必能寶 (PBI) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by. We do appreciate your patience today while the conference is assembling and good afternoon, welcome to the Pitney Bowes second quarter earnings conference call.

At this point we have all of your phone lines muted or in a listen-only mode, however, after the executive team's presentation today there will be a opportunities for your questions and those instructions will be given at that time.

Should you require any assistance during the earnings conference, you may reach an AT&T operator by pressing star then zero. And as a reminder, today's call is being recorded for replay purposes. That information will be announced at the conclusion of today's call.

With us today, ladies and gentlemen, we have our executive team from Pitney Bowes, chairman and Chief Executive Officer, Mr. Michael J. Critelli, Executive Vice President and Chief Financial Officer, Bruce P. Nolop.

Here with our opening remarks and Safe Harbor statement is Vice President of Investor Relations, Mr. Charles F. McBride. Good afternoon, sir, and please go ahead.

Thank you and good afternoon.

Let me remind you that you can find today's earnings press release and the attached schedules on our Web site at www.pb.com/investorrelations.

The forward-looking statements contained in this presentation involve risks and uncertainties and are subject to change based on various important factors including changes in international and national political or economic conditions, timely development and acceptance of new products, the timing of potential acquisitions, mergers, or restructurings, gaining product approval, successful entry into new markets, changes in interest rates and changes in postal regulations as more fully outlined in the Company's Form 10-K Annual Report filed with the Securities and Exchange Commission.

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

Now our Chairman and Chief Executive officer, Mike Critelli, will review with you the results for the quarter. Mike?

Thanks, Charlie, and good afternoon.

There are three things I'd like to highlight about the quarter. First, we're pleased with the recently completed sale of the Capital Services external finance business. We see this as an opportunity to provide more transparency into our business results and strategies.

Second, we had good improvement in our EBIT margins. And third, we continue to expand successfully throughout the mailstream, notably in mail services, marketing services, supplies and software.

We believe that our exit from the Capital Services business benefits our customers and shareholders as we focus on growing our core businesses and on pursuing the numerous opportunities to expand our presence throughout the mailstream. Without this non-core operation the strength of our underlying business should be more evident than our results and the execution of our growth strategies should be clearer.

We're also providing more information about the performance of our segments and more financial detail on our income statement. We believe this expanded look, when combined with the Capital Services sale, provides investors enhanced visibility into our business performance.

With Capital Services as a discontinued operation we now have two segment groups, Mailstream Solutions and Mailstream Services. The Mailstream Solutions group includes U.S. mailing, international mailing, production mail and software, which consists of Group One and MTEX.

The Mailstream Services Group includes management services, mail services and marketing services. And Marketing Services consist of both Imagistic and our recently acquired AASPMH companies.

To assist with your analysis on a comparative basis we have provided nine quarters of historical information on a restated basis to reflected the discontinued operations of Capital Services and also to show the expanded reporting for our segments. These tables are now available at www.pb.com/investorrelations.

In light of all these changes we thought it would be helpful to have an Investor Update Day, which we've scheduled for September 12th in New York. During this meeting we will provide you with a general update on our outlook for the future growth of our business.

We will also provide you with 2007 guidance which we expect will be in our targeted range for both revenue and earnings per share growth. Additional information on this meeting will follow shortly.

Turning to the results for the quarter, our revenue rose 5%, which was at the low end of our guidance range of 5 to 7%. Revenue growth was adversely affected this quarter as we experienced a delay in some anticipated orders and a higher than anticipated proportion of orders where revenue is recognized over time.

We continue to integrate acquisitions, enhance processes and productivity and manage costs throughout the enterprise during the quarter. This resulted in year-over-year improvement in EBIT that was particularly evident in mail services, management services, software and production mail.

We are pleased to note that our margin improvement during the quarter also enabled us to deliver diluted earnings per share in the middle of our adjusted guidance, which excluded Capital Services, despite revenue at the low end of our range.

Adjusted diluted earnings per share from continuing operations rose 8.5% to $0.64 as compared to $0.59 in last year's second quarter if we exclude restructuring cost and the tax provision related to the anticipated settlement with the IRS. If earnings per share were calculated on the same basis as we initially gave guidance it would have been $0.69 compared with our guidance of 66 to $0.70 and the First Call estimate of $0.68.

Our adjusted free cash flow for the quarter was $70 million following a very strong first quarter of adjusted free cash flow. Adjusted free cash flow, as you know, can vary from quarter-to-quarter depending upon the timing of normal tax payments.

Year-to-date our adjusted free cash flow is $261 million and we are on target to achieve our goal of $600 million in adjusted free cash flow for the year.

We continue to grow customer and shareholder value by diversifying throughout the mailstream. This morning we announced the acquisition of Print, Inc., a leading provider of bundled offerings of printer supplies, service and equipment to manage document production, which is a print management market projected to grow at 30% per year.

As we look to the third quarter we expect revenue growth from continuing operations in the range of 7 to 9%.

We expect earnings from continuing operations of $0.62 to $0.65 per share which compares with $0.58 per share on the same basis last year, and excluding potential restructuring charges, we anticipate third quarter earnings from continuing operations in the range of $0.65 to $0.67 per share versus $0.61 for the third quarter of 2005. For the full-year of 2006 we increased our guidance range for revenue growth from continuing operations from 5 to 7% to 6 to 8%.

Based on the results of the first half of the year we now expect full-year diluted earnings per share from continuing operations in the range of $2.47 to $2.56 compared to $2.04 in 2005, and excluding the anticipated restructuring charges for the year and the increase in tax reserves, we expect adjusted earnings per share from continuing operations of $2.66 to $2.72 compared to $2.46 per diluted share last year on the same basis.

In closing, we continue to see many opportunities to grow our presence and expand our offerings throughout the mailstream, which will allow us to increase our value for customers and shareholders.

Thank you and now we will be happy to answer your questions.

Indeed, well thank you very much, sir, for your time and that overview today. We do appreciate that. Ladies and gentlemen, as you just heard then, at this point we do turn towards your questions and comments. [OPERATOR INSTRUCTIONS] First in queue we go to the line of Carol Sabbagha representing Lehman Brothers. Please go ahead.

Thanks very much. A couple quick questions.

First a clarification on what you said about the September analyst meeting, Mike. Did you say you're going to give '07 guidance?

Yes.

And you expect that guidance to be within that 8 to 10% EPS growth range?

Yes.

And that 4 to 6% organic top line growth, those are your targets, therefore?

Yes. We'll give you more detail then but that's based on our planning process we, at this point, would expect to do that.

Okay. I wanted to make sure I heard you right.

And then on the revenues this quarter, as you said, they were a little bit light. Can you give us a little bit more detail first sort of on U.S. mailing, that seemed, if I'm looking at the right numbers, that it was up 1% versus the 4% plus it's been able to achieve in the last several quarters? Has the trading down effect gotten worse and if so, why so?

And then, can you give a little bit more detail about what kind of business fell into this quarter that forced you to stretch out the revenue recognition?

Three factors. First of all we had higher traded down effect that was not any different this quarter than any previous quarter, materially different. So that was not a factor in these results.

Three factors. One, on the spreading of revenue over time we hit a higher proportion of operating leases, particularly in the government sales, than normal.

As you know, governments conclude their fiscal years, many of them second quarter and more of the mix fell into operating leases versus sales. And that's a good economic outcome for us in terms of long-term shareholder value, but clearly it's short-term we do not get the big revenue pop from it.

Secondly, we actually were very happy that we had double-digit growth both in the mail creation and shipping solutions written business, but we booked those revenues not just on delivery, but acceptance. And we did not get the acceptances during the quarter, but we would expect to get them as the year goes on.

And third, in the mail finishing space, we're at a stage in meter migration where there's a disproportionate number of customers that own their mailing equipment that are doing large solicitations and that, by the way, not only includes our equipment, but competitive equipment. So we -- and those have been taking a little longer.

They clearly have to be done for the most part for this space by the end of the year, and we did get some of the business popping in July in terms of being awarded the business, but it didn't get installed, awarded or installed in the second quarter. But that will correct itself we believe over the next two quarters.

So we would project we will be back closer on our normal run rate and perhaps at or above it in U.S. mailing in the second half of the year.

And that normal run rate, is that like 4%?

Yeah, 3 to 4%.

Okay. Got it.

And then still sticking with revenues for a second, it seemed that mail services growth decelerated a bit, but that's a weird business because so many are opening new sites, et cetera, was there anything different this quarter versus the last several quarters there?

No, we haven't -- we've slowed down the opening of new sites and with the, you know, completion of the Ancora integration we've, you know, we've focused now on profitability, although this is still a very, very good growth rate and we're very pleased with it. But our margins in that business went up very substantially during the quarter and that was clearly our major focus. You can see it on the EBIT line, the 192% improvement in EBIT margin.

So although normally when we say we're focused on profitability, that signals low revenue growth, I was particularly pleased that we could have double-digit revenue growth and these kind of improvements in EBIT margins.

One last question on the stock buyback. It seems like you're approaching the upper end of the target, the 350 target that you laid out for the year.

Does that mean that for the remainder of the year you're going to be buying back at a much slower pace or would you consider increasing the stock buyback?

I'll let Bruce answer that one.

Sure. You're right Carol, we have front loaded much of our repurchase program. We still have almost 60 million of authority left and our plan is definitely to buy in that much.

Whether we increase the, or not authority but our plan to hit 350, whether we do above that will depend on a number of factors and we'll discuss that with the board of directors and the rating agencies and, that don't have any announce at this point.

Okay. Thank you very much.

Thank you, Ms. Sabbagha. Next in queue we go to the line of Matthew Troy representing Citigroup. Please go ahead.

Thanks.

Question with respect to your commentary on the size of the deals currently being negotiated as the last legs of meter migration. Are you seeing any kind of shift in terms of competitive wins, i.e., invigorated Ascom Hassler/Neopost combination, are they more relevant than they were two, three years ago or is the business falling out largely as expected?

I'm glad you asked that question. We actually gained a little bit of share during the quarter, but the bottom line is so far at least the deals that we have, where we've been at risk so far have fallen as expected and we have had a few competitive takeaways, but they haven't hit the revenue line yet.

But in order of magnitude, nothing out of expectation [inaudible], just pricing? Pricing's as expected?

A little bit, we will see a little bit of discounting as we get to the, as we go through the year. But that's going to depend in part on how strictly the U.S. Postal Service enforces the meter migration deadline.

We got a bit of good news during the quarter, which is that the USPS will allow leased equipment, and that's going to particularly affect our paragon, to run to the end of lease, which means that we will be able to do the selling in the normal course rather than trying to force customers to prematurely trade out. So that is going to help our top pricing.

But as you get closer to a deadline we do have to discount a little with the recalcitrant customers to get them to keep on the program. But not really a big deal in terms of overall results.

Okay.

Last question I had, I hate to return to this point, but we were actually in Washington on Friday meeting with a group of lobbyists on the postal reform issue.

Okay.

And seems as if we're gradually inching towards the finish line here, but I'm just looking out at the congressional calendar. You've August recess looming, you're going to have the distraction of November elections and then a lame duck Congress.

I was wondering if you could just give us a broader update on what you see as the trajectory of postal reform and likelihood of passage? Thanks, Mike.

I think it's still very likely to pass. Our latest information came from Chairman Davis who is very confident of the bill's passage as recently as the end of last week. But, you know, since the last earnings call I think I might have mentioned at the analyst day, there were really four issues.

I think the one issue left that is being worked through is the price cap both how it will be defined and what will be the exceptions to it. I always felt and I think I said this before, that that would be the toughest issue because it has an interplay with collective bargaining and with the Postal Service's freedom of operation.

I see potential compromise solutions out there and people working toward them. And that will probably be what gets worked on even during recess in August.

And we certainly, the industry and a lot of the other stakeholders, including the legislators that have worked for years on this, take a real passion to get this done this year, because we would have to reintroduce the legislation if it didn't get done. That being said, I do want to make the comment, many of the benefits that we hope to get from postal reform are starting to come into play with the postal transformation initiatives.

The rate case has some excellent initiatives, work sharing, the Postal Service is really aggressively moving toward a more creativity in its product design. I think the only two things that postal reform will do that postal transformation can't, one is to resolve the retirement benefit issue once and for all, and the second is this price cap.

I think most of the other key benefits to Pitney Bowes can probably be accomplished through transformation, although reform will make them somewhat, I emphasize somewhat easier. The real benefit to reform is resolving this long-term retirement benefit cost issue and getting price stability sort of locked in legislatively, even though over time the Postal Service's rate of increase has been at about the rate of inflation.

Thanks Mike.

Sure.

Representing Merrill Lynch a question now from the line of Jay Vleeschhouwer. Please go ahead, sir.

Thanks. Good afternoon.

Mike, you raised the possibility in some of your outlook comments about some additional restructuring charges. Could you elaborate on where those might pertain? I mean what are still some of the problematic areas of the Company in your mind?

I think that's just continuation of what we talked about previously that we're completing our process in Europe and it takes a little bit longer. We will be pretty much done with that this year.

I don't have anything else in mind.

Okay.

Now, you did a reclass of your segments and the greater breakout is certainly appreciated. Could you maybe just give us a quick explanation of some of the rationale or methodology you went through, however, in terms of the reclassification?

If we look back at some of the categories that stayed the same for instance versus a year ago, there were definitely some reasonably sizeable changes in the historical numbers from what you had previously reported for businesses that are ostensibly more or less the same. So maybe just walk us through what some of those rationales or changes were.

Well, I'll deal with the two changes, but I am curious about your comment about the radical. If you can elaborate on that, maybe I can answer it. What did you mean by really radical change in historical reporting?

I didn't say radical. For instance, support services, it was about 25 million less than it was a year ago, the rentals is the same. Just curious as to why nominally similar businesses would have had changes like that?

Jay, that one in particular, software has a support service component and so before you add software, which was in both product sales and support services and now it's in a software segment.

The other change that maybe creating confusion is production mail. In the past had only been a U.S. business and now it includes worldwide. So the international business will look different, because you will now have the international production mail pulled out and combined with U.S. so we think that will eliminate, frankly, a source of confusion which we'd always had when we explained our results.

So those are probably the two things that would affect what you had looked at historically. Otherwise it's simply additional.

We also broke out marketing services because it has -- it's at a different, it's under different management, but more importantly it's at a much earlier stage in the mailstream value chain from mail services which is sort of at the tail end of that. And the mail services consolidation-type service, marketing services are services that we provide one client at a time.

Let me just make a comment about why we took, a couple comments. First of all, production mail was separated from international mailing, because we really wanted to show the difference as we do in the U.S. between the regulated businesses, the businesses that are driven by, you know, small desktop and small office mailing where at the end of the process something ends up in the postal system and usually ends up being processed by a postage meter, as opposed to production mail which is largely an unregulated business with very large dedicated customers, very different economic profiles.

And internationally we are making very, very good progress in the mailing businesses to get very consistent revenue streams. Production mail tends to be a little lumpier outside the United States and we wanted the financials to reflect that.

And software clearly has a different business model with licenses and maintenance relationships with customers and no natural, you know, we usually don't have leasing every five years with software. We have a lot of very long-term licensing and maintenance agreements with our customers so we want to reflect those.

Sure.

Now, with respect to software, it's still small but it's certainly growing well and it's been an important part of your acquisitions. Do you regard software now in terms of development and operation and management to really be fully part of, let's call it the Company's DNA or is this still something that's a new and not completely familiar kind of business to you?

I think parts of that are extremely familiar to us. Anything to do with address management, which is still a sizable part of Group One and customer communication management are part of our DNA.

MTEX, we had a comparable product called StreamWeaver which has been out there for ten years.

The only new piece of software that I would say, which is very fast growing, by the way but still very small, is this business geographics geocoding, which very we're, very excited about, but that's a small piece of this revenue stream today. That's the only part where we really have to break new ground.

We're doing, we're getting great success in it, but we'll probably see a little bit more lumpiness in that part of the business until we really establish ourselves. But that's probably the fastest growing part of that business with the highest potential of any part of the software business, but it is still very, very small.

Okay.

Then finally, in prior calls you've sometimes discussed some of the individual country markets in Europe and elsewhere, Germany, France, U.K. et cetera. Could you do something similar today Mike, please?

Yeah.

The ones I will talk about where we, in the international mailing business, which I'm going to talk about separately from production mail, because I think they have, as I said, very different dynamics. Europe and Asia Pacific had very, very strong performance. In fact between them in mailing we were over 10% revenue growth.

The one area we were, you know, we don't show as much revenue growth in France with strong written business because if we get a lot of written business on the mail finishing side, the postage meter base side, that's rental, that's booked like operating lease and rental.

But year-to-date in France we've had over 20% growth rate in written business and new business put on the books, but it spreads over time so it doesn't show as big of a pop as it would if the same business were booked in the United States where the base part of the business would be booked as a sale lease. So France is a pure rental market, but we had a very strong Europe-Asia quarter.

Our one disappointment was in Canada. And the problem in Canada was, frankly, that we, like we have the Danka integration, we had some transitional issues with sales compensation and structure, we have new leadership in place and I'm confident that Canada will bounce back the second half of the year.

The DMT business was, I think, challenged in some parts of our operation, particularly in France, because of some unlawful conduct by one of our competitors and we have already gotten a ruling that that conduct has hurt us where we will probably over the next year work toward damage recovery. And, you know, as I said, it's still a little bit of a lumpy business.

So our production mail business internationally was a little lower than we'd like it to be in some of the markets but strong in others. For example, very strong in Germany, although our mailing business is not as big in Germany as we'd like. We've had a very strong production mail business there. So I felt pleased about international outside of Canada.

Thank you very much.

Next we'll go to the line of Steven Nissan representing Excalibur. Please go ahead.

Thank you very much. I like the results, I really like what I'm hearing. A couple questions, Mike.

Regarding your selling process, how are you guys now streamlining the selling process to make it easier for customers to [configure] your products and do better business with you?

There are a couple things we're doing. On the very low end we have recognized that many small business customers actually prefer the Internet or the telephone and we have really beefed up our inside sales capability.

And many of our upgrades of our small business customers today, in fact, most are done through outbound telesales and people can as well order over the Internet. So we've recognized that the field sales leader specialists really need to focus on the middle to high end of the customer base.

We've also focused our efforts and are rolling out more specialization for what we call our mail creation and shipping solutions products, because these are longer sales cycles, they're more relationship based, you have to sell very often to the CIO's or heads of operations as opposed to selling to the mailroom manager only and so we are migrating in that group more towards specialization.

And then we have really focused on beefing up our cross unit enterprise sales capability for our top 25 accounts. And we have, we're slowly but surely as we solidify our enterprise sales model, we're bringing the units together under a single relationship manager, more like, I'd say, a model that you'd see in other business sectors.

So those would be the three areas where we've worked on the sales process. And we have invested in, and I think successfully so far, in early feedback and a better sales automation process.

We have greater visibility as to what's going on in sales activity and better ability to give our sales people good leads and better ability to track their own opportunities.

So what you mean by specialization, so you're beefing up your systems that way those big customers, the CIO's et cetera can [configure] your products more efficiently and price their products on their own?

The mail creation solutions and shipping solutions very often integrate with the customer's information network and they are multi-piece solutions. For example, something like our rival system for incoming shipping products will be a tracking and tracing solution that very well could involve some integration with our customer's information systems and we do not want to confuse that with a sale of a plug and play mail finishing system.

There's a lot of customization in these mail creation and shipping solutions. Very often our customers as well want specific carrier rates and they want accounting and reporting back to their, you know, general ledger.

So we do a lot of the documentation and the tracking and tracing that they need for financial reporting as well as operational monitoring.

Regarding like DSOs, how do you plan to reduce those? Has that been a concern with you and what are you guys planning on in reducing them?

I'll let Bruce comment on it.

We have had very good success in some of our opportunity areas like France and I think at some of our other international operations. Our finance receivables are in outstanding shape. So DSOs on leases and purchase power and other financial products are in excellent shape.

On our rentals, or enterprise sales, maybe Bruce can comment on some of the initiatives that we're undertaking there.

First I'd say that this quarter if you look at the combination of receivables and advanced billings we had a net positive cash flow, so that's a good sign, about 7 million positive. And what I would say is just country-by-country, including the U.S., is just focus so we have people assigned.

And as Mike said, we've really had a very strong finance receivables organization, and what we've done is transfer some of that, even people and expertise from the finance receivables area into accounts receivable to really make sure that we don't have any issue about ultimate collectability.

But so it's just focus. We've got targets and we'll continue to make progress, as I say, country-by-country and business-by-business.

Final question.

Mike, as we go into 2007, what would you say the top challenge that Pitney Bowes is facing and how do you plan to tackle that head on?

Our top challenge is really I think going beyond getting very good results to being able to give all of you and anybody else interested in buying our stock a clear roadmap on how we are both going to achieve the top line growth through our strategies and get the operating leverage to get the bottom line.

We've done a lot of, we've really talked to a lot of investors and we think giving clear, the clear roadmap on how we're going to do it without, you know, we've in the past had the benefit of major restructuring programs, on a go forward basis we're going to be getting to our results without major restructuring programs and we're confident we can get there, we just have to be able to explain it. So we get some of the future optimism about the stock, baked into the stock price.

Okay. Perfect. I wish you continued success down the road. Great job. Thank you.

We have a question now from the line of Peter Polt representing Banc of America. Please go ahead.

Good afternoon. Just a very quick question.

I would assume that the [inaudible] on your balance sheet in terms of the tax obligations of around $1billion, a little shy of that, reflects the sale of Capital Services and the reduction in long-term debt that's shown is the non-recourse debt that goes along with that. I just wanted to clarify that.

This is Bruce. The answer is yes and yes, you're exactly right. Those are just Capital Services adjustments.

Thank you very much.

We have a question now from the line of Chris Whitmore, representing Deutsche Bank. Please go ahead.

Thanks. Good afternoon. First I wanted to get a couple numbers from you.

What was organic growth in the quarter and what is baked into guidance for both Q3 and Q4, organic growth only?

We were at 3.6% for the quarter, which because of the three factors I mentioned took us about a percentage point below our previous couple of quarter run rate and our guidance on organic with, well, our growth range is 4 to 6 and that's what we would be up -- saying that we would achieve for the rest of the year.

Okay.

And secondly, when you talked about weakness in the U.S. mailing business it's kind of like you're seeing some delays, but yet you're expecting back to trend line in the back half. Why wouldn't growth exceed trend line if it was just merely business shifting out from Q2 into the back half?

It certainly would get us higher up in the range than we were in this quarter. The reason we say 4 to 6 rather than, you know, giving you 5 to 6 is if for example we have a chance to do state and local government business and it comes in as an operating lease we will do it rather than do a sale, because that's better long-term shareholder value.

There are always swings like that in any given quarter where the business can break as a sale or it can break as an operating lease or rental. And we like to keep the flexibility of saying that the trend line is 4 to 6% and we'll celebrate it if we do better than 6% but I think it's safe to say that we expect to be in that range.

Okay.

Lastly in looking at the recurring revenue model of the business, is this at all being impacted by the mix you're seeing in your hardware sales? And by that I mean if I just add up the rental revenue and the supplies revenue in the quarter combined, that revenue was about flat while the rental business revenue was down about 4%, you know, coming off a fairly strong upgrade cycle.

How do you think about the combination of those two lines going forward or even individually in terms of being able to grow those at that organic growth rate?

The rental line will probably, I'd say migration at this stage is actually a negative for the reasons I articulated. I think steady state on rental line, we should be in the, let's say, more in the negative 2 to 3% because of the down shifting phenomenon even with offsets from new customer acquisition and population improvement.

Supplies, we would expect to stay north of 10% and with the Print, Inc. acquisition we're even more confident that we can grow supplies at more than 10% over time.

But we get, we think we can get a good lift from equipment sales. We have plenty of opportunity not only -- and we will, by the way, on September 12th, we will give you a roadmap for 2007 about the U.S. mailing business, which today is about -- the U.S. mailing business that's affected in some way shape or form by migration and meters is 40% of our -- roughly 40% of our total revenue. We will give you a roadmap about 2007 relative to that 40%.

But suffice it to say supplies is strong, we expect, you know, continued strong growth in financial services because of the purchase power and a component of that business, global payment solutions. We expect to get more multi-vendor services business, which is in the mailing solutions segment in the United States and Print, Inc. is going to help with that.

And we expect continued strength in the mail creation and shipping solutions business, which is the part of the business that's absolutely not affected by migration and probably has not been given as much focus because of migration.

So a sales rep that's a general, even though we will have specialists we are going to give our general sales force the opportunity to continue to sell mail creation and shipping systems and we expect next year they're going to sell a lot more of those, because the migration, much of the migration will be behind them. There'll still be migration opportunity for two more years, but it's going to be on a smaller scale in 2007 than 2006.

So would you say it's fair to say to maintain that 4 to 6% organic growth number you're more reliant on equipment sales going forward or is that not the case?

We're more reliant on the other four components, equipment sales, financial services, supplies and support services. When I say support services, the support services on other than Pitney Bowes mail finishing equipment, because we also get support services on our mail creation and shipping exclusions.

And also software. As the software revenue streams that are in the U.S. mailing business, which are still small today.

Final question and then I'll wrap up.

Just kind of curious in terms of what you're seeing more broadly about spending in general. We've heard from some other large companies that there may be some hesitation about making large investments or deployments currently. Can you provide any color in terms of what you're seeing just from a broad standpoint around willingness to spend? Thanks.

I would say that in the United States we have, where we would feel that with DNR production mail business and that had a phenomenal quarter, you know, and I think that the reason for that is we have a value proposition so compelling that customers get a relatively quick pay back and are willing to spend the money for this, even when they don't do other capital spending.

Where it does hurt us is in Europe where the value proposition is one that causes a customer to select us during a normal replacement cycle, but outside the U.K. we probably don't have the ability with the offerings we have today to get customers to accelerate their spending in a down capital spending cycle. So Europe as we've been affected more in this product line.

Otherwise we have done a lot of things to try to minimize the impact of capital spending by, you know, doing more leasing and rentals. You know, state, local governments are obviously doing more rentals, so that minimizes the capital spending impact.

So the one area where we would see it would be in production mail, and at this point we're seeing it more in Europe than anywhere else.

You still have your line open Mr. Whitmore. Did you have any follow-up questions?

Thank you very much. That covers it.

And two others in queue now, Mr. Critelli. Next is Shannon Cross with Cross Research. Please go ahead.

Good afternoon. Just a couple of quick questions.

Bruce, can you talk a little bit about cash flow especially as we go into 2007? Any puts and takes we should keep in mind in terms of what we should expect for cash flow?

And then secondly, I just wanted to confirm 266 to 272, how does that compare to what you guys had out prior? I think there's no change, but I want to make sure I'm right on that.

It is narrowed, we took out the low end of the range, so essentially $0.02 narrowing and $0.02 in the positive direction.

Right. So it's 264 now it's 266? Is that correct?

That's correct.

Bruce, do you want to--?

In terms of cash, that's one thing I'll update you on September 12th for '07, but I think in general that two things, one is deferred taxes will -- that's not on our end. But anyway, deferred taxes because you want [inaudible] Capital Services and, so with cash taxes more closely aligned with the effective tax rate.

And the other thing I think Cap Ex we may have room for a lower level of Cap Ex because it's peaking right now with rental assets and also in PBMS we have opportunity to reduce that. So those would be the two areas I think there may be some change from this year to focus on.

Okay. Oh, sorry.

We will have, I think, some improvements as we work through these accounts, small accounts receivable issues and we've got a little bit of an inventory build up to deal with, the implementation of the Ross regulatory compliance for products in Europe, that will wind down next year certainly.

But in general just in terms of the way we think about it, the 8 to 10% EPS growth in [inaudible] should just be reflected to a large extent in terms of cash flow growth?

I would not make that leap at this point, Shannon. What I would feel comfortable is that you can continue to assume that it will be at least the $600 million level. But until we work through I need to caution you.

Thank you.

Yeah.

And next we'll go to the line of Lloyd Zeitman representing Bernstein. Please go ahead.

Good afternoon, folks.

Afternoon.

Let's see, first of all could you tell us what impact foreign exchange had on the bottom line?

Almost no impact at all this quarter. It was a negative roughly about a quarter of a cent.

Okay. And --

I just want to mention, by the way, it did probably have a little bit of, did have impact on SG&A, because, you know, ratios, but not on the bottom line.

Right. Okay.

And PBMS, could you give us some idea as to when we should expect this to start growing again on the top line?

We get very good written business in the quarter. Little higher losses than we've had let's say a couple, two to three years ago, but some of that, in fact a good chunk of it is planned.

By the end of this quarter we will finally have [segue] out of the prior year numbers and we had a couple more sizable accounts, low margin accounts out this quarter. So I would say you will see relative, small improvement this year, but higher revenue growth in 2007.

Okay.

And your expectations, the third quarter revenue growth of 7 to 9%, is there some expectation, I would imagine there would be, of let's say, spillover from what you had anticipated in the second quarter appearing in the third?

Some, yes. What I can't predict is whether these things are going to hit in the third or fourth quarter. You know, we've gotten, as I said, we've gotten some written business, or in the case of mail finishing, some competitive and other contract awards.

What I cannot predict is whether customers will want us to install -- these are big customers so these are not totally within our control. But I'd say over the next two quarters these, the 1% or so shortfall should find its way back into our revenue. What I can't predict is the timing between third and fourth quarter.

So has your expectation for third quarter revenues maybe improved somewhat excluding what happened in the second quarter?

You know, I don't think it's going to bump above 6%. As I said, I think that we want to have the flexibility to do a lease rather than a sale and if it comes down as an operating lease as we more aggressively go after state and local government business, which we're doing, we want to be able to do that. I don't want to be worried about a guidance that gets us above 6%.

We want to do what maximizes shareholder value. And if it's an operating lease that does that instead of a sale that's what we're going to do. So I want to stay within the range at this point.

And Lloyd, I would just add that, your overall question, our guidance for third and fourth quarter, it's consistent with what we had thought. So the message is that we continue to be confident about the rest of the year.

We don't view the second quarter as portending any change in the fundamental business. So we feel good about the last half of the year.

Okay. Great. Thanks very much.

You're welcome.

And thank you, Mr. Zeitman. Well with that, Mr. Critelli, I'll turn the call back to you. There are no further questions.

Okay.

Well, we are very pleased that this is our first quarter without having the complexity of Capital Services in our continuing operations income statement and we very much look forward to a dialogue with you on September 12th. Thanks very much.

And ladies and gentlemen, Mr. Critelli is making today's conference available for digitized replay. It's for eight days starting at 8:30 p.m. Eastern Daylight Time July the 24th all the way through 11:59 p.m. August the 1st. To access AT&T's Executive Replay Service please dial 320-365-3844 and at the voice prompt enter today's conference ID of 834739.

That does conclude our earnings call for this second quarter. Thank you very much for your participation as well as for using AT&T's Executive Teleconferences Service. You may now disconnect.