Pitney Bowes Inc. (PBI) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Pitney Bowes Fourth Quarter Full Year 2016 Results Conference Call. [Operator Instructions] Today’s call is also being recorded. If you have any objections, please disconnect your lines at this time. I would now like to introduce your speakers for today’s conference. Mr. Marc Lautenbach, President and Chief Executive Officer; Mr. Michael Monahan, Executive Vice President, Chief Operating Officer; and Mr. Adam David, Vice President, Investor Relations. Mr. David will now begin the call with a Safe Harbor overview.

Good morning. Included in this presentation are forward-looking statements about our expected future business and financial performance. Forward-looking statements involve risks and uncertainties that could cause actual results to be materially different from our projections. More information about these risks and uncertainties can be found in our 2015 Form 10-K annual report and other reports filed with the SEC that are located on our website at www.pb.com and by clicking on Investor Relations. Please keep in mind that we do not undertake any obligation to update any forward-looking statements as a result of new information or developments. Also for non-GAAP measures used in the press release or discussed in this presentation, you can find reconciliations to the appropriate GAAP measures in the tables attached to our press release and also on our Investor Relations website. Additionally, we have provided slides that summarize many of the points we will discuss during the call. These slides can also be found on our Investor Relations website. Now, our President and Chief Executive Officer, Marc Lautenbach, will start with a few opening remarks. Marc?

Thank you, Adam and good morning. Let me start by saying that the fourth quarter was not the quarter we wanted or expected. As always, there were puts and takes in the business. However, the primary story is in software. In the third quarter earnings call, I referenced several large software deals that our expectations were built on. We were encouraged not only by the size of these deals, which were substantial for any large software company and especially for a company of our size, but also because these opportunities were with clients with whom we have a strong long-term relationship and have successfully closed business in the past. There was every indication that we would close these deals by the end of the fourth quarter. Unfortunately, these deals slipped into 2017. While I am confident we will close many of these deals this year, the failure to close these deals in 2016 caused a different quarterly performance than we were expecting. While I continue to be confident in the future of our software business, there is no question we need to up our game going forward. This was not the first quarter we have had a foreclosed rate on large deals. Consequently, we have made a series of changes in our software executive sales management team. Going forward, Bob Guidotti will personally direct the software sales organization. Moments like these requires you to step back and to take stock of the lessons learned. I would summarize my learnings as follows. First, this reaffirms our initiative to build an indirect channel for our software business. Systems integrators bring reach, technical skills, brand credibility and more executive relationships to our business. All of this will be helpful to Pitney Bowes. Second, we need to up our own game selling to executives in our software business and in general, continue to improve the skills of our software direct sales force. Third, we need to continue to sharpen our analytical capabilities to provide us a clear view of our pipeline. Our new business platform will help us a lot in this respect. Finally, based on how 2016 ended, especially in software, we are adding conservatism to our 2017 guidance. While we are not happy with our tactical performance in the quarter or for that matter, the year, we did continue to make progress, creating the strategic foundation for our business. In terms of reinventing our mail business in 2016, we have shipped more than 50,000 SmartLink devices, 22,000 SendPro applications and 10,000 send kits. Moreover, our shipping APIs delivered through PB Commerce Cloud are positioned to make a real difference for us in 2017. Two weeks ago, we announced SendPro online shipping and mailing solution. This latest solution is the only online application in the market that provides both USPS postage for mailing and multiple shipping options. We have learned much from our new meter products and will incorporate those insights into our complete meter refresh, which we will rollout later this year. The entirety of these efforts will move our meter business from 20th century technology to a new contemporary form factor, supported by an open platform and software delivered as a service. Turning to our enterprise business, the new postal rate case in the United States and our Production Mail opportunity pipeline has positioned us well for 2017. The new rate case, which was effective on January 22, creates a greater incentive for high volume mailers to leverage our solutions. And our new inserting solutions continued to outperform our expectations. In terms of operational excellence, we are through much of the stabilization work of our enterprise business platform and continue to be very encouraged by the opportunities this platform not only creates to deliver productivity, but also a totally different client experience and enables many of our new offerings. Our Global Ecommerce business performed well, especially in the context of a difficult currency environment. The solid results are a clear demonstration of the resilience and the robustness of this market opportunity. We continue to be confident in both the short and the long-term prospects of this business. And while our software business performed poorly in the quarter, we continued to make good progress building our indirect channel. We increased the number of absolute partners, enabled more of the professionals and the pipeline continued to build. More work to do for sure, however, this new channel is making a difference now with improved quarter-to-quarter as well as year-to-year performance. It has clearly took a lot on in 2016. And our annual performance may have suffered because of it. But the changes we made were necessary and have positioned the business to create long-term value for our shareholders. With that, let me turn the call over to Mike.

Thank you, Marc and good morning. As Marc discussed and as most of you have had a chance to see by now, we had a weaker-than-expected finish to the fourth quarter for both revenue and earnings per share. Let me spend some time going through the three specific factors affecting the quarter. I will then get into the financial details of the full year and the fourth quarter before providing more color around our 2017 expectations. First, as Marc noted, software revenue fell short of our expectation, mostly on lower license sales in the last few weeks of the quarter. Given the high margin nature of this revenue, the shortfall significantly impacted earnings. Entering the quarter, we had a healthy pipeline of deals. However, typical with this business, we expected a significant portion of business to close in the last 2 to 3 weeks of the quarter. Unfortunately, there were three large deals worth $17 million, along with a few smaller deals that did not get finalized in those last few weeks as we expected. We have consequently made changes in our software executive sales management team as Marc stated. Bob Guidotti’s experience and leadership, coupled with our aggressive effort to build and train our partner network sales teams, are expected to produce better results relative to our performance over the course of 2016. Second, while year-to-year comparisons for North American SMB in the quarter reflect modest revenue improvements from the last two quarters, we expected a stronger sales finish. As Marc noted, we have launched a number of new solutions in SMB, some of which are equipment sales based and others that will create streams over time. The product mix in the quarter resulted in lower than expected equipment sales. And third, the U.S. dollar further strengthened relative to key currencies in December, just as consumer spending began to ramp up for the holiday season. While the marketplace and retail business still grew an impressive 18% in the quarter from prior year on a constant currency basis, growth slowed from the pace earlier in the quarter. Despite currency fluctuations, the business continues to turn out a strong performance, again growing revenue double-digits and improving its EBIT margin. We continue to add new clients to the platform, which will continue to contribute to revenue growth and margin improvement as the business scales. The total Global Ecommerce business, including office shipping, grew 10% from prior year when excluding currency changes. Let me now turn to the financials. First, I will take you through a high-level review of our annual results and then I will discuss the quarter in more detail. Please note that a reconciliation of GAAP to non-GAAP results can be found in the financial schedules in our earnings press release and posted on our Investor Relations website. Turning to our full year results, annual revenue was $3.4 billion, a 3% decline from prior year, excluding both the impact of currency and market exits, a 4% decline excluding the impact of currency and a 5% decline on a reported basis. When compared to prior year on a constant currency basis and excluding the impacts of market exits, Digital Commerce Solutions revenue grew 6%, enterprise revenue was flat and SMB revenue declined 6%. On a reported basis, Digital Commerce Solutions revenue grew 4%, enterprise revenue declined 2% and SMB revenue declined 7%. Adjusted earnings per diluted share from continuing operations was $1.68. GAAP earnings per share were $0.50. GAAP earnings per share included $0.22 of restructuring and asset impairment charges, $0.03 in charges related to the redemption of the company’s PBIH preferred stock, $0.02 from the loss on disposition from our market exits and $0.01 for discontinued operations. In addition, the company recorded a non-cash estimate of $0.88 per share goodwill impairment charge related to the Software Solutions business, principally as a result of recent operating experience. The company expects to finalize the valuation assessment and resulting goodwill impairment charge at the time the 10-K is filed and does not anticipate any material adjustment. Free cash flow was $430 million. And on a GAAP basis, we generated $491 million in cash from operations. Overall, free cash flow was in line with our annual guidance range. During the year, we used a substantial portion of our cash flow to return capital to our common shareholders in the form of a common dividend and share repurchases. For the year, the company paid $141 million of cash dividends, bought back more than 10 million shares of common stock for $197 million and made $65 million in restructuring payments. From a debt management perspective, earlier in the year, the company obtained $300 million in new bank term loan, which were used to partially refinance $371 million of notes that matured in January of 2016. In September, we issued $600 million of 3.375% 5-year fixed rate notes. The issuance was a debt neutral transaction as the company paid down commercial paper outstanding and redeemed all $300 million of outstanding shares of our PBIH preferred stock on November 1, 2016. At year end, we had $3.4 billion of debt on the balance sheet, which was about $118 million more than prior year, including the refinancing of the PBIH preferred stock with debt. The company ended the year with $771 million of cash on hand and no commercial paper outstanding. Looking at the full year income statement, as a reminder, a reconciliation of GAAP to non-GAAP measures can be found on our financial statements attached to our press release and posted on our Investor Relations website. Adjusted earnings before interest and taxes or adjusted EBIT was $631 million, which was $85 million lower than the prior year. Adjusted EBIT margin was 18.5%, which was a decline of 150 basis points from prior year and largely the result of the decline in SMB and software revenue. Adding back depreciation and amortization, adjusted EBITDA for the year was $810 million. SG&A for the year was $1.2 billion, which was $80 million or 6% lower than the prior year. As a percent of revenue, SG&A was 35.2%, which was an improvement of 60 basis points from the prior year. SG&A declined largely from operational excellence actions taken to improve the company’s efficiency and also on lower variable compensation costs, which were adjusted to align with the company’s performance. Partially offsetting these reductions were investments in advertising in support of our brand and expenses to support our U.S. enterprise business platform implementation and stabilization. Since 2012, we have reduced absolute SG&A by $290 million while investing in our new enterprise business platform, expanding our digital capabilities through the Commerce Cloud, investing in our Global Ecommerce platform and also launching new products as well as a new advertising and brand campaign. R&D costs for the full year were $121 million, which was an $11 million or 10% increase from prior year. The higher R&D was in support of the company’s investments in Global Ecommerce and digital products in SMB. For the full year, we have recorded pre-tax restructuring and asset impairment charges totaling $63 million, primarily related to actions associated with our previously announced plans to reduce costs. This resulted in a 4% decline in full-time equivalent headcount during the year. Additionally, the company recorded a pre-tax non-cash goodwill impairment estimated charge of $169 million related to the company’s Software Solutions business. Net interest expense, which includes financing interest, was $144 million, which was a decline of $15 million when compared to the prior year. This was primarily the result of lower average interest rate on debt and actions we have taken to manage our debt over the last year. The effective tax rate on adjusted earnings for the year was 31.6% compared with 33.5% last year. Now let me turn to the quarter’s results. Revenues for the fourth quarter totaled $887 million. Compared to the prior year, revenue declined 4% on a constant currency basis and 5% on a reported basis. Adjusted earnings per share from continuing operations were $0.53 for the quarter, which represents a $0.05 per share or 11% growth over prior year. GAAP earnings per share was a loss of $0.44 this quarter. GAAP earnings per share included a non-cash estimate of $0.89 goodwill impairment charge, $0.05 restructuring and asset impairment charges, $0.01 related to the redemption of the company’s PBIH preferred stock and about $0.01 for disposition expense related to our market exits. Free cash flow during the quarter was $164 million. And on a GAAP basis, we generated $200 million in cash from operations. During the quarter, we used $35 million of cash to return capital to our common shareholders in the form of dividends. And we made $14 million in restructuring payments. Turning to the income statement, adjusted EBIT was $187 million this quarter, which was $1.8 million higher than the prior year. Adjusted EBIT margin was 21.1%, which was an increase of 130 basis points over the prior year. Adding back depreciation and amortization, adjusted EBITDA for the quarter was $225 million. SG&A for the quarter was $284 million, which was $57 million or 17% lower than the prior year. As a percent of revenue, SG&A was 32%, which was about 440 basis points lower than prior year. The decline in SG&A is due to operational excellence initiatives taken to reduce our cost structure, along with adjusting variable compensation cost to align with the company’s performance. R&D costs for the quarter were $32 million, which was a $5 million or a 19% increase from prior year. This was in support of Global Ecommerce and the launch of new SMB products. During the quarter, we recorded a pre-tax restructuring and asset impairment charge of $14 million, primarily related to actions associated with our previously announced plans to reduce costs. Additionally as noted, the company recorded a pre-tax non-cash goodwill impairment estimated charge of $169 million during the quarter related to the software business. Net interest expense, which includes financing interest was $40 million, which was relatively flat to the prior year. The effective tax rate on adjusted earnings for the quarter was 31.9%, which was about 20 basis points lower than the prior year. I would now like to discuss the fourth quarter results for each of our business segments. This information could also be found in our earnings press release and the slides that we post to the pb.com website under the Investor Relations section. North American Mailing revenue was $341 million and EBIT was $138 million. Overall, the revenue decline reflects lower recurring stream revenue. Included in reported results, equipment sales were down 7% while support services increased 4%. This result reflects a re-class of service revenue out of equipment sales of approximately $2.6 million. There was no impact to total revenue in the quarter. Excluding this re-class, equipment sales were down low single-digits, while support services were essentially flat in the quarter. Total recurring revenue streams, which include supplies, rentals, financing and services, declined from prior year, largely driven by lower financing and supplies revenue. EBIT margin was 40.6%, which was about 470 basis points lower than prior year. EBIT and EBIT margin for the segment were largely impacted by the decline in the high margin revenue streams, equipment sales mix and higher R&D costs related to the launch of our new products. In addition, we increased our bad debt provision in line with our policy as a result of some delay in payments from our clients associated with our business enterprise platform cutover. In International Mailing, revenue was $101 million and EBIT was $12 million. Excluding the FX from currency and market exits, revenue declined at a mid-single-digit rate. Overall, equipment sales declined from prior year as strong equipment sales growth in France was more than offset by weakness in the UK and Italy. Italy’s year-to-year weakness was a result of a large government transaction in the prior year. The decline in recurring revenue streams was consistent with the prior quarter. EBIT margin was 12.1%, which was a decline from prior year of about 60 basis points largely due to the decline in higher margin revenue streams partially offset by lower expenses. Turning to Enterprise Business Solutions, in Production Mail, revenue was $115 million and EBIT was $19 million. Equipment sales grew 1% over prior year on higher inserter equipment placements. Support services revenue declined as a result of the shift from in-house mail production to third-party service bureaus who tend to self serve as well as reduced service revenue associated with market exits. EBIT margin was 16.2%, which was an improvement of about 250 basis points from prior year due to higher equipment sales margin and lower expenses. In Presort Services, revenue was $118 million and EBIT was $26 million. The revenue decline was driven by lower first class volumes along with lower average revenue per piece with mail processed largely as a result of the earlier USPS rate change. This was somewhat offset by an increase in standard class mail volumes processed. EBIT margin was 21.9%, which was a decline of about 80 basis points versus prior year primarily due to the revenue decline. For the Digital Commerce Solutions Group, in Software Solutions, revenue was $91 million and EBIT was $12 million. As noted earlier, the revenue decline was driven by several anticipated large deals that did not get completed in the last few weeks of the quarter. Customer engagement and location intelligence license revenues declined but were partially offset by growth in customer information management licenses. The company continues to invest in expanding the indirect channel and training partner sales and technical resources to build future partner led pipeline and revenue. We added three new regional systems integrators during the quarter. As I mentioned earlier, we have made changes to the sales organization structure to improve the direct sales force effectiveness. EBIT margin was 13.5%, which was an improvement of about 30 basis points versus prior year, mostly due to lower expenses. In Global Ecommerce, revenue was $121 million and EBIT was $10 million. Excluding the impact of currency, e-commerce marketplace and retail revenue grew 18% from prior year. This was driven by strong growth in UK outbound marketplace and retail volumes. Results reflect the impact of both a stronger U.S. dollar and a weaker British pound sterling. Office shipping revenue declined from prior year due to lower licensing and professional services revenue which impacted the overall revenue growth rate for the Global Ecommerce segment this quarter. EBIT margin was 8.6%, which was an improvement of about 30 basis points versus prior year due to cross-border synergy savings and revenue growth. This was partially offset by a decline in higher margin office shipping and higher R&D cost to support e-commerce expansion. The Global Ecommerce segment had a 15% EBITDA margin this quarter. This reflects the continuing profit and cash improvements post the Borderfree acquisition. That concludes my comments on our financial performance for the quarter and year. Now, I would like to discuss our 2017 guidance. Based on our 2016 results, including the final fourth quarter outcome, the company is updating its 2017 annual guidance, principally to reflect a more conservative outlook for the software business. We still expect 2017 revenue, excluding the impact of currency, to be in the range of a 2% decline to 1% growth from 2016 levels. The company now expects 2017 earnings per share to be in the range of $1.70 to $1.85. Accordingly, we now expect 2017 free cash flow to be in the range of $400 million to $460 million. The lower free cash flow range reflects the adjustment to earnings guidance as we expect free cash flow to be predominantly earnings driven. There are several key factors to take into consideration within our business that will impact our 2017 results. The company expects 2017 to benefit from improving trends throughout the year from SMBs new products and digital capabilities; software’s expansion of its indirect channel and improvement in the direct channel; Global Ecommerce to continue to add new clients and volume through the retail and marketplace networks, which will contribute to revenue growth and benefit earnings as the business continues to scale; Presort Services network expansion as well as the January 2017 USPS rate change and ongoing improvement in cost savings initiatives driven by the expected benefits from the company’s operational excellence initiatives. Additionally, the company expects 2017 earnings to be impacted by incremental marketing expense related to enhancing the company’s digital capabilities and the normalization of variable compensation to align with company’s performance. We also expect the annual tax rate on adjusted earnings to be in the range of 31% to 35%, which similar to 2016 and 2015, is expected to be highest in the first quarter. From a capital allocation perspective, maintaining investment grade ratios remains priority. We plan to continue to provide a competitive dividend yield and also continue investing organically in order to grow the business. Operator, that concludes my remarks. Please open the line for questions.

Thank you. [Operator Instructions] The first question comes from the line of Kartik Mehta with Northcoast Research. Please proceed with your question.

Hey, good morning Marc and Mike. Marc, I wanted to ask you a little bit about the software business. I know you thought that, that business was going to turn around for a number of quarters and it struggled. And you talked about a sales reorganization. Is this – I guess, where are you in terms of sales reorganization? Is this a second or third try at how you are aligning the sales force or is this really the first time you are truly realigning the sales force to get to where you want to?

Yes, thanks for the question. So, to be clear, what we did is we removed a layer of executives as well as flattened our Asia organization. So, it does not affect and therefore should not be disruptive to our sales efforts of people working with clients. But I will allow Bob in particular to have his hands directly on the sales force. So we think, first, removing the layer as well as having Bob directly over the sales organization will help. It will not, in that sense, create the kind of disruptions that we have had with our software sales reorganizations in the past.

And Marc, just – just had your Analyst Day, you seemed pretty confident how the business was trending. Is this change to guidance for 2017 strictly related to the software business or are you seeing any other businesses having some issues that you weren’t anticipating?

From my perspective, the change in guidance is principally around software. And as we got together, December 6, for Analyst Day, the transactions that Mike referenced we thought were in reasonable shape. Over the next couple of weeks, that changed. So based on where we finished, which was basically because of software as well as our closed rates in our software business, we thought the prudent move was to adjust our guidance, but it is really around our software performance.

And just one last question, Marc, I apologize for continuing on the software. But on the software side, do you think it’s a product issue at all? I know you struggled with this for a number of quarters. Could it be a product issue that maybe the products that you have aren’t competing?

If you look at the transactions that were deferred and we have obviously looked at them some level of depth. None of those were because of competitive losses. There were all simply deferrals. That’s one fact that I think is important and informs my point of view. The second is if you look at the transactions that we are working on, that we didn’t get, there were large transactions with sophisticated clients. And as I said in my remarks, these are transactions that we think we have good line of sight out for this year. So I continue to take confidence in the fact that sophisticated clients are buying these products. And moreover, sophisticated systems integrators are making investments in their people to include these products in their solutions. So for those reasons, I continue to believe that this was principally a channel problem. And I would just – I mean not that we over rotate on this, but I mean yesterday, Gartner again, pointed out that we are in the magic quadrant for our CS products. So in anyway, I triangulate on this and obviously we have – moments like this, you go back and you look at every one of the assumptions you made in the business and that’s appropriate. But I just don’t see the evidence for a product, actually I see the evidence more strongly on a channel issue.

Alright. Well, thanks Marc. I appreciate it.

The next question is from the line of George Tong with Piper Jaffray. Please proceed with your question.

Hi, thanks. Good morning. You are updating guidance primarily to reflect a more conservative view on software can you elaborate on what’s changed in the software business that caused you to be more conservative in your expectations?

Sure. Our close rates, in particular their direct sales force have not been where we thought they would be. So we continue to think they are going to improve and they haven’t. So we simply looked at our pipeline for 2017, applied different close rates for our direct sales force, factored in what we thought the influence of channel would add. And that’s kind of how we got what we got.

Got it, that’s helpful. And you lowered 2017 EPS guidance by $0.10, but left revenue guidance unchanged, assuming margin expansion and no real changes in the tax rate, the $0.10 of EPS reduction corresponds to about $160 million in lower revenue, can you discuss whether the updated guidance reflects only reduced revenue assumptions in software or if you also have more conservative views about margins?

Yes. I think George, if you look at the way we give revenue guidance, it’s obviously as a percentage as opposed to earnings per share, we give an absolute. So I think if you apply those same percentages to the changed revenue base in 2016, it’s a rather modest change in revenue. So we did in effect, change the revenue guidance, but kept the percentage change the same just off the lower base.

Got it.

I would just note in terms of our overall evaluation of guidance is obviously, we saw strengthening dollar at the end of the year. And we quite frankly have a more uncertain business environment. So as we looked across and looked at the opportunities, as Marc said of fun to add some conservatism to our guidance, certainly software was the dominant factor in that, but we consider other factors as well.

Yes, it makes sense. Within North America Mailing, you called out some weakness in equipment sales, is there a residual impact in North America from the earlier ERP cutover or do you view 6% revenue decline as the new norm?

No. I would not necessarily associate it with the cutover in the system. There may be some drag on the recurring revenue streams as a result of the lower equipment sales we had earlier in the year. But in terms of overall equipment sales going forward, I would say we were a little less than what we would expect in the fourth quarter. In some ways, there is a positive reason for that, which is we have launched some new products. We probably were more conservative in how broadly we exposed those new products to get some early learnings from them. We expect to open those products to a bigger set of our clients as we get into the first quarter of 2017. So clearly, we think there is opportunities for improvement on equipment sales. And yes indeed, business which ultimately leads to the stream revenues.

Yes. Let me just to be clear, we don’t consider that new norm.

Got it. And then last for me, within E-commerce, marketplace and retail showed strong double-digit growth, but this was partially offset by declines in office shipping, can you discuss trends in office shipping and it’s been potential for office shipping to reflect a positive growth?

Yes. In terms of office shipping, I would say, we have different sets of products there in terms of our outbound product, we saw less license sales in that product. We have seen good performance in our inbound product. We are making some changes to focus on those products as we go forward. We have launched some new shipping functionality in our SMB business. So we think that we will have the opportunity for improved performance as we go forward, but did have a weak finish to 2016.

Pretty helpful. Thank you.

Thank you.

The next question is from the line of Shannon Cross with Cross Research. Please proceed with your question.

Thank you very much for taking my question. Can you just remind us with the software business, how integrated it is in the other parts of your business, I would think with the connect platform that there was a lot of the software that had been integrated in there, but I am just trying to figure out – is this something you need to shed parts of, you need to fund partners, I don’t know, I know I am sure you have been looking at all of these things, but maybe if you can just talk a little bit about how much its standalone versus within everything else?

Sure. The sales organization is fairly discrete. I would say the product aspects of software you find different instantiations of in different businesses. And the development organizations are fairly intertwined. So it’s kind of, as a gradation depending on which aspect of the organization that you are looking at. As I indicated, we monetize the software assets not just from the software business, but also in our enterprise and SMB and Ecommerce business as well.

Great. Thank you. And then with regard to North American Mailing, can you talk a bit about the – I guess, what you have heard from customers following the elections, if there has been any change in tone and one of the things I remember, I think Mike, you talked to me about a while ago was that Pitney Bowes is positively exposed to small business creation, so if that picks up and things get better, so I am just curious as to how we should think about that, if you think that’s changed given more movement online or is that still something that theoretically could be a positive this year, assuming…?

I think it remains relevant to our business in particular as we bring more SaaS based applications, more shipping applications, we just launched an integrated mailing and shipping online functionality. So new business that come online will tend to be shippers if not mailers. And so we are adjusting our product set to make sure that we have opportunities to capture that new business growth.

Okay, great. And then from a pre-source standpoint, is there – how are you thinking about trying to drive revenue growth there and that’s been a pretty solid business over time, so I am curious are there some new geographies you could go to or new cities or what are your thoughts within that business?

I would say two things about pre-source. The first is the 2016 results were negatively impacted by the rate case at the beginning of the year. Conversely in 2017, there is a different rate case that took effect, I believe at the end of January, January 22. So while we had headwinds in that business in 2016, we are downwind in 2017 from an economic perspective, so that will help drive volume into the system. And then secondly, we continue to work for small tuck-in acquisitions to help grow that business and to take advantage of the fixed costs that we haven’t put more volume in the network. And finally, I expect that the system grow organically on its own. So 2016 was a different kind of year in pre-source than what we had expected, but what we had experienced in the past. But fundamentally, that business is strong and I think it will be back on the kind of growth rate that we had seen historically in 2017.

Got it. And that’s my segue to my usual question just on cash usage and how you are thinking about it given the cash generation target you put out this year and then what you spent money on last year?

Well, I would say I agree with what we said at Investor Day in terms of we are trying to create strategic flexibility and along with that, maintain investment grade ratios. So we will continue to invest what we need in the business. I would underline the fact that last year, while we were challenged at top line, we continue to invest in new products, invest in advertising, invest in systems. So we continue to make the kind of investments that while they are difficult to absorb in the short-term, we do everything that you want to create long-term value.

Thank you.

And the next question comes from the line of Allen Klee with Sidoti. Please go ahead with your question.

Hi. Good morning. In the SMB segment, I am just trying to understand how you think about, how you can do there relative to your expectation that this is a market that declines 2% to 4%, can you kind of help bridge to, if you still think you can be in that type of range or are there some other factors working there now?

Sure. If you take a look at 2016 and you were to back out what we identified in the second quarter and third quarter as specific impacts related to the go live of our business platform, we were down about 4.8% on the full year. So near the bottom edge of that 2% to 4% range that we say is the market. Obviously, with the introduction of a number of new products with more experience on the platform, one of the things we mentioned about investments in 2017 is in digital capabilities. That’s really around significantly expanding our digital presence, our digital store capability, our self-serve capability and our supply sales capability online. So it’s a combination of the products, the maturing of the investments we have made and the go to market opportunities enhanced with the digital channel.

And then in pre-source, can you just remind me of the January rate case, how that affects the business positively?

Sure. In the 2017 rate case, one of the factors is providing high density mail prepared in a way that postal service can induct that more effectively into their network. That’s the whole concept about work share. And looking at our ability relative to the marketplace, we help customers qualify that mail and meet those high standards of density. We sit very uniquely positioned given the scale of our network. And so we believe we can help clients qualify more of their mail, and therefore drive more volume through our network.

Okay. Thank you so much.

Thank you.

The next question is from the line of Glenn Mattson with Ladenburg Thalmann. Please go ahead with your question.

Yes. Good morning. On the software business, you talk about close rates a lot, what about pipeline, can you characterize if it’s growing or stable or shrinking?

Pipeline was healthy. As we enter the quarter, we are – our judgment based on historical close rates enough, more than enough pipe to get done what we needed to do. And then kind of when we worked with the large transactions, which to a degree, we factor out of the numbers because they can skew and we had a positive view of that. So pipe was healthy. It was healthy in the second half of last year. I would say that was a little bit of a departure from the first half. So pipeline was improved. And as we enter into 2017, we continue to be optimistic about our pipe. So back to the earlier question about is this is a product problem we see in the pipe, evidence of demand for our products.

And I will this question because I will probably get it later today, the large deals that slipped in 4Q ‘15, are those related to these or are did those closed this year, I know you don’t want to talk about deal to deal basis, but generally, the characterization of those deals that slipped last year?

Yes. Those were different deals. I mean that’s kind of why we made some of the changes in the sales executive team as – that we did. I mean when you have a problem twice – when you have a problem once you kind of look like it, when you have it twice, you make changes. And I hold the senior executives responsible for getting those deals done.

And given the nature of some of these deals and the complexity of them, we would expect that they will, to the extent that we capture those deals in 2017, they will come in over the course of the year. Some of them in the first quarter, but they could extend in the second quarter or third quarter depending upon the specific circumstances of those clients.

Okay. And then on the smart meters, you are couple of months now into selling those, what’s the experience of any uptake or are our clients happy to convert over, is it a new sense for them or what’s been your experience so far?

Yes. With the SmartLink product and that’s the ability to connect our traditional analog meters to the web through this digital connection. We have had very good experience. In fact, what we have seen in taking a sample of those customers who have been connected are actually generating more volume. And that’s because we are giving them insight and analytics back and tips on how to use it more effectively – how to use the meter more effectively. So it’s certainly early days of experience with it, but we are also seeing the clients’ ability to connect quite good, in fact we have been pleasantly surprised that a high proportion of the customers are connecting via WiFi versus a plug-in type of connection. So that’s giving us assurance that it’s relatively straightforward and simple process for people to connect their device.

Okay, great. And lastly on the free cash flow, what is the impact of finance receivables, how does that relate to the free cash flow guidance for ‘17?

Yes. So with respect to free cash flow guidance and finance receivables, one of the reasons why the midpoint is essentially flat to this year’s free cash flow while we have earnings growth is the fact that we would expect less runoff of the finance receivables in 2017 than 2016, that’s linked obviously to our expectation of improved equipment sales performance in the SMB business.

Okay, great. Thanks.

Thank you.

And the next question is from the line of Hunter Martin with BNP. Please proceed with your question.

Hi. One question, that was just a follow-up on the last question, just to clarify, so these three large software deals that didn’t close at the end of 2016, they haven’t closed yet, but you expect they will close kind of spread across Q1 to Q3, was that correct based on the comments on the last question?

That’s correct.

Okay. And then other question…

Just had one additional piece of color and I said it in my prepared remarks. Those three deals were places where we have done business before. So these were not customers or clients that we are unfamiliar with. We knew the buyers to a degree it’s incremental software into the existing deployments, that’s a different kind of sale and one that while we were obviously not able to predict the timing whether you would have more confidence to execute.

Okay, that was very helpful. And then just on potential for a corporate tax reform in the U.S. like I seem to recall at the Investor Day kind of just mentioned the high tax rates this year, 31%, I think to 35%, so I know there is no clarity at, but just any I guess incremental thoughts on I guess the possibility of tax reform and the impacts on your business could be helpful?

Well, your crystal ball was good as mine in terms of that. I mean we are helpful that tax reform along with regulation relief and in particular, the ability to repatriate money, which we have got close to $500 million overseas, is all part of the economic reform that gets done. So obviously, with the tax rate in the 30s and they are talking about is incrementally helpful.

And given our share of income generated in the U.S., obviously changes in the U.S. corporate tax rate would have an impact for us.

Alright. Thanks a lot.

Thank you.

There are no further questions. Mr. Lautenbach, do you have some additional remarks?

I do and thank you. As I said at the outset of my prepared remarks, we were disappointed in our fourth quarter performance and our 2016 results. That said, there to get a few transactions done isn’t a broad based failure. For a company our size, there is thousands of things that need to go right. Unfortunately, in the fourth quarter, we had a few very significant things, not materialized. I would like to spend a minute putting this journey in perspective. In 2013 and 2014, in many ways, we turned around the business, cutting expenses, reducing inventory, improving sales execution. And the results reflected those initiatives. You can see it in the revenue growth in 2014 and you can see it in the stock price. At the same time, we are beginning an important work to transform the business. And when I say transform the business, I mean to fundamentally change what this company is. We moved to new channels, built our brand, improved our products and built new systems. These are the right things to do in order to create long-term value. But they certainly didn’t help our short-term results. In many ways, they are disruptive. These were however, the absolute right things to do in order to build long-term value for our company. I am not happy about the disruptions these initiatives caused and I am sure there were things we could have done better to navigate our way through the transition. For sure, there are things I would like to do over on, but there is no doubt in my mind that to build sustainable long-term value, you absolutely have to be willing to take the short-term hits to build long-term value. And we have done the hard work as we move into 2017 and we are poised to take advantage of that hard work. That’s not to say that things will improve all at once. That’s not the way transformations work. They are never a straight line. However, from where I sit, the evidence is clear that our work is beginning to payoff. You see it in our new products, you see it in new systems, you see it in the new channels. Finally, I would be remised if I did not mention that this is Mike’s last earning call as Chief Financial Officer. Mike will continue to be an integral part of our transformation as Chief Operating Officer and we will invite him back to every once in a while to make guest appearances on this call. I am sure you won’t want to miss that. Stan will take over effective today and we are all glad to have him on board. But Stan has got big shoes to fill and he knows it. I want to thank Mike for nearly 40 quarters as our CFO. And I look forward to working with both Mike and Stan to help transform our company. That concludes our call. Thank you very much.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T. You may now disconnect.