, “Accounting for Stock-Based Compensation,” was issued. FAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and requires more prominent and more frequent disclosures in the financial statements of the effects of stock-based compensation. The provisions of FAS No. 148 are effective for fiscal years ending after December 15, 2002.
The company adopted FAS No. 123, “Accounting for Stock-Based Compensation,” on January 1, 1996. Under FAS No. 123, companies can, but are not required to, elect to recognize compensation expense for all stock-based awards using a fair value methodology. The company has adopted the disclosure-only provisions, as permitted by FAS No. 123. The company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based plans. Accordingly, no compensation expense has been recognized for its U.S. and U.K. Stock Option Plans (ESP) or its U.S. and U.K. Employee Stock Purchase Plans (ESPP), except for the compensation expense recorded for its performance-based awards under the ESP and the Directors’ Stock Plan as discussed herein. If the company had elected to recognize compensation expense based on the fair value method as prescribed by FAS No. 123, net income and earnings per share for the years ended 2002, 2001 and 2000 would have been reduced to the following proforma amounts:
In accordance with FAS No. 123, the fair value method of accounting has not been applied to awards granted prior to January 1, 1995. Therefore, the resulting pro forma impact may not be representative of that to be expected in future years.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
See Note 8 to the consolidated financial statements.
Translation of Non-U.S. currency amounts
Assets and liabilities of subsidiaries operating outside the U.S. are translated at rates in effect at the end of the period and revenue and expenses are translated at average rates during the period. Net deferred translation gains and losses are included in accumulated other comprehensive income in stockholders’ equity.
Derivative instruments
The company adopted the provisions of FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by FAS No. 138, in the first quarter of 2001. The adoption of FAS No. 133 has resulted in an after-tax reduction to accumulated
other comprehensive income of $7.0 million for the year ended December 31, 2001, including a one-time cumulative effect of accounting change which reduced accumulated other comprehensive income by approximately $9.2 million in the first quarter of 2001. The adoption of FAS No. 133 has also impacted assets and liabilities recorded on the Consolidated Balance Sheet. The adoption of FAS No. 133 did not materially impact results of operations for the year ended December 31, 2001.
In the normal course of business, the company enters into foreign exchange contracts for purposes other than trading primarily to minimize its risk of loss from exchange rate fluctuations on the settlement of intercompany receivables and payables arising in connection with transfers of finished goods, inventories between affiliates and certain intercompany loans. Foreign exchange contracts are primarily designated as cash flow hedges and the resulting gains and losses on these contracts are included in other comprehensive income. At December 31, 2002, the company had approximately $636 million of foreign exchange contracts outstanding, most of which mature in 2003, to buy or sell various currencies. Risks arise from the possible non-performance by counterparties in meeting the terms of their contracts and from movements in securities values, interest and/or exchange rates. However, the company does not anticipate non-performance by the counterparties as they are composed of a number of major international financial institutions. Maximum risk of loss on these contracts is limited to the amount of the difference between the spot rate at the date of the contract delivery and the contracted rate.
In the normal course of business, the company uses a variety of derivative financial instruments, principally interest rate swaps, to manage the impact of interest rate changes on earnings and cash flows. To qualify for hedge accounting, the company requires that the instruments be effective in reducing the risk exposure that they are designed to hedge. For instruments that are associated with the hedge of an anticipated transaction, hedge effectiveness criteria also require that it be probable that the underlying transaction will occur. Instruments that meet these hedging criteria are formally designated as hedges at the inception of the contract. Derivatives designated as cash flow hedges include primarily interest rate swaps related to variable-rate debt. Derivatives designated as fair value hedges include primarily interest rate swaps related to fixed-rate debt.
All derivative instruments are recognized as either assets or liabilities in the Consolidated Balance Sheet, measured at fair value. Changes in the fair value of those instruments are reflected as gains or losses. The accounting for the gains or losses depends on the intended use of the derivative, the resulting designation and the effectiveness of the instrument in offsetting the risk exposure they are designed to hedge.
Reclassification
Certain prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation.
2. Inventories
Inventories consist of the following:
If all inventories valued at LIFO had been stated at current costs, inventories would have been $25.7 million and $25.1 million higher than reported at December 31, 2002 and 2001, respectively. The increase in inventories in 2002 is mainly due to the launch of the DM seriesTM of digital, network mailing systems and new production mail systems.
3. Fixed assets
Depreciation expense was $236.7 million, $290.6 million and $294.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. Excluding discontinued operations, depreciation expense was $220.7 million and $223.9 million for the years ended December 31, 2001 and 2000, respectively.
4. Current liabilities
Accounts payable and accrued liabilities and notes payable and current portion of long-term obligations are comprised as follows:
In countries outside the U.S., banks generally lend to non-finance subsidiaries of the company on an overdraft or term-loan basis. These overdraft arrangements and term-loans, for the most part, are extended on an uncommitted basis by banks and do not require compensating balances or commitment fees.
Notes payable were issued as commercial paper, loans against bank lines of credit, or to trust departments of banks and others at below prevailing prime rates. Fees paid to maintain lines of credit were $.5 million in 2002, $.6 million in 2001, and $.8 million in 2000.
At December 31, 2002, U.S. notes payable totaled $859.7 million. Unused credit facilities outside the U.S. totaled $14.6 million at December 31, 2002, of which $12.7 million were for finance operations. In the U.S., the company, together with its financial service businesses, had unused credit facilities of $1.5 billion at December 31, 2002, largely in support of commercial paper borrowings. The weighted average interest rates were 1.3% and 1.8% on notes payable and overdrafts outstanding at December 31, 2002 and 2001, respectively.
The company periodically enters into interest rate swap agreements as a means of managing interest rate risk on both its U.S. and non-U.S. debt. The interest differential to be paid or received is recognized over the life of the agreements as an adjustment to interest expense. The company is exposed to credit losses in the event of non-performance by swap counterparties to the extent of the difference between the fixed and variable rates; such risk is considered minimal.
The company uses a balanced mix of debt maturities, variable and fixed rate debt and interest rate swap agreements to manage interest rate risk. The company’s variable and fixed rate debt mix, after adjusting for the effect of interest rate swap agreements, was 32% and 68%, respectively, at December 31, 2002. The company utilizes interest rate swap agreements when it considers the economic benefits to be favorable. At December 31, 2002, the company had outstanding interest rate swap agreements with notional principal amounts of $151.2 million and terms expiring at various dates from 2004 to 2018. The company exchanged $141.2 million notional principal amounts of variable commercial paper rates on an equal notional amount of notes payable and overdrafts for fixed rates ranging from 5.5% to 8.9%. In addition, the company exchanged $10.0 million notional principal amounts of fixed rate debt on an equal notional amount of variable rate debt. The variable rates for the swaps are based on three month LIBOR plus a spread, equal to the difference between the fixed rate of the debt and the fixed rate currently available for similar debt.
5. Long-term debt
*
In 2002, the company received $95 million in cash from the termination of four swap agreements associated with these notes. This amount will be reflected as a reduction of interest expense over the remaining term of these notes. As a result of this transaction, the weighted average effective rate on these notes is 4.77%.
On December 31, 2002, $1.4 billion remained available under the shelf registration statement filed in October 2001 with the SEC, permitting issuances of up to $2 billion in debt securities, preferred stock and depositary shares.
In September 2002, the company issued $400 million of unsecured fixed rate notes maturing in October 2012. These notes bear interest at an annual rate of 4.625% and pay interest semi-annually beginning April 2003. The proceeds from these notes were used for general corporate purposes, including the repayment of commercial paper in anticipation of 2003 debt maturities.
In February 2002, the company completed an offering of Euros 250 million of senior unsecured notes. These notes bear interest at a floating rate of EURIBOR plus 20 basis points, set two Euro business days preceding the quarterly interest payment dates and mature in August 2003. The notes are listed on the Luxembourg Stock Exchange and have been designated as a hedge of Euro denominated assets held by the company. The proceeds from these notes were used for general corporate purposes including repaying commercial paper, financing acquisitions and the repurchase of company stock.
In August 2001, the company issued $350 million of unsecured fixed rate notes maturing in August 2008. These notes bear interest at an annual rate of 5.75% and pay interest semi-annually beginning February 15, 2002. The proceeds from these notes were used for general corporate purposes, including the repayment of commercial paper.
In July 2001, the company issued four non-recourse promissory notes totaling $111.5 million in connection with four lease transactions. The promissory notes are all due in monthly installments over 194 months at an interest rate of 7.24%. In September 2001, the company sold its interest in two of the lease transactions and transferred the obligation on two of the non-recourse
promissory notes totaling $55.3 million in principal balance. In December 2002, the company sold its interest in one of the lease transactions and transferred the obligation on one non-recourse promissory note with a total principal balance of $25.6 million.
In April 2001, the company issued the remaining $300 million of notes available under a prior shelf registration, permitting issuances of up to $500 million in debt securities (including medium-term notes) with a minimum maturity of nine months. These unsecured notes bear annual interest at 5.875% and mature in May 2006. The proceeds were used for general corporate purposes, including the repayment of commercial paper, financing acquisitions and the repurchase of the company’s stock.
The annual maturities of the outstanding debt during each of the next five years are as follows: 2003, $0.8 billion; 2004, $0.5 billion; 2005, $0.3 billion; 2006, $0.3 billion; and $1.2 billion thereafter.
Under terms of their senior and subordinated loan agreements, certain of the finance operations are required to maintain earnings before taxes and interest charges at prescribed levels. With respect to such loan agreements, the company will endeavor to have these finance operations maintain compliance with such terms and, under certain loan agreements, is obligated, if necessary, to pay to these finance operations amounts sufficient to maintain a prescribed ratio of earnings available for fixed charges. The company has not been required to make any such payments to maintain earnings available for fixed charges coverage. The company is in compliance with the terms under the senior and subordinated loan agreements.
The fair value hedges basis adjustment represents the revaluation of fixed rate debt that has been hedged in accordance with FAS No. 133. See Note 1.
6. Preferred stockholders’ equity in a subsidiary company
Preferred stockholders’ equity in a subsidiary company represents 3,000,000 shares of variable term voting preferred stock issued by Pitney Bowes International Holdings, Inc., a subsidiary of the company, which are owned by certain outside institutional investors. These preferred shares are entitled to 25% of the combined voting power of all classes of capital stock. All outstanding common stock of Pitney Bowes International Holdings, Inc., representing the remaining 75% of the combined voting power of all classes of capital stock, is owned directly or indirectly by Pitney Bowes Inc. The preferred stock, $.01 par value, is entitled to cumulative dividends at rates set at auction. The weighted average dividend rate in 2002 and 2001 was 1.8% and 3.3%, respectively. Preferred dividends are reflected in the Consolidated Statements of Income in selling, service and administrative expenses. The preferred stock is subject to mandatory redemption based on certain events, at a redemption price not less than $100 per share, plus the amount of any dividends accrued or in arrears. No dividends were in arrears at December 31, 2002 or 2001.
In 1998, the company sold 100 shares of 9.11% Cumulative Preferred Stock, mandatorily redeemable in 20 years, in a subsidiary company to an institutional investor for approximately $10 million.
7. Capital stock and capital in excess of par value
At December 31, 2002, 480,000,000 shares of common stock, 600,000 shares of cumulative preferred stock, and 5,000,000 shares of preference stock were authorized, and 235,373,782 shares of common stock (net of 87,964,130 shares of treasury stock), 488 shares of 4% Convertible Cumulative Preferred Stock (4% preferred stock) and 52,897 shares of $2.12 Convertible Preference Stock ($2.12 preference stock) were issued and outstanding. In the future, the Board of Directors can issue the balance of unreserved and unissued preferred stock (599,512 shares) and preference stock (4,947,103 shares). This will determine the dividend rate, terms of redemption, terms of conversion (if any) and other pertinent features. At December 31, 2002, unreserved and unissued common stock (exclusive of treasury stock) amounted to 106,340,826 shares.
The 4% preferred stock outstanding, entitled to cumulative dividends at the rate of $2 per year, can be redeemed at the company’s option, in whole or in part at any time, at the price of $50 per share, plus dividends accrued to the redemption date. Each share of the 4% preferred stock can be converted into 24.24 shares of common stock, subject to adjustment in certain events.
The $2.12 preference stock is entitled to cumulative dividends at the rate of $2.12 per year and can be redeemed at the company’s option at the rate of $28 per share. Each share of the $2.12 preference stock can be converted into 16.53 shares of common stock, subject to adjustment in certain events.
At December 31, 2002, a total of 886,216 shares of common stock were reserved for issuance upon conversion of the 4% preferred stock (11,829 shares) and $2.12 preference stock (874,387 shares). In addition, 1,691,390 shares of common stock were reserved for issuance under the company’s dividend reinvestment and other corporate plans.
Each share of common stock outstanding has attached one preference share purchase right. Each right entitles each holder to purchase 1/200th of a share of Series A Junior Participating Preference Stock for $97.50 and will expire in February 2006.
Following a merger or certain other transactions, the rights will entitle the holder to purchase common stock of the company or the acquirers at a 50% discount.
8. Stock plans
The company has the following stock plans which are described below: the U.S. and U.K. Stock Option Plans (ESP), the U.S. and U.K. Employee Stock Purchase Plans (ESPP), and the Directors’ Stock Plan.
Stock Option Plans
Under the company’s stock option plans, certain officers and employees of the U.S. and the company’s participating subsidiaries are granted options at prices equal to the market value of the company’s common shares at the date of grant. Options generally become exercisable in three equal installments during the first three years following their grant and expire after ten years. At December 31, 2002, there were 19,469,120 options available for future grants under these plans. The per share weighted average fair value of options granted was $9 in 2002, 2001 and 2000.
The following table summarizes information about stock option transactions:
The following table summarizes information about stock options outstanding and exercisable at December 31, 2002:
Beginning in 1997, certain employees eligible for performance-based compensation may defer up to 100% of their annual awards, subject to the terms and conditions of the Pitney Bowes Deferred Incentive Savings Plan. Participants may allocate deferred compensation among specified investment choices, including stock options under the U.S. stock option plan. Stock options acquired under this plan are generally exercisable three years following their grant and expire after a period not to exceed ten years. There were 389,118, 372,829 and 285,289 options outstanding under this plan at December 31, 2002, 2001 and 2000, respectively, which are included in outstanding options under the company’s U.S. stock option plan. The per share weighted average fair value of options granted was $9 in 2002, $8 in 2001 and $12 in 2000.
The U.S. stock option plan permits the issuance of restricted stock. Restricted stock awards are subject to one or more restrictions, which may include continued employment over a specified period or the attainment of specified financial performance goals. Where a restricted stock award is subject to both tenure and attainment of financial performance goals, the restrictions would be released, in total or in part, only if the executive is still employed by the company at the end of the performance period and if the performance objectives are achieved. Where the sole restriction of a restricted stock award is continued employment over a specified period, such period may not be less than three years. The compensation expense for each award is recognized over the performance period. There were no restricted stock awards in 2002, 2001 or 2000.
Employee Stock Purchase Plans
The U.S. ESPP enables substantially all employees to purchase shares of the company’s common stock at a discounted offering price. In 2002, the offering price was 85% of the average price of the company’s common stock on the New York Stock Exchange on the offering date. At no time will the exercise price be less than the lowest price permitted under Section 423 of the Internal Revenue Code. The U.K. ESPP also enables eligible employees of the company’s participating U.K. subsidiaries to purchase shares of the company’s stock at a discounted offering price. In 2002, the offering price was 90% of the average closing price of the company’s common stock on the New York Stock Exchange for the three business days preceding the offering date. The company may grant rights to purchase up to 8,548,664 common shares to its regular employees under these plans. The company granted rights to purchase 562,208 shares in 2002, 542,309 shares in 2001 and 758,741 shares in 2000. The per share fair value of rights granted was $7 in 2002, $6 in 2001 and $9 in 2000 for the U.S. ESPP and $10 in 2002, $11 in 2001 and $10 in 2000 for the U.K. ESPP.
Directors’ Stock Plan
Under this plan, each non-employee director is granted 1,400 shares of restricted common stock annually as part of his or her compensation. Shares granted at no cost to the directors were 15,400 in 2002, 14,176 in 2001 and 13,475 in 2000. Compensation expense, net of taxes, recorded by the company was $.4 million for 2002 and $.3 million for 2001 and 2000, respectively. The shares carry full voting and dividend rights but, except as provided herein, may not be transferred or alienated until the later of (1) termination of service as a director, or, if earlier, the date of a change of control, or (2) the expiration of the six month period following the grant of such shares. If a director terminates service as a director prior to the expiration of the six month period following a grant of restricted stock, that award would be forfeited. In 1999, the Directors’ Stock Plan was amended to permit certain dispositions of restricted common stock to family members, trusts or partnerships, as well as donations to charity after the expiration of the six month holding period, provided the director retain restricted common stock with a minimum market value of $.4 million. The per share weighted average fair value of shares granted was $30 in 2002, $29 in 2001 and $30 in 2000.
Beginning in 1997, non-employee directors may defer up to 100% of their eligible compensation, subject to the terms and conditions of the Pitney Bowes Deferred Incentive Savings Plan for directors. Participants may allocate deferred compensation among specified investment choices, including stock options under the Directors’ Stock Plan. Stock options acquired under this plan are generally exercisable three years following their grant and expire after a period not to exceed ten years. There were 44,543, 35,598 and 18,136 options outstanding under this plan at December 31, 2002, 2001 and 2000, respectively. The per share weighted average fair value of options granted was $8 in 2002, $9 in 2001 and $10 in 2000.
9. Earnings per share
A reconciliation of the basic and diluted earnings per share computations for income from continuing operations for the years ended December 31, 2002, 2001 and 2000 is as follows:
In accordance with FAS No. 128, “Earnings per Share,” the common stock equivalent shares issuable upon the exercise of stock options which were not included in the calculation were 4.7 million, 2.7 million and 6.6 million in 2002, 2001 and 2000, respectively, because they were antidilutive.
10. Taxes on income
Income from continuing operations before income taxes and the provision for income taxes consist of the following:
Including discontinued operations, the provision for income taxes consists of the following:
A reconciliation of the U.S. federal statutory rate to the company’s effective tax rate for continuing operations follows:
The effective tax rate for discontinued operations in 2002, 2001 and 2000 differs from the statutory rate due primarily to foreign, state and local income taxes.
Deferred tax liabilities and (assets)
(a)
The table of deferred tax liabilities and (assets) above includes $243.3 million and $241.4 million for 2002 and 2001, respectively, of current net deferred taxes, which are included in income taxes payable in the Consolidated Balance Sheets.
During 2002 the deferred tax asset for net operating losses changed due to income generated in certain foreign subsidiaries and the valuation allowance changed due to losses incurred by certain other foreign subsidiaries. As of December 31, 2002 and 2001, approximately $84.8 million and $87.2 million, respectively, of net operating loss carryforwards were available to the company. Most of these losses can be carried forward indefinitely.
11. Retirement plans and nonpension postretirement benefits
The company has several defined benefit and defined contribution pension plans covering substantially all employees worldwide. Benefits are primarily based on employees’ compensation and years of service. Company contributions are determined based on the funding requirements of U.S. federal and other governmental laws and regulations.
The company contributed $27.1 million, $19.8 million and $21.0 million to its defined contribution plans in 2002, 2001 and 2000, respectively.
The change in benefit obligations and plan assets and the funded status for defined benefit pension plans is as follows:
At December 31, 2002, 30,000 shares of the company’s common stock with a fair value of $979.8 were included in the plan assets of the company’s pension plan.
The company provides certain health care and life insurance benefits to eligible retirees and their dependents. The cost of these benefits is recognized over the period the employee provides credited service to the company. Substantially all of the company’s U.S. and Canadian employees become eligible for retiree health care benefits after reaching age 55 and with the completion of the required service period. Postemployment benefits include primarily company-provided medical benefits to disabled employees and company-provided life insurance as well as other disability and death-related benefits to former or inactive employees, their beneficiaries and covered dependents.
The change in benefit obligations and plan assets and the funded status for nonpension postretirement benefit plans is as follows:
The assumed weighted average discount rate used in determining the accumulated nonpension postretirement benefit obligations was 6.75% in 2002 and 7.25% in 2001.
The components of the net periodic benefit cost for defined benefit pension plans and nonpension postretirement benefit plans are as follows:
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligations was 9.0% for 2003 and 10.0% for 2002. This was assumed to gradually decline to 5.0% by the year 2007 and remain at that level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
The curtailment gains and losses reported in 2001 were related to the spin-off of Imagistics International Inc. (IGI).
12. Discontinued Operations
On January 14, 2000, the company sold Atlantic Mortgage & Investment Corporation (AMIC), a wholly-owned subsidiary of the company, to ABN AMRO North America. In connection with this transaction, the company recorded a gain of $12.5 million (net of taxes of $7.4 million) for the year ended December 31, 2002. This gain resulted from the favorable resolution of certain contingent liabilities recorded at the time of sale.
On October 30, 1998, Colonial Pacific Leasing Corporation (CPLC), a wholly-owned subsidiary of the company, transferred the operations, employees, and substantially all assets related to its broker-oriented external financing business to General Electric Capital Corporation, a subsidiary of the General Electric Company. In connection with this transaction, the company recorded a gain of $25.5 million (net of taxes of $15.0 million) for the year ended December 31, 2002. This gain resulted from the favorable resolution of certain contingent liabilities recorded at the time of sale.
On December 3, 2001, the company completed the spin off of its office systems business to stockholders as an independent, publicly-traded company operating under the name of IGI. On that date, the company paid a special stock dividend of IGI common stock to the company’s common shareholders. Through this special dividend, the company distributed 100% of the shares of IGI stock to common shareholders of the company. The historical carrying amount of the IGI net assets distributed to shareholders on the spin-off date has been recorded as a stock dividend of $311.7 million. Each eligible common stockholder of record of the company on November 19, 2001 received 0.08 shares of IGI stock for each share of Pitney Bowes stock. The Internal Revenue Service has notified the company that the spin-off will be tax free as provided for under the Internal Revenue Code. The company received a net amount of approximately $111 million in cash from IGI after repayment of certain amounts due and a dividend.
Operating results of IGI, prior to the spin off, have been segregated and reported as discontinued operations in the Consolidated Statements of Income. Revenue of IGI was $568.0 million and $641.3 million for the period ended December 3, 2001 and the year ended December 31, 2000, respectively. Net interest expense allocated to IGI discontinued operations was $10.3 million for the period ended December 3, 2001 and $11.3 million for the year ended December 31, 2000, respectively. Interest has been allocated based on the net assets of IGI charged at the company’s weighted average borrowing rate. Income from IGI discontinued operations was $9.1 million (net of taxes of $6.2 million) for the period ended December 3, 2001, offset by costs, expenses and restructuring charges directly associated with the spin-off. The total amounts of costs, expenses and restructuring charges directly related to the spin-off exceeded the income from discontinued operations of IGI between the measurement date (December 11, 2000) and the spin-off date by $26.0 million (net of taxes of $12.2 million), primarily as a result of continued weakness in the copier business and the company’s restructuring initiatives. This amount has been reflected as a loss on disposal of discontinued operations in the Consolidated Statements of Income for the period ended December 31, 2001. Income from discontinued operations of IGI, net of taxes, was $64.1 million for the period ended December 11, 2000.
13. Restructuring Charges
In 2001, the company adopted a formal restructuring plan to implement a common, streamlined business infrastructure across the corporation as a result of the company’s decisions to spin off its office systems business and align its mailing business on a global basis, as well as cost saving opportunities resulting from strategic acquisitions and partnerships, and additional benefits attained from the consolidation of its IT organization and ERP initiatives. In connection with this plan, the company recorded pre-tax restructuring charges of $149.3 million in 2001, of which $116.1 million was related to continuing operations and the remaining $33.2 million was related to discontinued operations. The restructuring charges related to continuing operations have been segregated in the Consolidated Statements of Income for the year ended December 31, 2001. The restructuring charges related to discontinued operations have been reported in discontinued operations in the Consolidated Statements of Income for the year ended December 31, 2001. See Note 12 to the consolidated financial statements.
The restructuring charges related to continuing operations are composed of:
All restructuring charges, except for the asset impairments, will result in cash outflows. The severance and benefit costs relate to a reduction in workforce of approximately 1,500 employees worldwide which was initiated in 2001 and was substantially completed at December 31, 2002. The workforce reductions relate to actions across several of our businesses resulting from infrastructure and process improvements and our continuing efforts to streamline operations, and include managerial, professional, clerical and technical roles. Approximately 80% of the workforce reductions are in the U.S. The majority of the international workforce reductions are in Europe. None of the reductions will impact sales coverage. At December 31, 2002, 1,529 employees were separated under these initiatives and approximately $73.6 million of severance and benefit costs were paid. Asset impairments relate primarily to the disposal or abandonment of certain hardware and software applications, resulting from the alignment of our mailing business on a global basis and ERP initiatives. Other exit costs relate primarily to lease termination costs, non-cancelable lease payments, and other costs associated with business activities that have been exited and the consolidation of excess facilities.
The restructuring charges related to discontinued operations are composed of:
The severance and benefit costs relate to a reduction in workforce of approximately 25 employees. The asset impairments relate primarily to an impairment of residual values, in connection with leases of copier equipment, and the write-down of certain facsimile and copier equipment, resulting from the spin-off of our office systems business. Other exit costs relate primarily to incremental costs associated with cancellation and separation of facility occupancy leases that are shared between the company and IGI.
Accrued restructuring charges at December 31, 2002 consist of the following:
(Dollars in millions)
This restructuring plan was substantially completed at December 31, 2002.
In 2000, the company recorded a pre-tax charge of approximately $19 million related to the consolidation of information technology staff and infrastructure. This initiative was focused on creating an efficient global organization and technology platform to leverage the benefits of our current ERP and e-business initiatives. The majority of the initiatives and cash outflows relating to this consolidation were completed by December 31, 2001.
14. Meter Transition
In 2001, the company adopted a formal plan to transition to the next generation of networked mailing technology. The information capture and exchange, made possible by advanced technology, turns the postage meter into an “intelligent” terminal that networks the mailer to postal and carrier information and systems. This two-way information architecture, in turn, enables convenient access to and delivery of value-added services such as tracking, delivery confirmation and rate information. The adoption of this plan was facilitated by our expanded access to technology and our ability to move to networked products combined with our expectations that the U.S. and posts around the world will continue to encourage the migration of mailing systems to networked digital technologies. As a result of this plan, certain electronic meter rental assets and related equipment will not be placed back in service. In addition, certain leased equipment will either not be remarketed or will result in lower realization at end of lease as a result of the introduction of new technology. In connection with this plan, the company recorded non-cash pre-tax charges of $268.3 million for the year ended December 31, 2001, related to assets associated with our non-networked mailing technology. In November 2001, postal regulations were issued, consistent with the company’s meter transition plan, defining the meter migration process and timing.
The charges related to the meter transition plan are composed of:
15. Acquisitions
PSI Group, Inc. (PSI)
On August 1, 2002, the company completed the acquisition of PSI, the nation’s largest mail presort company, for approximately $127 million in cash and $39 million in debt assumed. The results of PSI’s operations have been included in the consolidated financial statements since the date of acquisition. PSI prepares, sorts and aggregates mail to earn postal discounts and expedite delivery for its customers. As a wholly-owned subsidiary of the company, PSI will operate under its current management and continue to focus on providing presort mail services.
The following table summarizes the preliminary estimated fair values of the major assets acquired and liabilities assumed at the date of acquisition:
The major intangible asset classes and weighted average amortization period for these asset classes were as follows:
The goodwill was assigned to the Global Mailing segment. No research and development assets were acquired.
Secap SA (Secap)
On October 31, 2001, the company announced it had completed the acquisition of Secap, the France-based mailing systems subsidiary of Fimalac, for approximately Euros 220 million ($206 million) in cash. Secap offers a range of mail processing and paper handling equipment, supplies and technology for low- to mid-volume mailers. Secap holds more than 30% of the postage meter market share in France. The results of Secap’s operations have been included in the consolidated financial statements since the date of acquisition.
The following table summarizes the estimated fair values of the major assets acquired and liabilities assumed at the date of acquisition:
The major intangible asset classes and weighted average amortization period for these asset classes were as follows:
The goodwill was assigned to the Global Mailing segment. No research and development assets were acquired.
Danka Services International (DSI)
On June 29, 2001, the company completed its acquisition of DSI from Danka Business Systems PLC. The final purchase price, following post-closing adjustments, was $285.5 million in cash. DSI provides on- and off-site document management services, including the management of central reprographic departments, the placement and maintenance of photocopiers, print-on-demand operations and document archiving and retrieval services. The acquisition has been accounted for under the purchase method and accordingly, the operating results of DSI have been included in the company’s consolidated financial statements since the date of acquisition.
The following table summarizes the estimated fair values of the major assets acquired and liabilities assumed at the date of acquisition:
The intangible assets relate to customer relationships and have a useful life of approximately 15 years. The goodwill was assigned to the Enterprise Solutions segment. No research and development assets were acquired.
Bell & Howell International Mail and Messaging Technologies (MMT)
On June 5, 2001, the company completed the acquisition of MMT in Europe, Africa, the Middle East and Asia. The final purchase price, following post closing adjustments, was $44 million in cash. MMT markets and services high-end mail processing, sorting and service-related products through a network of distributors and direct operations. The acquisition has been accounted for under the purchase method and accordingly, the operating results of the acquisition have been included in the company’s consolidated financial statements since the date of acquisition.
The following table summarizes the estimated fair values of the major assets acquired and liabilities assumed at the date of acquisition:
The major intangible asset classes and weighted average amortization period for these asset classes were as follows:
The goodwill was assigned to the Global Mailing segment. No research and development assets were acquired.
Consolidated impact of acquisitions
These acquisitions increased our operating profit, but including related financing costs, did not materially impact earnings either on a per share or aggregate basis.
The following unaudited pro forma consolidated results of operations have been prepared as if the acquisitions of PSI, Secap, DSI, and MMT had occurred on January 1, 2001:
The pro forma consolidated results do not purport to be indicative of results that would have occurred had the acquisitions been completed on January 1, 2001, nor do they purport to be indicative of the results that will be obtained in the future. The pro forma earning results of these acquisitions were not material to earnings on either a per share or an aggregate basis.
During 2002 and 2001 the company also completed several smaller acquisitions including, the remaining 43% ownership interest of MailCode Inc. in 2002, the acquisition of Alysis Technologies Inc. in 2001, a leading provider of digital document delivery solutions, the acquisition of some of the company’s international dealerships and acquisitions of presort businesses. The cost of these acquisitions was in the aggregate less than $50 million in each year. These acquisitions did not have a material impact on the company’s financial results either individually or on an aggregate basis.
16. Goodwill and other intangibles
At December 31, 2002, acquired intangible assets consisted of the following:
The aggregate acquired intangible asset amortization expense for the year ended December 31, 2002 was $12.6 million. Estimated acquired intangible amortization expense is as follows:
Changes in the carrying amount of goodwill for the year ended December 31, 2002 are as follows:
17. Commitments, contingencies and regulatory matters
At December 31, 2002, as part of the company’s Capital Services programs, the company has committed to potentially extend credit of $333 million to pre-approved creditworthy customers. The company will sell or syndicate transactions that are funded during the commitment period. In accordance with the company’s new Capital Services strategy, the company will no longer enter into new credit commitments.
In the ordinary course of normal business, the company is routinely a defendant in or parties to a number of pending and threatened legal actions including proceedings purportedly brought on behalf of classes of claimants. These may involve litigation by or against the company relating to, among other things: contractual rights under vendor, insurance, or other contracts; intellectual property or patent rights; equipment, service, payment or other disputes with customers; or disputes with employees. In those cases where the company is a defendant, plaintiffs may seek to recover large and sometimes unspecified amounts of damages or other types of relief and some matters may remain unresolved for several years. Although management cannot predict the ultimate outcome of such matters, based on current knowledge, management does not believe that the ultimate outcome of these litigations will have a material adverse effect on the company’s financial position, results of operations or cash flows.
In June 2002, the company received an examination report from the Internal Revenue Service (IRS) showing proposed income tax adjustments for the 1992 to 1994 tax years. The total additional tax proposed by the IRS for the 1992 through 1994 tax years is about $24 million. In August 2002, the company filed a protest with the IRS to challenge most of the proposed deficiencies asserted by the IRS. The company believes that it has meritorious defenses to those deficiencies and that the ultimate outcome will not result in a material effect on its results of operations, financial position or cash flows. However, if the IRS prevails on its asserted deficiencies, additional tax may be due for 1995 and future tax years, which could materially affect its results of operations, financial position or cash flows. At any time, the company’s provision for taxes could be affected by changes in tax law and interpretations by governments or courts.
In December 2001, the company recorded a pre-tax charge of approximately $24 million associated with the settlement of a lawsuit related to lease upgrade pricing in the early to mid-1990’s. The $24 million charge relates to the following settlement costs: award certificates to be provided to members of the class for purchase of office products through Pitney Bowes supply line and the cost of legal fees and related expenses of $8.3 million. This charge has been included in other income in the Consolidated Statement of Income for the year ended December 31, 2001.
In June 2001, the company and Hewlett-Packard announced that they had reached an agreement resolving a lawsuit filed by the company in 1995. The lawsuit arose out of a dispute over print technology patents. Under the terms of the agreement, the companies resolved all pending patent litigation without admission of infringement and the company received $400 million in cash and ten year supply and technology agreements. The cash payment, net of legal fees and related expenses of $37.8 million, was recorded as other income in the Consolidated Statement of Income for the year ended December 31, 2001.
In November 2001, the U.S. Postal Service (USPS) issued its finalized service plan for the retirement of non-digital, or letterpress, meters. New placements of non-digital meters without the “timeout” feature that enables the meters to be automatically disabled, if not reset within a specified time period are no longer permitted after December 31, 2002. These meters must be off the market by December 31, 2006. New placements of non-digital meters with a “timeout” feature are no longer permitted after June 2004. These meters must be off the market by December 31, 2008.
In 2000, the USPS issued a proposed schedule for the phaseout of manually reset electronic meters in the U.S. As of February 1, 2000, new placements of manually reset electronic meters were no longer permitted. Current users of manually reset electronic meters could continue to use these meters for the term of their rental and lease agreements. Leases or rentals due to expire in 2000 could be extended to December 31, 2001.
In connection with the above, the company adopted a formal plan in the second quarter of 2001, to transition to the next generation of networked mailing technology. See Note 14 to the consolidated financial statements.
In May 1995, the USPS publicly announced its concept of its Information Based Indicia Program (IBIP) for future postage evidencing devices. As initially stated by the USPS, the purpose of the program was to develop a new standard for future digital postage evidencing devices which would significantly enhance postal revenue security and support expanded USPS value-added services to mailers. The program would consist of the development of four separate specifications: (i) the Indicium specification - the technical specifications for the indicium to be printed; (ii) a Postal Security Device specification - the technical specification for the device that would contain the accounting and security features of the system; (iii) a Host specification; and (iv) a Vendor Infrastructure specification. During the period from May 1995 through December 31, 2001, the company submitted extensive comments to a series of proposed IBIP specifications issued by the USPS, including comments on the IBI Performance Criteria.
In June 1999, the company was served with a Civil Investigative Demand (CID) from the Justice Department’s Antitrust Division. A CID is a tool used by the Antitrust Division for gathering information and documents. The company believes that the Justice Department may have been reviewing the company’s efforts to protect its intellectual property rights. The company believes it has complied fully with the antitrust laws and cooperated fully with the department’s investigation. In February 2002, the Justice Department advised the company that it has decided to close this investigation with no further action.
18. Guarantees
In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” The Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002.
In connection with its Capital Services programs, the company has sold finance receivables and entered into guarantee contracts with varying amounts of recourse. See Off-Balance Sheet Items in Note 20 to the consolidated financial statements.
In connection with the sale of certain businesses, the company has agreed to indemnify the buyer for certain losses related to assets acquired by the buyer. At December 31, 2002, the company’s Consolidated Balance Sheet includes a liability of approximately $9 million for these indemnifications, which reflects the company’s maximum probable exposure.
The company provides product warranties in conjunction with certain product sales, generally for a period of 90 days from the date of installation. The Company’s product warranty liability reflects management’s best estimate of probable liability under its product
warranties based on historical claim experience, which has not been significant, and other currently available evidence. Accordingly, the company’s product warranty liability at December 31, 2002 and 2001, respectively, was not material.
19. Leases
In addition to factory and office facilities owned, the company leases similar properties, as well as sales and service offices, equipment and other properties, generally under long-term lease agreements extending from three to 25 years. Certain of these leases have been capitalized at the present value of the net minimum lease payments at inception. Amounts included under liabilities represent the present value of remaining lease payments.
Future minimum lease payments under both capital and non-cancelable operating leases at December 31, 2002 are as follows:
Rental expense was $134.3 million, $108.1 million and $103.5 million in 2002, 2001 and 2000, respectively.
20. Financial services
The company has several consolidated finance operations which are engaged in lease financing of the company’s products in the U.S., Canada, the U.K., Germany, France, Norway, Ireland, Australia, Austria, Spain, Switzerland, Sweden and Italy, as well as other financial services to the commercial and industrial markets in North America.
Condensed financial data for the consolidated finance operations follows:
Condensed summary of operations
Condensed balance sheet
Capital Services
Capital Services charges
In 2002, the company recorded a non-cash pre-tax charge of approximately $213 million, to write down its investments in commercial passenger aircraft leases primarily with US Airways Group, Inc. (US Airways) and United Air Lines (United) and to increase its provision for credit losses primarily related to aircraft leasing investments in the U.S. The charge was composed of the following:
•
A write-down of U.S. aircraft lease receivables and residuals of approximately $110 million
•
Additional credit loss reserves related to U.S. aircraft lease investments of approximately $82 million
•
Other costs related to the company’s aircraft leasing investments of approximately $1 million; and
•
Additional credit loss reserves related to non-aircraft Capital Services investments of approximately $20 million.
A further breakdown of the charge related to aircraft lease investments by individual airline is presented on page 66.
The decision of US Airways and United to file for bankruptcy exacerbated an already difficult environment in the airline industry. As a result of the rapid deterioration of the U.S. airline industry as well as our revised Capital Services strategy, the company recorded a charge of approximately $82 million to increase our provision for credit losses related to its aircraft leasing investments in the U.S. As a result of these events, combined with both the deteriorating financial condition in various other industries and the change in its Capital Services strategy, the company recorded a charge of approximately $20 million to increase its provision for credit losses related to non-aircraft leasing investments, including investments in the telecommunications industry.
Investment in commercial passenger and cargo aircraft leasing transactions
At December 31, 2002, the company’s net investment in commercial passenger and cargo aircraft leasing transactions was $344.4 million, which is composed of transactions with U.S. and foreign airlines of $62.0 million and $282.4 million, respectively. This portfolio is diversified across 13 airlines and 30 aircraft and is financed through investments in leveraged lease transactions, direct financing lease transactions and through its equity investment in PBG Capital Partners LLC (PBG). Risk of loss under these transactions is primarily related to: (1) the inability of the airline to make underlying lease payments; (2) the company’s inability to generate sufficient cash flows either through the sale of the aircraft or secondary lease transactions to recover its net investment; and/or (3) in the case of the leveraged lease portfolio, the absence of an equity defeasance or other third party credit arrangements. Approximately 35% of the company’s remaining net investment in commercial passenger and cargo aircraft leasing investments is further secured by approximately $120 million of equity defeasance accounts or third party credit arrangements.
At December 31, 2002, the company’s net investment in commercial passenger and cargo aircraft leasing transactions was composed of the following:
(A)
The company’s investment in commercial passenger aircraft leasing transactions with United included four aircraft leased to United and one aircraft leased to a wholly-owned regional carrier subsidiary of United, for a total investment of approximately $72 million. In December 2002, United filed for protection under Chapter 11 of the U.S. Bankruptcy Code. The company is currently in discussions with United as to whether it will continue leasing these aircraft to them post-bankruptcy at reduced lease rates. Based on the expected outcome of these negotiations and the continued deterioration of the U.S. airline industry, the company recorded a charge of approximately $54 million to write down lease receivables and residuals to reflect the estimated cumulative loss of future cash flows over the next nine years.
(B)
Prior to these charges and an exchange transaction as discussed below, the company’s investment in commercial passenger aircraft leasing transactions with US Airways included four aircraft for a total investment of approximately $60 million. In August 2002, US Airways filed for protection under Chapter 11 of the U.S. Bankruptcy Code. To eliminate the company’s exposure to US Airways, in December 2002, the company exchanged the four aircraft leased to US Airways, which were then valued at approximately $9 million and paid approximately $11 million in cash for a leased aircraft operated by Federal Express. The company recorded a charge of approximately $51 million to write down its remaining investment in US Airways.
(C)
The company recorded a charge of approximately $5 million to write down lease residuals on leases with Delta Airlines based on an analysis of the underlying leases and aircraft.
The write-down of lease receivables and residuals of $110 million and additional credit loss reserves of $82 million includes $31 million and $70 million, respectively, related to aircraft financed through the company’s equity investment in PBG.
Capital Services portfolio
The company’s investment in Capital Services lease related assets included in its Consolidated Balance Sheet was composed of the following:
The company’s investment in leveraged leases assets consists of the following:
•
The $1.6 billion is the amount that is on the company’s Consolidated Balance Sheet.
•
Rental receivables represent total lease payments from the company’s customers over the remaining term of the leveraged leases.
•
Residual value represents the value of the property anticipated at the end of the leveraged lease terms and is based on independent appraisals. The company regularly reviews the recorded residual value to ensure it is appropriate.
•
Principal and interest on nonrecourse loans represent amounts due to unrelated third parties from the company’s customers over the remaining term of the leveraged leases. The nonrecourse loans are secured by the lessees’ rental obligations and the leased property. If a lessee defaults and if the amounts realized from the sale of these assets are insufficient, the company has no obligation to make any payments due on these nonrecourse loans to the unrelated third parties. Accordingly, the company is required by generally accepted accounting principles to subtract the principal and interest over the remaining term of the nonrecourse loans from its rental receivables and residual value. At December 31, 2002, the principal balances on the nonrecourse loans totaled $3.6 billion and the related interest payments over the remaining terms of the leases totaled $3.3 billion. Maturities of the principal balances on the nonrecourse loans are $141 million, $76 million, $112 million, $158 million, $151 million and $2,943 million for the years ended December 31, 2003, 2004, 2005, 2006, 2007 and thereafter, respectively.
•
Unearned income represents the company’s future financing income that will be earned over the remaining term of the leases.
The $1.6 billion investment in leveraged leases on the company’s Consolidated Balance Sheet is diversified across the following types of assets:
•
$340.1 million related to commercial real estate facilities, with original lease terms ranging from 17 to 25 years.
•
$307.1 million for postal equipment with international postal authorities, with original lease terms ranging from 16 to 24 years.
•
$303.1 million related to locomotives and railcars, with original lease terms ranging from 20 to 40 years.
•
$302.4 million related to nine commercial passenger and cargo aircraft, with original lease terms ranging from 23 to 25 years.
•
$132.5 million for telecommunications equipment, with original lease terms ranging from 14 to 16 years.
•
$131.3 million for rail and bus facilities with original lease terms ranging from 27 to 37 years.
•
$43.4 million for shipping and handling equipment with an original lease term of 24 years.
The company’s leveraged lease investment in telecommunications equipment represents leases to three highly rated international telecommunication entities. Approximately 86 percent of this portfolio is further secured by equity defeasance accounts or other third party credit arrangements. Additionally, the company’s leveraged lease investment in commercial real estate facilities includes approximately $84 million related to leases of corporate facilities to four U.S. telecommunication entities, of which $69 million is with lessees that are highly rated. In addition, as part of the Capital Services charges discussed on page 65, the company increased its provision for credit losses related to its investments in the telecommunications industry.
Overall, approximately 48 percent of the company’s $1.6 billion leveraged lease portfolio is further secured by equity defeasance accounts or other third party credit arrangements. In addition, approximately 17 percent of the remaining leveraged lease portfolio represents leases to highly rated government related organizations which have guarantees or supplemental credit enhancements upon the occurrence of certain events.
Following is a summary of the components of income from leveraged leases excluding capital services charges:
Finance receivables are composed of the following:
(Dollars in millions)
The company expects to phase out its assets held for sale portfolio by the end of 2003. The company’s Consolidated Statement of Income includes financing revenue of $32.6 million and $33.8 million for the years ended December 31, 2002 and 2001, respectively, attributable to its assets held for sale portfolio.
Other assets represent the company’s 50% equity interest in PBG. The company formed PBG with GATX Corporation during 1997 for the purposes of financing and managing certain leasing related assets. The company accounts for its investment in PBG under the equity method. The company’s net investment in PBG was reduced by a write-down of aircraft lease receivables of approximately $31 million and additional credit loss reserves of approximately $70 million related to aircraft lease investments in the U.S. See Capital Services charges on page 65.
Finance Receivables
Finance receivables are generally due in monthly, quarterly or semiannual installments over periods ranging from three to 15 years.
The components of net finance receivables were as follows:
Maturities of gross finance receivables for the finance operations are as follows:
Finance operations’ net purchases of Pitney Bowes equipment amounted to $684.8 million, $701.4 million and $698.7 million in 2002, 2001 and 2000, respectively.
Credit Risk
The company regularly reviews its risk of default on both an individual lessee basis as well as its overall exposure by industry. The company also regularly reviews its equipment and property values. This may include industry and equipment studies, physical inspections and third party appraisals.
A summary of the allowance for credit losses were as follows:
The increase in the amount of additions charged to continuing operations in 2002 is primarily due to the charge recorded related to the company’s aircraft leasing investments in the U.S. See Capital Services charges. The decrease in the amount of additions charged to continuing operations in 2001 is due to the sale of the credit card operation in June 2000.
The carrying values of non-performing assets are disclosed in the table below. As of December 31, 2002, the lessees in the company’s U.S. commercial passenger aircraft leasing portfolio, other than United and US Airways, have made all lease payments as contractually agreed and continue to perform all obligations under their respective leases. These assets, which are detailed on page 66, are therefore not included in the summary of non-performing assets below. The company has, however, as a result of the continuing deterioration in the U.S. airline industry, decided to suspend the recognition of financing income on all aircraft leases in the U.S. (other than Federal Express) beginning January 1, 2003.
Off-Balance Sheet Items
Finance receivables sales
As part of the company’s Capital Services program, the company has, from time-to-time sold, through securitizations, net finance receivables with limited recourse. In these transactions, the company has surrendered control over the transferred assets in accordance with paragraph 9 of FAS No. 140 and received a cash payment from the transferee. Specifically, the finance receivables were sold to a bankruptcy remote limited liability company. At the time of sale, the company obtained legal counsel’s opinion that the assets were isolated and that the sale qualified as a true sale at law. Under the terms of the sale, the transferee has the right to pledge or exchange the assets it received. There are no conditions that both constrain the transferee from taking advantage of its right to pledge or exchange and provide more than a trivial benefit to the transferor. The company does not maintain effective control over the transferred assets.
The company has accounted for these transactions as a sale recognizing assets obtained and liabilities incurred in consideration as proceeds of the sale. Any resulting gain or loss was recognized in income at the time of sale. The maximum risk of loss in these transactions arises from the possible non-performance of lessees to meet the terms of their contracts. The company believes adequate provisions for losses have been established for receivables sold which may become uncollectible and for which it has recourse obligation, in accordance with paragraph 113 of FAS No. 140.
The company has sold net finance receivables and in selective cases entered into guarantee contracts with varying amounts of recourse in privately-placed transactions with unrelated third-party investors. The uncollected principal balance of receivables sold and guarantee contracts totaled $183.0 million and $181.2 million at December 31, 2002 and 2001, respectively. In accordance with generally accepted accounting principles, the company does not record these amounts as liabilities on its Consolidated Balance Sheet.
The company’s maximum risk of loss on these net financing receivables and guarantee contracts arises from the possible non-performance of lessees to meet the terms of their contracts and from changes in the value of the underlying equipment. These contracts are secured by the underlying equipment value, and supported by the creditworthiness of its customers. At December 31, 2002, the underlying equipment value exceeded the sum of the uncollected principal balance of receivables sold and the guarantee contracts. As part of the company’s review of its risk exposure, the company believes it has made adequate provision for sold receivables and guarantee contracts which may not be collectible. See Note 18 and 22 to the consolidated financial statements. The company does not depend on these types of transactions to fund its leasing investments. The company selectively uses these transactions when the overall economic impact on the company is more favorable than debt.
Equity interest
During 1997, the company formed PBG Capital Partners LLC (PBG) with GATX Corporation (GATX) for the purpose of financing and managing certain leasing related assets existing at that time. The company contributed assets to PBG and maintains a 50% interest. The company accounts for its investment in PBG under the equity method. The company’s maximum exposure is its investment of $61 million on the company’s Consolidated Balance Sheet at December 31, 2002. PBG’s total assets and liabilities at December 31, 2002 were $379 million and $239 million, respectively. In accordance with generally accepted accounting principles, the company does not record these assets and liabilities on its Consolidated Balance Sheet.
State and local government financing
The company has originated tax-exempt secured loans to state and local governments and has sold certificates of interest in these loans. Generally, the company recognizes revenue for the fees it receives upon the sale of these certificates. These transactions however, may require the company to buy back certificates if interest rates rise significantly. The company’s maximum risk of loss arises because it may be required to buy back certificates and resell them to other third parties at below its cost. The company has structured these transactions so that even in a rising interest rate environment, its losses would be minimal. The company has further minimized any risk of non-performance on the state and local government loans by obtaining credit guarantees of these loans from a highly-rated nationally recognized insurance company. Certificates outstanding at December 31, 2002 and 2001 were $216.8 million and $263.7 million, respectively, which represent the company’s maximum exposure to state and local government financing. In accordance with generally accepted accounting principles, the company does not record these certificates as assets or liabilities on our Consolidated Balance Sheet.
The company’s potential requirement to buy back certificates is based on movements of the Bond Market Association (BMA) Municipal Index. The company’s weighted average coupon rate on the underlying secured loans is approximately 4.96%. The current market rate per the BMA Index is 1.08% on January 3, 2003. The company pays a premium over the BMA Index in the range of 25 to 40 basis points. The company would be required to buy back certificates if rates rise by approximately 350 basis points. The company has periodically entered into a fixed rate contract with investors whereby it locks in a fixed rate for a fixed period, generally 13 months. This insulates the company’s interest rate risk for that set period of time. The company recognized net pre-tax gains/(losses) after expenses of $2.5 million, $8.1 million and $(.7) million in 2002, 2001 and 2000, respectively.
21. Business segment information
For a description of the company’s reportable segments and the types of products and services from which each reportable segment derives its revenue, see “Overview” on page 10. That information is incorporated herein by reference. The information set forth below should be read in conjunction with such information. The accounting policies of the segments are the same as those described in the summary of significant accounting policies, with the exception of the items outlined below.
Operating profit of each segment is determined by deducting from revenue the related costs and operating expenses directly attributable to the segment. Segment operating profit excludes general corporate expenses, income taxes and net interest attributable to corporate debt. Interest from financial services businesses includes intercompany interest. Identifiable assets are those used in the company’s operations and exclude cash and cash equivalents, short-term investments and general corporate assets. Long-lived assets exclude finance receivables and investment in leveraged leases.
Revenue and operating profit by business segment and geographic area for the years ended 2000 to 2002 were as follows:
Additional segment information is as follows:
Reconciliation of segment amounts to consolidated totals:
22. Fair value of financial instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Cash, cash equivalents, short-term investments, accounts receivable, accounts payable and notes payable
The carrying amounts approximate fair value because of the short maturity of these instruments.
Investment securities
The fair value of investment securities is estimated based on quoted market prices, dealer quotes and other estimates.
Loans receivable
The fair value of loans receivable is estimated based on quoted market prices, dealer quotes or by discounting the future cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings and similar remaining maturities.
Long-term debt
The fair value of long-term debt is estimated based on quoted dealer prices for the same or similar issues.
Interest rate swap agreements and foreign currency exchange contracts
The fair values of interest rate swaps and foreign currency exchange contracts are obtained from dealer quotes. These values represent the estimated amount the company would receive or pay to terminate agreements taking into consideration current interest rates, the creditworthiness of the counterparties and current foreign currency exchange rates.
Transfer of receivables with recourse
The fair value of the recourse liability represents the estimate of expected future losses and has accordingly been recorded in the company’s Consolidated Balance Sheet. The company periodically evaluates the adequacy of reserves and estimates of expected losses; if the resulting evaluation of expected losses differs from the actual reserve, adjustments are made to the reserve.
The estimated fair value of the company’s financial instruments at December 31, 2002 is as follows:
(a)
Carrying value includes accrued interest and deferred fee income, where applicable.
The estimated fair value of the company’s financial instruments at December 31, 2001 is as follows:
(a)
Carrying value includes accrued interest and deferred fee income, where applicable.
23. Quarterly financial data (unaudited)
Summarized quarterly financial data (dollars in millions, except for per share data) for 2002 and 2001 follows:
The sum of the quarters and earnings per share amounts may not equal the annual and total amounts due to rounding.
Report of Independent Accountants
To the Stockholders and Board of Directors of Pitney Bowes Inc.:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 78 present fairly, in all material respects, the financial position of Pitney Bowes Inc. and its subsidiaries (the company) at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 78 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 of the notes to the consolidated financial statements, in 2002 the company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
Stamford, Connecticut
January 28, 2003
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except for information regarding the company’s executive officers the information called for by this Item is incorporated herein by reference to the sections entitled “Election of Directors,” “How much stock is owned by directors, nominees and executive officers?” and “Security Ownership” of the Pitney Bowes Inc. Notice of the 2003 Annual Meeting and Proxy Statement.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The sections entitled “Directors’ Compensation,” “Executive Officer Compensation,” “Severance and Change of Control Arrangements” and “Pension Benefits” of the Pitney Bowes Inc. Notice of the 2003 Annual Meeting and Proxy Statement are incorporated herein by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
EQUITY COMPENSATION PLAN INFORMATION TABLE
The following table provides information as of December 31, 2002 regarding the number of shares of the company’s common stock that may be issued under the company’s equity compensation plans.
The sections entitled “How much stock is owned by directors, nominees and executive officers?” and “Security Ownership” of the Pitney Bowes Inc. Notice of the 2003 Annual Meeting and Proxy Statement is incorporated herein by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As part of the spin-off of IGI, Pitney Bowes has entered into several agreements with IGI that govern the ongoing relations between the two companies. The purpose of the agreements is to provide an orderly transition for both companies. Additional or modified agreements, arrangements or transactions, which would be negotiated at arm’s length, may be entered into between Pitney Bowes and IGI.
Agreements included matters such as cross-indemnification, employee benefits, non-competition provisions, restrictions on solicitation or employment of employees, access of information, provision of witnesses, confidentiality, transaction expenses, employee termination, transition services, tax separation, intellectual property, vendor financing, real estate and a credit agreement.
ITEM 14
ITEM 14 - CONTROLS AND PROCEDURES
(a) Explanation of Disclosure Controls and Procedures
Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) as of a date (the “Evaluation Date”) within 90 days of the filing date of this annual report, have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.
(b) Changes in Internal Controls
There were no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the Evaluation Date, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
1.
Financial statements - see Item 8 on page 37 and “Index to Financial Schedules” on page 87.
2.
Financial statement schedules - see “Index to Financial Schedules” on page 87.
3.
Exhibits (numbered in accordance with Item 601 of Regulation S-K).
4.
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act on pages 85-86.
5.
Certification of Chief Executive Officer.
6.
Certification of Chief Financial Officer.
Reg. S-K Exhibits
Description
Status or incorporation by reference
(3)(a)
Restated Certificate of Incorporation, as amended
Incorporated by reference to Exhibit (3a) to Form 10-K as filed with the Commission on March 30, 1993. (Commission file number 1-3579)
(a.1)
Certificate of Amendment to the Restated Certificate of Incorporation (as amended May 29, 1996)
Incorporated by reference to Exhibit (a.1) to Form 10-K as filed with the Commission on March 27, 1998. (Commission file number 1-3579)
(b)
By-laws, as amended
Incorporated by reference to Exhibit (3b) to Form 10-K as filed with the Commission on April 1, 1996. (Commission file number 1-3579)
(c)
By-laws, as amended
Incorporated by reference to Exhibit (3)(ii) to Form 10-Q as filed with the Commission on November 16, 1998. (Commission file number 1-3579)
(4)(a)
Form of Indenture dated as of November 15, 1987 between the company and Chemical Bank, as Trustee
Incorporated by reference to Exhibit (4a) to Form 10-K as filed with the Commission on March 24, 1988. (Commission file number 1-3579)
(b)
Form of Debt Securities
Incorporated by reference to Exhibit (4b) to Form 10-K as filed with the Commission on March 24, 1988. (Commission file number 1-3579)
(c)
Form of First Supplemental Indenture dated as of June 1, 1989 between the company and Chemical Bank, as Trustee
Incorporated by reference to Exhibit (1) to Form 8-K as filed with the Commission on June 16, 1989. (Commission file number 1-3579)
(d)
Form of Indenture dated as of April 15, 1990 between the company and Chemical Bank, as successor to Manufacturers Hanover Trust Company, as Trustee
Incorporated by reference to Exhibit (4.1) to Registration Statement on Form S-3 (No. 33-33948) as filed with the Commission on March 28, 1990.
(e)
Forms of Debt Securities
Incorporated by reference to Exhibit (4) to Form 10-Q as filed with the Commission on May 14, 1990. (Commission file number 1-3579)
(f)
Form of Indenture dated as of May 1, 1985 between Pitney Bowes Credit Corporation and Bankers Trust Company, as Trustee
Incorporated by reference to Exhibit (4a) to Registration Statement on Form S-3 (No. 2-97411) as filed with the Commission on May 1, 1985.
(g)
Letter Agreement between Pitney Bowes Inc. and Bankers Trust Company, as Trustee
Incorporated by reference to Exhibit (4b) to Registration Statement on Form S-3 (No. 2-97411) as filed with the Commission on May 1, 1985.
(h)
Form of First Supplemental Indenture dated as of December 1, 1986 between Pitney Bowes Credit Corporation and Bankers Trust Company, as Trustee
Incorporated by reference to Exhibit (4b) to Registration Statement on Form S-3 (No. 33-10766) as filed with the Commission on December 12, 1986.
Executive Compensation Plans:
(10)(a)
Retirement Plan for Directors of Pitney Bowes Inc.
Incorporated by reference to Exhibit (10a) to Form 10-K as filed with the Commission on March 30, 1993. (Commission file number 1-3579)
(b)
Pitney Bowes Inc. Directors’ Stock Plan (as amended and restated 1997)
Incorporated by reference to Exhibit (i) to Form 10-K as filed with the Commission on March 31, 1997. (Commission file number 1-3579)
(b.1)
Pitney Bowes Inc. Directors’ Stock Plan (as amended and restated 1999)
Incorporated by reference to Exhibit (i) to Form 10-K as filed with the Commission on March 30, 2000. (Commission file number 1-3579)
(c)
Pitney Bowes 1991 Stock Plan
Incorporated by reference to Exhibit (10b) to Form 10-K as filed with the Commission on March 25, 1992. (Commission file number 1-3579)
(c.1)
First Amendment to Pitney Bowes 1991 Stock Plan
Incorporated by reference to Exhibit (ii) to Form 10-K as filed with the Commission on March 31, 1997. (Commission file number 1-3579)
(c.2)
Second Amendment to Pitney Bowes 1991 Stock Plan
Incorporated by reference to Exhibit (i) to Form 10-Q as filed with the Commission on November 13, 1997. (Commission file number 1-3579)
(c.3)
Pitney Bowes 1991 Stock Plan (as amended and restated)
Incorporated by reference to Exhibit (10) to Form 10-Q as filed with the Commission on May 14, 1998. (Commission file number 1-3579)
(c.4)
Pitney Bowes 1998 Stock Plan (as amended and restated)
Incorporated by reference to Exhibit (ii) to Form 10-K as filed with the Commission on March 30, 2000. (Commission file number 1-3579)
(d)
Pitney Bowes Inc. Key Employees’ Incentive Plan (as amended and restated)
Incorporated by reference to Exhibit (10c) to Form 10-K as filed with the Commission on March 25, 1992. (Commission file number 1-3579)
(d.1)
First Amendment to Pitney Bowes Inc. Key Employees’ Incentive Plan (as amended and restated June 10, 1991)
Incorporated by reference to Exhibit (iii) to Form 10-K as filed with the Commission on March 31, 1997. (Commission file number 1-3579)
(d.2)
Second Amendment to Pitney Bowes Inc. Key Employees’ Incentive Plan (as amended and restated)
Incorporated by reference to Exhibit (i) to Form 10-K as filed with the Commission on March 26, 2001. (Commission file number 1-3579)
(e)
1979 Pitney Bowes Stock Option Plan (as amended and restated)
Incorporated by reference to Exhibit (10d) to Form 10-K as filed with the Commission on March 25, 1992. (Commission file number 1-3579)
(f)
Pitney Bowes Severance Plan, as amended, dated December 12, 1988
Incorporated by reference to Exhibit (10) to Form 10-K as filed with the Commission on March 23, 1989. (Commission file number 1-3579)
Executive Compensation Plans:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ MICHAEL J. CRITELLI
Chairman and Chief Executive Officer - Director
March 18, 2003
Michael J. Critelli
/s/ BRUCE P. NOLOP
Executive Vice President and Chief Financial Officer (principal financial officer)
March 18, 2003
Bruce P. Nolop
/s/ ARLEN F. HENOCK
Vice President - Finance (principal accounting officer)
March 18, 2003
Arlen F. Henock
/s/ LINDA G. ALVARADO
Director
March 18, 2003
Linda G. Alvarado
/s/ COLIN G. CAMPBELL
Director
March 18, 2003
Colin G. Campbell
/s/ JESSICA P. EINHORN
Director
March 18, 2003
Jessica P. Einhorn
/s/ ERNIE GREEN
Director
March 18, 2003
Ernie Green
/s/ HERBERT L. HENKEL
Director
March 18, 2003
Herbert L. Henkel
/s/ JAMES H. KEYES
Director
March 18, 2003
James H. Keyes
/s/ JOHN S. MCFARLANE
Director
March 18, 2003
John S. McFarlane
/s/ EDUARDO R. MENASCÉ
Director
March 18, 2003
Eduardo R. Menascé
/s/ MICHAEL I. ROTH
Director
March 18, 2003
Michael I. Roth
/s/ DAVID L. SHEDLARZ
Director
March 18, 2003
David L. Shedlarz
/s/ ROBERT E. WEISSMAN
March 18, 2003
Director
Robert E. Weissman
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Michael J. Critelli, certify that:
1.
I have reviewed this annual report on Form 10-K of Pitney Bowes Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c.
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a.
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 18, 2003
/s/ MICHAEL J. CRITELLI
Michael J. Critelli
Chief Executive Officer
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Bruce P. Nolop, certify that:
1.
I have reviewed this annual report on Form 10-K of Pitney Bowes Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c.
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a.
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 18, 2003
/s/ BRUCE P. NOLOP
Bruce P. Nolop
Chief Financial Officer
INDEX TO FINANCIAL SCHEDULES
The financial schedules should be read in conjunction with the financial statements included in Item 8 in this Form 10-K. Schedules not included herein have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. Also, separate financial statements of less than 100 percent owned companies, which are accounted for by the equity method, have been omitted because they do not constitute significant subsidiaries.
PITNEY BOWES INC.
SCHEDULE II - VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2000 TO 2002
(Dollars in thousands)
(1)
Included in balance sheet as a liability.
(2)
Principally uncollectible accounts written off.
(3)
Includes additions related to the meter transition plan.
(4)
Includes $32 million of additions related to Capital Services charges.
(5)
Excludes $70 million of additional credit loss reserves related to PBG. See Note 20 to the consolidated financial statements.
EXHIBIT (i)
PITNEY BOWES INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (1)
(Dollars in thousands)
(1)
The computation of the ratio of earnings to fixed charges has been computed by dividing income from continuing operations before income taxes as adjusted by fixed charges. Included in fixed charges is one-third of rental expense as the representative portion of interest.
(2)
Amounts reclassified to reflect Office Systems, CPLC and AMIC as discontinued operations. Interest expense and the portion of rents representative of the interest factor of these discontinued operations have been excluded from fixed charges in the computation.
Including these amounts in fixed charges, the ratio of earnings to fixed charges would be 3.98, 3.95, 4.37 and 3.56 for the years ended December 31, 2001, 2000, 1999 and 1998, respectively. The ratio of earnings to fixed charges excluding minority interest would be 4.19, 4.21, 4.66 and 3.78 for the years ended December 31, 2001, 2000, 1999 and 1998, respectively.
EXHIBIT (ii)
Page 1 of 2
PITNEY BOWES INC.
SUBSIDIARIES OF THE REGISTRANT
The Registrant, Pitney Bowes Inc., a Delaware Corporation, has no parent.
The following are subsidiaries of the Registrant
(as of December 31, 2002)
EXHIBIT (ii)
Page 2 of 2
PITNEY BOWES INC.
SUBSIDIARIES OF THE REGISTRANT
The Registrant, Pitney Bowes Inc., a Delaware Corporation, has no parent
The following are subsidiaries of the Registrant
(as of December 31, 2002)
EXHIBIT (iii)
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on:
of Pitney Bowes Inc. of our report dated January 28, 2003 relating to the financial statements and financial statement schedule, which appears in this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
Stamford, Connecticut
March 18, 2003