Edgar Filing: PITNEY BOWES INC /DE/

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2017

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

Commission file number: 1-3579

PITNEY BOWES INC.

(Exact name of registrant as specified in its charter)



Delaware		06-0495050
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3001 Summer Street, Stamford, Connecticut		06926
(Address of principal executive offices)		(Zip Code)

(203) 356-5000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer þ	Accelerated filer o	Non-accelerated filer o
Smaller reporting company o	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 28, 2017, 186,681,977 shares of common stock, par value $1 per share, of the registrant were outstanding.

PITNEY BOWES INC.

INDEX



		Page Number

Part I - Financial Information:

Item 1:	Financial Statements (Unaudited)

	Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2017 and 2016	3

	Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016	4

	Condensed Consolidated Balance Sheets at June 30, 2017 and December 31, 2016	5

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3:	Quantitative and Qualitative Disclosures about Market Risk	39

Item 4:	Controls and Procedures	39


Part II - Other Information:

Item 1:	Legal Proceedings	40

Item 1A:	Risk Factors	40

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 6:	Exhibits	42


Signatures		43

PART I. FINANCIAL INFORMATION

Item 1: Financial Statements

PITNEY BOWES INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited; in thousands, except per share amounts)



	Three Months Ended June 30,					Six Months Ended June 30,
	2017		2016			2017		2016
Revenue:
Equipment sales	$	158,625	$	152,641		$	321,599	$	312,002
Supplies	63,228		65,274			130,046		137,325
Software	86,664		90,615			164,531		168,673
Rentals	95,999		102,869			195,869		206,959
Financing	83,653		91,609			169,398		189,032
Support services	115,299		131,418			234,146		259,678
Business services	217,903		201,460			442,422		406,806
Total revenue	821,371		835,886			1,658,011		1,680,475
Costs and expenses:
Cost of equipment sales	77,189		78,055			146,751		149,594
Cost of supplies	19,909		19,624			41,380		40,314
Cost of software	24,795		26,983			50,103		53,798
Cost of rentals	21,576		18,415			42,238		38,910
Financing interest expense	12,843		13,495			25,817		28,410
Cost of support services	73,190		74,742			146,544		149,991
Cost of business services	153,063		140,830			303,906		276,368
Selling, general and administrative	297,468		289,116			603,771		615,998
Research and development	32,958		34,513			64,814		61,081
Restructuring charges and asset impairments, net	26,927		26,076			29,009		33,009
Interest expense, net	27,600		20,799			53,276		40,100
Total costs and expenses	767,518		742,648			1,507,609		1,487,573
Income before income taxes	53,853		93,238			150,402		192,902
Provision for income taxes	4,952		33,394			36,368		70,418
Income from continuing operations	48,901		59,844			114,034		122,484
Loss from discontinued operations, net of tax	—		(1,660		)	—		(1,660		)
Net income	48,901		58,184			114,034		120,824
Less: Preferred stock dividends attributable to noncontrolling interests	—		4,594			—		9,188
Net income attributable to Pitney Bowes Inc.	$	48,901	$	53,590		$	114,034	$	111,636
Amounts attributable to common stockholders:
Net income from continuing operations	$	48,901	$	55,250		$	114,034	$	113,296
Loss from discontinued operations, net of tax	—		(1,660		)	—		(1,660		)
Net income attributable to Pitney Bowes Inc.	$	48,901	$	53,590		$	114,034	$	111,636
Basic earnings per share attributable to common stockholders ⁽¹⁾:
Continuing operations	$	0.26	$	0.29		$	0.61	$	0.60
Discontinued operations	—		(0.01		)	—		(0.01		)
Net income attributable to Pitney Bowes Inc.	$	0.26	$	0.29		$	0.61	$	0.59
Diluted earnings per share attributable to common stockholders ⁽¹⁾:
Continuing operations	$	0.26	$	0.29		$	0.61	$	0.59
Discontinued operations	—		(0.01		)	—		(0.01		)
Net income attributable to Pitney Bowes Inc.	$	0.26	$	0.28		$	0.61	$	0.59
Dividends declared per share of common stock	$	0.1875	$	0.1875		$	0.375	$	0.375

(1) The sum of the earnings per share amounts may not equal the totals due to rounding.

See Notes to Condensed Consolidated Financial Statements

PITNEY BOWES INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; in thousands)



	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
Net income	$	48,901		$	58,184		$	114,034		$	120,824
Less: Preferred stock dividends attributable to noncontrolling interests	—			4,594			—			9,188
Net income attributable to Pitney Bowes Inc.	48,901			53,590			114,034			111,636
Other comprehensive income (loss), net of tax:
Foreign currency translations	46,791			(9,520		)	66,706			30,325
Net unrealized (loss) gain on cash flow hedges, net of tax of $(120), $281, $235 and $264, respectively	(196		)	450			383			422
Net unrealized gain on investment securities, net of tax of $758, $1,415, $1,102 and $3,443, respectively	1,291			2,409			1,876			5,863
Adjustments to pension and postretirement plans, net of tax of $(304) and $(777) for the six months ended June 30, 2017 and 2016, respectively.	—			—			(1,482		)	(1,230		)
Amortization of pension and postretirement costs, net of tax of $3,442, $4,122, $6,956 and $7,921, respectively	6,624			6,080			13,335			12,828
Other comprehensive income (loss), net of tax	54,510			(581		)	80,818			48,208
Comprehensive income attributable to Pitney Bowes Inc.	$	103,411		$	53,009		$	194,852		$	159,844

See Notes to Condensed Consolidated Financial Statements

PITNEY BOWES INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; in thousands, except share and per share amounts)



	June 30, 2017			December 31, 2016
ASSETS
Current assets:
Cash and cash equivalents	$	840,564		$	764,522
Short-term investments	164,716			38,448
Accounts receivable (net of allowance of $14,709 and $14,372, respectively)	389,262			455,527
Short-term finance receivables (net of allowance of $14,491 and $13,323, respectively)	857,764			893,950
Inventories	121,478			92,726
Current income taxes	28,732			11,373
Other current assets and prepayments	89,061			68,637
Total current assets	2,491,577			2,325,183
Property, plant and equipment, net	327,140			314,603
Rental property and equipment, net	182,997			188,054
Long-term finance receivables (net of allowance of $5,121 and $7,177, respectively)	662,384			673,207
Goodwill	1,604,320			1,571,335
Intangible assets, net	152,019			165,172
Noncurrent income taxes	75,105			74,806
Other assets	541,806			524,773
Total assets	$	6,037,348		$	5,837,133

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities	$	1,339,287		$	1,378,822
Current income taxes	17,349			34,434
Current portion of long-term debt	985,291			614,485
Advance billings	291,180			299,878
Total current liabilities	2,633,107			2,327,619
Deferred taxes on income	214,287			204,289
Tax uncertainties and other income tax liabilities	51,112			61,276
Long-term debt	2,543,476			2,750,405
Other noncurrent liabilities	565,993			597,204
Total liabilities	6,007,975			5,940,793

Commitments and contingencies (See Note 12)

Stockholders’ equity (deficit):
Cumulative preferred stock, $50 par value, 4% convertible	1			1
Cumulative preference stock, no par value, $2.12 convertible	463			483
Common stock, $1 par value (480,000,000 shares authorized; 323,337,912 shares issued)	323,338			323,338
Additional paid-in capital	131,691			148,125
Retained earnings	5,152,241			5,107,734
Accumulated other comprehensive loss	(859,315		)	(940,133		)
Treasury stock, at cost (136,967,821 and 137,669,194 shares, respectively)	(4,719,046		)	(4,743,208		)
Total Pitney Bowes Inc. stockholders’ equity (deficit)	29,373			(103,660		)
Total liabilities and stockholders’ equity (deficit)	$	6,037,348		$	5,837,133

See Notes to Condensed Consolidated Financial Statements

PITNEY BOWES INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)



	Six Months Ended June 30,
	2017			2016
Cash flows from operating activities:
Net income	$	114,034		$	120,824
Restructuring payments	(19,016		)	(33,866		)
Special pension plan contributions	—			(36,731		)
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on disposal of businesses	—			2,099
Gain on sale of technology	(6,085		)	—
Depreciation and amortization	88,160			89,538
Gain on debt forgiveness	—			(10,000		)
Stock-based compensation	12,531			9,511
Restructuring charges and asset impairments, net	29,009			33,009
Changes in operating assets and liabilities, net of acquisitions/divestitures:
Decrease in accounts receivable	78,279			46,828
Decrease in finance receivables	77,877			73,496
Increase in inventories	(26,812		)	(22,601		)
(Increase) decrease in other current assets and prepayments	(18,850		)	7,206
Decrease in accounts payable and accrued liabilities	(71,783		)	(75,042		)
Decrease in current and noncurrent income taxes	(40,774		)	(10,801		)
Decrease in advance billings	(20,218		)	(45,410		)
Other, net	(11,705		)	10,524
Net cash provided by operating activities	184,647			158,584
Cash flows from investing activities:
Purchases of available-for-sale securities	(70,405		)	(77,185		)
Proceeds from sales/maturities of available-for-sale securities	61,913			84,854
Net change in short-term and other investments	(131,303		)	55,702
Capital expenditures	(76,621		)	(71,359		)
Proceeds from sale of buildings	—			17,671
Acquisition of businesses, net of cash acquired	(7,889		)	(13,417		)
Divestiture of businesses, net of cash transferred	—			(3,039		)
Change in reserve account deposits	2,514			(7,143		)
Other investing activities	(3,000		)	(4,480		)
Net cash used in investing activities	(224,791		)	(18,396		)
Cash flows from financing activities:
Proceeds from the issuance of long-term debt	395,772			300,000
Principal payments of long-term debt	(229,323		)	(370,952		)
Net change in short-term borrowings	—			229,875
Dividends paid to stockholders	(69,527		)	(70,979		)
Common stock repurchases	—			(194,776		)
Dividends paid to noncontrolling interests	—			(9,188		)
Other financing activities	(5,551		)	(4,997		)
Net cash provided by (used in) financing activities	91,371			(121,017		)
Effect of exchange rate changes on cash and cash equivalents	24,815			4,355
Increase in cash and cash equivalents	76,042			23,526
Cash and cash equivalents at beginning of period	764,522			640,190
Cash and cash equivalents at end of period	$	840,564		$	663,716
Cash interest paid	$	82,405		$	78,311
Cash income tax payments, net of refunds	$	78,649		$	84,225

See Notes to Condensed Consolidated Financial Statements

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

1. Description of Business and Basis of Presentation

Pitney Bowes Inc. (we, us, our, or the company), was incorporated in the state of Delaware in 1920. We are a global technology company offering innovative products and solutions that help our clients navigate the complex world of commerce. We provide innovative products and solutions for mailing, shipping and cross border ecommerce that enable the sending of packages globally and products and solutions for customer information management, location intelligence and customer engagement to help our clients market to their customer. Clients around the world rely on our products, solutions and services. For more information about us, our products, services and solutions, visit www.pb.com.

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In addition, the December 31, 2016 Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In management's opinion, all adjustments, consisting only of normal recurring adjustments, considered necessary to fairly state our financial position, results of operations and cash flows for the periods presented have been included. Operating results for the periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2017. These statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report to Stockholders on Form 10-K for the year ended December 31, 2016 (2016 Annual Report).

In the fourth quarter of 2016, we determined that certain investments were classified as cash and cash equivalents. Accordingly, the Condensed Consolidated Statement of Cash Flows for the period ended June 30, 2016 has been revised to reduce beginning cash and cash equivalents by $10 million and ending cash and cash equivalents by $12 million with a corresponding adjustment to net change in short-term and other investing activities.

New Accounting Pronouncements - Standards Adopted in 2017

In January 2017, the Financial Accounting Standard Board (FASB) issued Accounting Standard Update (ASU) 2017-04, Intangibles - Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment, which eliminates Step 2 of the current two-step goodwill impairment test and requires only a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). The ASU is effective for interim and annual periods beginning after December 15, 2019, and is required to be applied prospectively. We elected to early adopt this standard effective January 1, 2017. The adoption of this standard had no impact on our consolidated financial statements or disclosures.

In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The standard includes multiple provisions intended to simplify various aspects of the accounting for share-based payments. We retroactively adopted this ASU effective January 1, 2017. Accordingly, the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2016 has been recast to increase both net cash provided by operating activities and net cash used in financing activities by $5 million.

In July 2015, the FASB issued ASU 2015-11, Inventory - Simplifying the Measurement of Inventory, which requires inventory to be measured at the lower of cost and net realizable value (estimated selling price less reasonably predictable costs of completion, disposal and transportation). Inventory measured using the last-in, first-out (LIFO) basis is not impacted by the new guidance. This standard became effective January 1, 2017 and there was no impact on our consolidated financial statements or disclosures.

New Accounting Pronouncements - Standards Not Yet Adopted

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting. The ASU provides guidance about which changes to terms and conditions of a share-based payment award require an entity to apply modification accounting. The standard is effective for interim and annual periods beginning after December 15, 2017 and would be applied prospectively to awards modified on or after the effective date. We do not expect the adoption of this standard will have any impact on our consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium, requiring the premium to be amortized to the earliest call date. The standard will be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The standard is effective for interim and annual periods beginning after December 15, 2018 and early adoption is permitted. We are currently assessing the impact this standard will have on our consolidated financial statements.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Benefit Cost. The ASU requires the service cost component of net periodic benefit cost to be presented in the same income statement line item as other employee compensation costs arising from services rendered during the period. Other components of the net periodic benefit cost are to be presented separately, in an appropriately titled line item outside of any subtotal of operating income or disclosed in the footnotes. The standard also limits the amount eligible for capitalization to the service cost component. The standard is effective for interim and annual periods beginning after December 15, 2017 and we are currently assessing the impact this standard will have on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-06 – Plan Accounting: Defined Benefit Pension Plans (Topic 960); Defined Contribution Pension Plans (Topic 962); Health and Welfare Benefit Plans (Topic 965): Employee Benefit Plan Master Trust Reporting. The ASU requires separate disclosure in the statement of net assets available for benefits and the statement of changes in net assets available for benefits of changes in any interests held in a Master Trust and other enhanced disclosures. The standard is effective for interim and annual periods beginning after December 15, 2018 and we are currently evaluating the impact of this standard on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard is effective for interim and annual periods beginning after December 15, 2017. The impact on our consolidated financial statements will depend on the facts and circumstances of any specific future transactions.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Inter-entity Transfers of Assets other than Inventory, which requires tax expense to be recognized from the sale of intra-entity assets, other than inventory, when the transfer occurs, even though the effects of the transaction are eliminated in consolidation. Under current guidance, the tax effects of transfers are deferred until the transferred asset is sold or otherwise recovered through use. The standard is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted, including adoption during an interim period. We are currently assessing the impact this standard will have on our consolidated financial statements.

In August, 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). The ASU is intended to reduce diversity in practice in the presentation and classification of certain cash receipts and cash payments by providing guidance on eight specific cash flow issues. The ASU is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted, including adoption during an interim period. We are currently assessing the impact this standard will have on our consolidated statement of cash flows.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses. The ASU sets forth a “current expected credit loss” (CECL) model which requires companies to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. This standard is effective for interim and annual periods beginning after December 15, 2019. We are currently assessing the impact this standard will have on our consolidated financial statements and disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases. This standard, among other things, will require lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability and result in enhanced disclosures. The standard is effective for interim and annual periods beginning after December 15, 2018 and early adoption is permitted. We are currently assessing the impact this standard will have on our consolidated financial statements and disclosures.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This standard primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The standard is effective for interim and annual periods beginning after December 15, 2017, and early adoption is permitted. We are currently assessing the impact this standard will have on our consolidated financial statements and disclosures.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires companies to recognize revenue for the transfer of goods and services to customers in amounts that reflect the consideration the company expects to receive in exchange for those goods and services. In addition, the standard requires enhanced disclosures about the nature, amount, timing and uncertainty of revenue. There were several amendments to the standard during 2016, including clarification of the accounting for licenses of intellectual property and identifying performance obligations. The standard is effective beginning January 1, 2018 and can be adopted either retrospectively to each reporting period presented or on a modified retrospective basis with a cumulative effect adjustment at the date of the initial application. We plan to adopt the standard on the modified retrospective basis, with a cumulative effect adjustment.

We have completed the majority of our assessment of all potential impacts of the standard. We do not expect a change in revenue recognition for the majority of our product and service offerings. However, we believe that the most likely changes will be in our Software

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

Solutions segment related to the timing of software licenses and certain other ancillary revenue streams. In addition, we currently capitalize certain costs associated with the acquisition of new customers and recognize these costs over their expected revenue stream of eight years. Under the new standard, these costs will be expensed as incurred. Also, we have determined that certain sales commission plans will qualify for capitalization under the new standard. We plan to use the practical expedient that allows companies to expense costs to obtain a contract when the estimated amortization period is less than one year.

We are in the process of drafting our accounting policies and evaluating the new disclosure requirements and expect to complete our evaluation of the impacts of the accounting and disclosure requirements on our business processes, controls and systems by the end of the year.

2. Segment Information

Effective January 1, 2017, we revised our segment reporting to reflect a change in how we manage and report office shipping solutions, which we previously reported within the Global Ecommerce segment. The needs of retail and ecommerce clients differ from those of office shipping clients. Accordingly, we now report the results for office shipping solutions within Small & Medium Business Solutions and the retail and ecommerce shipping solutions remain in Global Ecommerce. We have recast prior period results to conform to our current segment presentation. The principal products and services of each of our reportable segments are as follows:

Small & Medium Business Solutions:

North America Mailing: Includes the revenue and related expenses from mailing and office shipping solutions, financing services, and supplies for small and medium businesses to efficiently create physical and digital mail, evidence postage and help simplify and save on the sending, tracking and receiving of letters, parcels and flats in the U.S. and Canada.

International Mailing: Includes the revenue and related expenses from mailing and office shipping solutions, financing services, and supplies for small and medium businesses to efficiently create physical and digital mail, evidence postage and help simplify and save on the sending, tracking and receiving of letters, parcels and flats in areas outside the U.S. and Canada.

Enterprise Business Solutions:

Production Mail: Includes the worldwide revenue and related expenses from the sale of production mail inserting and sortation equipment, high-speed production print systems, supplies and related support services to large enterprise clients to process inbound and outbound mail.

Presort Services: Includes revenue and related expenses from presort mail and parcel services for our large enterprise clients to qualify large mail and parcel volumes for postal worksharing discounts.

Digital Commerce Solutions:

Software Solutions: Includes the worldwide revenue and related expenses from the licensing of customer engagement, customer information and location intelligence software solutions and related support services.

Global Ecommerce: Includes the worldwide revenue and related expenses from cross-border ecommerce transactions and domestic retail and ecommerce shipping solutions.

We determine segment earnings before interest and taxes (EBIT) by deducting from segment revenue the related costs and expenses attributable to the segment. Segment EBIT excludes interest, taxes, general corporate expenses, restructuring charges, and other items that are not allocated to a particular business segment. Management uses segment EBIT to measure profitability and performance at the segment level and believes that it provides a useful measure of operating performance and underlying trends of the businesses. Segment EBIT may not be indicative of our overall consolidated performance and therefore, should be read in conjunction with our consolidated results of operations.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

Revenue and EBIT by business segment is presented below:



	Revenue
	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
North America Mailing	$	341,096	$	343,218	$	696,674	$	714,671
International Mailing	95,322		107,581		188,380		212,567
Small & Medium Business Solutions	436,418		450,799		885,054		927,238
Production Mail	85,570		95,874		174,525		183,299
Presort Services	118,452		115,765		251,129		243,161
Enterprise Business Solutions	204,022		211,639		425,654		426,460
Software Solutions	86,425		90,464		164,645		168,386
Global Ecommerce	94,506		82,984		182,658		158,391
Digital Commerce Solutions	180,931		173,448		347,303		326,777
Total revenue	$	821,371	$	835,886	$	1,658,011	$	1,680,475



	EBIT
	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
North America Mailing	$	120,877		$	146,897		$	261,885		$	307,728
International Mailing	13,969			12,468			27,238			23,644
Small & Medium Business Solutions	134,846			159,365			289,123			331,372
Production Mail	7,631			12,914			16,595			19,738
Presort Services	19,270			21,214			49,987			50,124
Enterprise Business Solutions	26,901			34,128			66,582			69,862
Software Solutions	7,555			10,151			10,304			7,579
Global Ecommerce	(4,030		)	(683		)	(8,300		)	(4,152		)
Digital Commerce Solutions	3,525			9,468			2,004			3,427
Total segment EBIT	165,272			202,961			357,709			404,661
Reconciling items:
Interest, net	(40,443		)	(34,294		)	(79,093		)	(68,510		)
Unallocated corporate expenses	(50,134		)	(48,777		)	(105,290		)	(106,544		)
Restructuring charges and asset impairments, net	(26,927		)	(26,076		)	(29,009		)	(33,009		)
Gain from the sale of technology	6,085			—			6,085			—
Acquisition and disposition-related expenses	—			(576		)	—			(3,696		)
Income before income taxes	53,853			93,238			150,402			192,902
Provision for income taxes	4,952			33,394			36,368			70,418
Loss from discontinued operations, net of tax	—			(1,660		)	—			(1,660		)
Net income	$	48,901		$	58,184		$	114,034		$	120,824

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

3. Earnings per Share

The calculations of basic and diluted earnings per share are presented below. The sum of earnings per share amounts may not equal the totals due to rounding.



	Three Months Ended June 30,					Six Months Ended June 30,
	2017		2016			2017		2016
Numerator:
Amounts attributable to common stockholders:
Net income from continuing operations	$	48,901	$	55,250		$	114,034	$	113,296
Loss from discontinued operations, net of tax	—		(1,660		)	—		(1,660		)
Net income attributable to Pitney Bowes Inc. (numerator for diluted EPS)	48,901		53,590			114,034		$	111,636
Less: Preference stock dividend	10		9			19		19
Income attributable to common stockholders (numerator for basic EPS)	$	48,891	$	53,581		$	114,015	$	111,617
Denominator:
Weighted-average shares used in basic EPS	186,333		187,395			186,136		189,929
Effect of dilutive shares:
Conversion of Preferred stock and Preference stock	288		300			290		302
Employee stock plans	756		667			519		575
Weighted-average shares used in diluted EPS	187,377		188,362			186,945		190,806
Basic earnings per share:
Continuing operations	$	0.26	$	0.29		$	0.61	$	0.60
Discontinued operations	—		(0.01		)	—		(0.01		)
Net Income	$	0.26	$	0.29		$	0.61	$	0.59
Diluted earnings per share:
Continuing operations	$	0.26	$	0.29		$	0.61	$	0.59
Discontinued operations	—		(0.01		)	—		(0.01		)
Net Income	$	0.26	$	0.28		$	0.61	$	0.59
Anti-dilutive shares not used in calculating diluted weighted-average shares	9,916		6,878			11,379		8,892

4. Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined on the last-in, first-out (LIFO) basis for most U.S. inventories and the first-in, first-out (FIFO) basis for most non-U.S. inventories. Inventories at June 30, 2017 and December 31, 2016 consisted of the following:



	June 30, 2017			December 31, 2016
Raw materials	$	38,322		$	28,541
Work in process	10,541			6,498
Supplies and service parts	53,265			45,152
Finished products	31,493			24,678
Inventory at FIFO cost	133,621			104,869
Excess of FIFO cost over LIFO cost	(12,143		)	(12,143		)
Total inventory, net	$	121,478		$	92,726

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

5. Finance Assets

Finance Receivables

Finance receivables are comprised of sales-type lease receivables and unsecured revolving loan receivables. Sales-type lease receivables are generally due in monthly, quarterly or semi-annual installments over periods ranging from three to five years. Loan receivables arise primarily from financing services offered to our customers for postage and supplies. Loan receivables are generally due each month; however, customers may rollover outstanding balances. Interest is recognized on loan receivables using the effective interest method and related annual fees are initially deferred and recognized ratably over the annual period covered. Customer acquisition costs are expensed as incurred.

Finance receivables at June 30, 2017 and December 31, 2016 consisted of the following:



	June 30, 2017									December 31, 2016
	North America			International			Total			North America			International			Total
Sales-type lease receivables
Gross finance receivables	$	1,061,888		$	276,795		$	1,338,683		$	1,088,053		$	273,262		$	1,361,315
Unguaranteed residual values	82,581			14,083			96,664			90,190			13,655			103,845
Unearned income	(221,083		)	(61,768		)	(282,851		)	(223,908		)	(60,458		)	(284,366		)
Allowance for credit losses	(8,456		)	(2,496		)	(10,952		)	(8,247		)	(2,647		)	(10,894		)
Net investment in sales-type lease receivables	914,930			226,614			1,141,544			946,088			223,812			1,169,900
Loan receivables
Loan receivables	351,077			36,187			387,264			374,147			32,716			406,863
Allowance for credit losses	(7,503		)	(1,157		)	(8,660		)	(8,517		)	(1,089		)	(9,606		)
Net investment in loan receivables	343,574			35,030			378,604			365,630			31,627			397,257
Net investment in finance receivables	$	1,258,504		$	261,644		$	1,520,148		$	1,311,718		$	255,439		$	1,567,157

Allowance for Credit Losses

We provide an allowance for probable credit losses based on historical loss experience, the nature and volume of our portfolios, adverse situations that may affect a client's ability to pay, prevailing economic conditions and our ability to manage the collateral. We continually evaluate the adequacy of the allowance for credit losses and make adjustments as necessary. The assumptions used in determining an estimate of credit losses are inherently subjective and actual results may differ significantly from estimated reserves.

We establish credit approval limits based on the credit quality of the client and the type of equipment financed. Our policy is to discontinue revenue recognition for lease receivables that are more than 120 days past due and for loan receivables that are more than 90 days past due. We resume revenue recognition when the client's payments reduce the account aging to less than 60 days past due. Finance receivables deemed uncollectible are written off against the allowance after all collection efforts have been exhausted and management deems the account to be uncollectible. We believe that our finance receivable credit risk is low because of the geographic and industry diversification of our clients and small account balances for most of our clients.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

Activity in the allowance for credit losses for the six months ended June 30, 2017 and 2016 was as follows:



	Sales-type Lease Receivables						Loan Receivables
	North America			International			North America			International			Total
Balance at January 1, 2017	$	8,247		$	2,647		$	8,517		$	1,089		$	20,500
Amounts charged to expense	5,182			466			2,891			450			8,989
Write-offs and other	(4,973		)	(617		)	(3,905		)	(382		)	(9,877		)
Balance at June 30, 2017	$	8,456		$	2,496		$	7,503		$	1,157		$	19,612

	Sales-type Lease Receivables						Loan Receivables
	North America			International			North America			International			Total
Balance at January 1, 2016	$	6,606		$	3,542		$	10,024		$	1,518		$	21,690
Amounts charged to expense	1,895			186			2,765			390			5,236
Write-offs and other	(2,784		)	(1,031		)	(3,798		)	(569		)	(8,182		)
Balance at June 30, 2016	$	5,717		$	2,697		$	8,991		$	1,339		$	18,744

Aging of Receivables

The aging of gross finance receivables at June 30, 2017 and December 31, 2016 was as follows:



	June 30, 2017
	Sales-type Lease Receivables				Loan Receivables
	North America		International		North America		International		Total
1 - 90 days	$	1,006,333	$	271,713	$	343,205	$	36,044	$	1,657,295
> 90 days	55,555		5,082		7,872		143		68,652
Total	$	1,061,888	$	276,795	$	351,077	$	36,187	$	1,725,947
Past due amounts > 90 days
Still accruing interest	$	7,484	$	1,578	$	—	$	—	$	9,062
Not accruing interest	48,071		3,504		7,872		143		59,590
Total	$	55,555	$	5,082	$	7,872	$	143	$	68,652

As of June 30, 2017, we had North America sales-type lease receivables aged greater than 90 days with a contract value of $56 million. As of August 1, 2017, we received payments with a contract value of approximately $26 million related to these receivables.



	December 31, 2016
	Sales-type Lease Receivables				Loan Receivables
	North America		International		North America		International		Total
1 - 90 days	$	1,025,313	$	269,247	$	366,726	$	32,420	$	1,693,706
> 90 days	62,740		4,015		7,421		296		74,472
Total	$	1,088,053	$	273,262	$	374,147	$	32,716	$	1,768,178
Past due amounts > 90 days
Still accruing interest	$	8,831	$	972	$	—	$	—	$	9,803
Not accruing interest	53,909		3,043		7,421		296		64,669
Total	$	62,740	$	4,015	$	7,421	$	296	$	74,472

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

Credit Quality

The extension of credit and management of credit lines to new and existing clients uses a combination of an automated credit score, where available, and a detailed manual review of the client's financial condition and, when applicable, payment history. Once credit is granted, the payment performance of the client is managed through automated collections processes and is supplemented with direct follow up should an account become delinquent. We have robust automated collections and extensive portfolio management processes. The portfolio management processes ensure that our global strategy is executed, collection resources are allocated appropriately and enhanced tools and processes are implemented as needed.

We use a third party to score the majority of the North America portfolio on a quarterly basis using a commercial credit score. We do not use a third party to score our International portfolio because the cost to do so is prohibitive, given that it is a localized process and there is no single credit score model that covers all countries.

The table below shows the North America portfolio at June 30, 2017 and December 31, 2016 by relative risk class based on the relative scores of the accounts within each class. The relative scores are determined based on a number of factors, including the company type, ownership structure, payment history and financial information. A fourth class is shown for accounts that are not scored. Absence of a score is not indicative of the credit quality of the account. The degree of risk (low, medium, high), as defined by the third party, refers to the relative risk that an account in the next 12 month period may become delinquent.


•	Low risk accounts are companies with very good credit scores and are considered to approximate the top 30% of all commercial borrowers.


•	Medium risk accounts are companies with average to good credit scores and are considered to approximate the middle 40% of all commercial borrowers.


•	High risk accounts are companies with poor credit scores, are delinquent or are at risk of becoming delinquent and are considered to approximate the bottom 30% of all commercial borrowers.



	June 30, 2017		December 31, 2016
Sales-type lease receivables
Low	$	837,486	$	879,823
Medium	152,362		135,953
High	21,767		22,600
Not Scored	50,273		49,677
Total	$	1,061,888	$	1,088,053
Loan receivables
Low	$	272,022	$	296,598
Medium	55,493		53,647
High	6,672		7,216
Not Scored	16,890		16,686
Total	$	351,077	$	374,147

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

6. Intangible Assets and Goodwill

Intangible Assets

Intangible assets at June 30, 2017 and December 31, 2016 consisted of the following:



	June 30, 2017							December 31, 2016
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Customer relationships	$	452,614	$	(319,812	)	$	132,802	$	445,039	$	(300,906	)	$	144,133
Software & technology	152,589		(139,947		)	12,642		150,037		(136,508		)	13,529
Trademarks & other	36,981		(30,406		)	6,575		36,212		(28,702		)	7,510
Total intangible assets	$	642,184	$	(490,165	)	$	152,019	$	631,288	$	(466,116	)	$	165,172

Amortization expense was $8 million and $11 million for the three months ended June 30, 2017 and 2016, respectively and $17 million and $21 million for the six months ended June 30, 2017 and 2016, respectively.

Future amortization expense as of June 30, 2017 was as follows:



Remaining for year ending December 31, 2017	$	14,245
Year ending December 31, 2018	27,632
Year ending December 31, 2019	24,260
Year ending December 31, 2020	19,126
Year ending December 31, 2021	15,401
Thereafter	51,355
Total	$	152,019

Actual amortization expense may differ from the amounts above due to, among other things, fluctuations in foreign currency exchange rates, impairments, acquisitions and accelerated amortization.

Goodwill

Changes in the carrying value of goodwill, by reporting segment, for the six months ended June 30, 2017 are shown in the table below. Prior year amounts have been recast for the change in reportable segments.



	December 31, 2016		Acquisitions		Foreign currency translation		June 30, 2017
North America Mailing	$	354,000	$	—	$	9,095	$	363,095
International Mailing	145,566		—		8,085		153,651
Small & Medium Business Solutions	499,566		—		17,180		516,746
Production Mail	101,099		—		3,963		105,062
Presort Services	196,890		6,229		—		203,119
Enterprise Business Solutions	297,989		6,229		3,963		308,181
Software Solutions	501,591		—		5,613		507,204
Global Ecommerce	272,189		—		—		272,189
Digital Commerce Solutions	773,780		—		5,613		779,393
Total goodwill	$	1,571,335	$	6,229	$	26,756	$	1,604,320

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

7. Fair Value Measurements and Derivative Instruments

We measure certain financial assets and liabilities at fair value on a recurring basis. Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. An entity is required to classify certain assets and liabilities measured at fair value based on the following fair value hierarchy that prioritizes the inputs used to measure fair value:


Level 1 –	Unadjusted quoted prices in active markets for identical assets and liabilities.


Level 2 –	Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


Level 3 –	Unobservable inputs that are supported by little or no market activity, may be derived from internally developed methodologies based on management’s best estimate of fair value and that are significant to the fair value of the asset or liability.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect its placement within the fair value hierarchy. The following tables show, by level within the fair value hierarchy, our financial assets and liabilities that are accounted for at fair value on a recurring basis at June 30, 2017 and December 31, 2016.



	June 30, 2017
	Level 1		Level 2			Level 3		Total
Assets:
Investment securities
Money market funds / commercial paper	$	169,023	$	464,970		$	—	$	633,993
Equity securities	—		24,186			—		24,186
Commingled fixed income securities	1,560		21,871			—		23,431
Debt securities - U.S. and foreign governments, agencies and municipalities	115,852		16,646			—		132,498
Debt securities - corporate	—		77,352			—		77,352
Mortgage-backed / asset-backed securities	—		162,081			—		162,081
Derivatives
Interest rate swap	—		1,909			—		1,909
Foreign exchange contracts	—		298			—		298
Total assets	$	286,435	$	769,313		$	—	$	1,055,748
Liabilities:
Derivatives
Foreign exchange contracts	$	—	$	(539	)	$	—	$	(539	)
Total liabilities	$	—	$	(539	)	$	—	$	(539	)

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)



	December 31, 2016
	Level 1		Level 2			Level 3		Total
Assets:
Investment securities
Money market funds / commercial paper	$	114,471	$	217,175		$	—	$	331,646
Equity securities	—		24,571			—		24,571
Commingled fixed income securities	1,536		22,132			—		23,668
Debt securities - U.S. and foreign governments, agencies and municipalities	116,822		19,358			—		136,180
Debt securities - corporate	—		69,891			—		69,891
Mortgage-backed / asset-backed securities	—		158,996			—		158,996
Derivatives
Interest rate swap	—		1,588			—		1,588
Foreign exchange contracts	—		637			—		637
Total assets	$	232,829	$	514,348		$	—	$	747,177
Liabilities:
Derivatives
Foreign exchange contracts	$	—	$	(3,717	)	$	—	$	(3,717	)
Total liabilities	$	—	$	(3,717	)	$	—	$	(3,717	)

Investment Securities

The valuation of investment securities is based on the market approach using inputs that are observable, or can be corroborated by observable data, in an active marketplace. The following information relates to our classification into the fair value hierarchy:

•

Money Market Funds / Commercial Paper: Money market funds typically invest in government securities, certificates of deposit, commercial paper and other highly liquid, low risk securities. Money market funds are principally used for overnight deposits and are classified as Level 1 when unadjusted quoted prices in active markets are available and as Level 2 when they are not actively traded on an exchange. Direct investments in commercial paper are not listed on an exchange in an active market and are classified as Level 2.


•	Equity Securities: Equity securities are comprised of mutual funds investing in U.S. and foreign common stock. These mutual funds are classified as Level 2 as they are not separately listed on an exchange.

•

Commingled Fixed Income Securities: Mutual funds that invest in a variety of fixed-income securities including securities of the U.S. government and its agencies, corporate debt, mortgage-backed securities and asset-backed securities. The value of the funds is based on the market value of the underlying investments owned by each fund, minus its liabilities, divided by the number of shares outstanding, as reported by the fund manager. These commingled funds are not listed on an exchange in an active market and are classified as Level 2.

•

Debt Securities – U.S. and Foreign Governments, Agencies and Municipalities: Debt securities are classified as Level 1 where active, high volume trades for identical securities exist. Valuation adjustments are not applied to these securities. Debt securities valued using quoted market prices for similar securities or benchmarking model derived prices to quoted market prices and trade data for identical or comparable securities are classified as Level 2.


•	Debt Securities – Corporate: Corporate debt securities are valued using recently executed transactions, market price quotations where observable, or bond spreads. The spread data used are for the same maturity as the security. These securities are classified as Level 2.


•	Mortgage-Backed Securities / Asset-Backed Securities: These securities are valued based on external pricing indices. When external index pricing is not observable, these securities are valued based on external price/spread data. These securities are classified as Level 2.

Investment securities include investments held by The Pitney Bowes Bank (the Bank), whose primary business is to provide financing solutions to clients that rent postage meters and purchase supplies. The Bank's assets and liabilities consist primarily of cash, finance receivables, short and long-term investments and deposit accounts.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

Available-For-Sale Securities

Certain investment securities are classified as available-for-sale and recorded at fair value in the Condensed Consolidated Balance Sheets as cash and cash equivalents, short-term investments and other assets depending on the type of investment and maturity. Unrealized holding gains and losses are recorded, net of tax, in accumulated other comprehensive income (AOCI).

Available-for-sale securities at June 30, 2017 and December 31, 2016 consisted of the following:



	June 30, 2017
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Estimated fair value
U.S. and foreign governments, agencies and municipalities	$	124,051	$	2,142	$	(1,092	)	$	125,101
Corporate notes and bonds	75,876		1,779		(303		)	77,352
Commingled fixed income securities	1,584		—		(24		)	1,560
Mortgage-backed / asset-backed securities	161,676		1,776		(1,371		)	162,081
Total	$	363,187	$	5,697	$	(2,790	)	$	366,094



	December 31, 2016
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Estimated fair value
U.S. and foreign governments, agencies and municipalities	$	136,316	$	1,571	$	(1,707	)	$	136,180
Corporate notes and bonds	69,376		1,180		(665		)	69,891
Commingled fixed income securities	1,568		—		(32		)	1,536
Mortgage-backed / asset-backed securities	159,312		1,566		(1,882		)	158,996
Total	$	366,572	$	4,317	$	(4,286	)	$	366,603

At June 30, 2017, investment securities that were in a loss position for 12 or more continuous months had aggregate unrealized holding losses of less than $1 million and an estimated fair value of $24 million, and investment securities that were in a loss position for less than 12 continuous months had aggregate unrealized holding losses of $2 million and an estimated fair value of $132 million.

At December 31, 2016, investment securities that were in a loss position for 12 or more continuous months had aggregate unrealized holding losses of less than $1 million and an estimated fair value of $12 million, and investment securities that were in a loss position for less than 12 continuous months had aggregate unrealized holding losses of $4 million and an estimated fair value of $171 million.

We have not recognized an other-than-temporary impairment on any of the investment securities in an unrealized loss position because we have the ability and intent to hold these securities until recovery of the unrealized losses and we expect to receive the contractual principal and interest on these investment securities at maturity.

Scheduled maturities of available-for-sale securities at June 30, 2017 were as follows:



	Amortized cost		Estimated fair value
Within 1 year	$	24,079	$	24,146
After 1 year through 5 years	116,356		116,910
After 5 years through 10 years	65,193		65,864
After 10 years	157,559		159,174
Total	$	363,187	$	366,094

The expected payments on mortgage-backed and asset-backed securities may not coincide with their contractual maturities as borrowers have the right to prepay obligations with or without prepayment penalties.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

We have not experienced any significant write-offs in our investment portfolio. The majority of our mortgage-backed securities are either guaranteed or supported by the U.S. Government. We have no investments in inactive markets that would warrant a possible change in our pricing methods or classification within the fair value hierarchy.

Derivative Instruments

In the normal course of business, we are exposed to the impact of changes in foreign currency exchange rates and interest rates. We limit these risks by following established risk management policies and procedures, including the use of derivatives. We use derivative instruments to limit the effects of exchange rate fluctuations on financial results and manage the related cost of debt. We do not use derivatives for trading or speculative purposes. We record derivative instruments at fair value and the accounting for changes in the fair value depends on the intended use of the derivative, the resulting designation and the effectiveness of the instrument in offsetting the risk exposure it is designed to hedge.

Foreign Exchange Contracts

We enter into foreign exchange contracts to mitigate the currency risk associated with the anticipated purchase of inventory between affiliates and from third parties. These contracts are designated as cash flow hedges. The effective portion of the gain or loss on cash flow hedges is included in AOCI in the period that the change in fair value occurs and is reclassified to earnings in the period that the hedged item is recorded in earnings. At June 30, 2017 and December 31, 2016, we had outstanding contracts associated with these anticipated transactions with notional amounts of $9 million and $13 million, respectively.

The valuation of foreign exchange derivatives is based on the market approach using observable market inputs, such as foreign currency spot and forward rates and yield curves. We have not seen a material change in the creditworthiness of those banks acting as derivative counterparties.

Interest Rate Swap

We entered into an interest rate swap with a notional amount of $300 million to mitigate the interest rate risk associated with our $300 million variable-rate term loans. The swap is designated as a cash flow hedge. The effective portion of the gain or loss on the cash flow hedge is included in AOCI in the period that the change in fair value occurs and is reclassified to earnings in the period that the hedged item is recorded in earnings. Under the terms of the swap agreement, we pay fixed-rate interest of 0.8826% and receive variable-rate interest based on 1-month LIBOR. The variable interest rate resets monthly.

The valuation of our interest rate swap is based on the income approach using a model with inputs that are observable or that can be derived from or corroborated by observable market data.

PITNEY BOWES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; table amounts in thousands unless otherwise noted, except per share amounts)

The fair value of derivative instruments at June 30, 2017 and December 31, 2016 was as follows:



Designation of Derivatives	Balance Sheet Location	June 30, 2017			December 31, 2016
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets and prepayments	$	50		$	487
	Accounts payable and accrued liabilities	(401		)	(136		)

Interest rate swap	Other assets	1,909			1,588

Derivatives not designated as hedging instruments
Foreign exchange contracts	Other current assets and prepayments	248			150
	Accounts payable and accrued liabilities	(138		)	(3,581		)

	Total derivative assets	$	2,207		$	2,225
	Total derivative liabilities	(539		)	(3,717		)
	Total net derivative asset (liabilities)	$	1,668		$	(1,492	)

The majority of the amounts included in AOCI at June 30, 2017 will be recognized in earnings within the next 12 months. No amount of ineffectiveness was recorded in earnings for these designated cash flow hedges.

The following represents the results of cash flow hedging relationships for the three and six months ended June 30, 2017 and 2016:



	Three Months Ended June 30,
	Derivative Gain (Loss) Recognized in AOCI (Effective Portion)				Location of Gain (Loss) (Effective Portion)	Gain (Loss) Reclassified from AOCI to Earnings (Effective Portion)
Derivative Instrument	2017			2016	Location of Gain (Loss) (Effective Portion)	2017	2016
Foreign exchange contracts	$	(599	)