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Diebold, Inc. (NYSE:DBD)

Q3 2008 Earnings Call

October 30, 2008 10:00 am

Executives

John D. Kristoff - Vice President, Chief Communications Officer

Thomas W. Swidarski - President and Chief Executive Officer

Kevin J. Krakora - Executive Vice President and Chief Financial Officer

Analysts

Zahid Siddique - Gabelli & Company, Inc.

Matt Summerville - KeyBanc Capital Markets

Kartik Mehta - FTN Midwest Securities Corp.

Reik Read - Robert W. Baird & Co.

Gil Luria - Wedbush Morgan Securities

Operator

Good day everyone and welcome to Diebold Incorporated's third quarter financial results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President and Chief Communications Officer, Mr. John Kristoff. Please go ahead, sir.

John Kristoff

Thank you, Alan. Good morning everyone and thank you for joining us for Diebold's third quarter conference call. Joining me today are Tom Swidarski, President and Chief Executive Officer and Kevin Krakora, Executive Vice President and Chief and Financial Officer.

Just a few notes before we begin. A replay of this conference call will be available later today from our web site and as a reminder, some of the comments today may be considered forward-looking statements. Internal and/or external factors could significantly impact results and as a precaution we refer you to the more detailed risk factors that have been previously filed with the SEC.

And now, let's jump to opening comments from Tom Swidarski.

Tom Swidarski

Thank you, John. Good morning, everyone. We're very pleased to be back on a regular reporting schedule and to be here with you today. But before we get into our quarterly results, I'd like to take a moment to reiterate that our strategy to transform Diebold to a services company is progressing well.

I recognize that a wide range of our skills, experience, expertise and resources is one of our greatest assets and a competitive advantage. Our global organization is focused on leveraging this advantage.

I'm extremely proud of the progress we're making in a very difficult operating environment. To illustrate, let me highlight a few recent examples that demonstrate how we're leveraging our core competencies in the marketplace.

First, during the quarter, the United States Postal Service chose Diebold to implement their nationwide security program. The Postal Service is capitalizing on Diebold's national presence, IT and security expertise to implement a multi-site, technologically-advanced video security program. With more than 40,00 sites across the country, the Postal Service has selected Diebold to manage this nationwide implementation.

Diebold is one of only a few security integrators with the service infrastructure and the technological expertise to undertake such an extensive product and deliver an integrated IP video security solution. This contract begins the revenue in 2009.

In another example, for the second year in a row, Diebold was ranked one of the world's top 100 outsourcing service providers by the International Association of Outsourcing Professionals. The fact that Diebold is an honoree of this prestigious award for two consecutive years speaks volumes about the growing success of our integrated services business.

Integrated services and outsourcing are built upon the backbone of our service infrastructure. This recurring revenue stream, when combined with our traditional recurring maintenance contract, represents more than half of our total revenue.

Finally, earlier this year, Diebold was chosen by the Bank of China to be the exclusive ATM provider for the Beijing Olympics. This is indicative of the reputation we have build in China since we first entered the country with a joint venture back in 1993.

These examples are gratifying for me as they demonstrate the market understands the value of our core competencies in various industries and geographies around the world.

Now, turning to our quarterly results, I'm extremely pleased with a very strong quarter we delivered both from a revenue and earnings perceptive. Several factors contributed to the outstanding performance we had during the quarter. First, we continued to make significant progress on our strategic cost reduction in profit and proven initiatives.

Second, we are seeing strong demand for our deposit automation solutions globally. Third, our services business continues to gain momentum in the market as evidenced by our outsourcing contract base which will nearly double by year end. And finally, the quarter benefited from the Brazilian election business and revenue from a large order in China that occurred earlier than anticipated.

We continue to execute our business plan very effectively. This is a testament to our global associates' focus on customers while improving efficiency and reducing cost throughout our operations worldwide. Their diligence and dedication during the challenges of the past year have been commendable.

As a result of this strong performance, we are again raising our full year earnings guidance. While this guidance reflects an exceptional year, it does result in fourth quarter earnings expectations that are lower than we historically realized. As we have communicated in prior quarters, our typical earning seasonality has been significantly impacted by purchases in China coming early in the year of 2008, rather than being concentrated in the fourth quarter. We anticipate our more historical earnings seasonality returning in 2009.

Parallel to the progress we've made on our operational initiatives, we have clearly witnessed unprecedented change in the financial services industry in recent weeks, both in the United States and internationally. For example, on September 7th, the government seized control of Fannie Mae and Freddie Mac.

A week later, Bank of America acquired Merrill Lynch. And on September 26th, the government seized Washington Mutual. At the same time. J.P. Morgan Chase acquired Washington Mutual's branch network.

In early October, Wachovia agreed to sell itself to Wells Fargo. In Europe, Fortis and Dexia were bailed out by several European governments. And on October 24th, PNC agreed to acquired National Citibank. In the United States, the federal government's Troubled Asset Recovery Program is reshaping the financial landscape almost daily.

Never in history have we seen such dramatic change within our customer base in such a short period of time. While we cannot yet predict the impact this change will have on the industry moving forward, we continued to see strong revenue and order growth in the third quarter.

Revenue growth grew more than 20% from the third quarter 2007 to the third quarter 2008, while financial self service orders upped double digits in each of the key geographies. We also remain well positioned for the long term. Our products and service offerings including integrated services in deposit automation provide financial institutions the ability to reduce cost and streamline processes while acquiring depositors.

We are on very solid footing as the financial services industry continues to consolidate in the United States. Of the top five U.S. bank ATM deployers representing approximately 65,000 ATMs, Diebold has more than 50% share of their installed base. But even with the importance of these top deployers, they still make up less than 25% of the total ATM installed base in the United States, which is approximately 250,000.

Thus, this provides us with continued opportunity with the remaining tier-two financial institutions, regional banks and credit unions where Diebold performs exceedingly well. Again, this is due to our strong services capability.

Looking at our financial self service business, demand remains strong with revenue growing 18.3% in the quarter. As I mentioned earlier, deposit automation represents a key ingredient in our recipe for global growth.

As we have demonstrated, we are the global leader in providing comprehensive deposit automation products and services, from cash and check acceptance modules at the ATM to teller automation in the branch, to check image processing services provided to our subsidiary, Aris.

Our deposit automation deployment has grown approximately 55% during the first nine months of this year. This growth is a result of strong relationships with a number of banks leading the effort in deposit automation such as Bank of America, Wells Fargo, J.P. Morgan Chase, and mid-sized institutions like Commerce Bank and Sun Coast Federal Credit Union.

Additionally, we have experienced strong growth internationally particularly in China where cash recycling is increasingly in demand; Russia, with currency exchange applications; and Latin America as well.

Our ability to deliver unique hardware, software and services that meet our customers; full deposit automation needs has been one of our top priorities for several years. We will be demonstrating some of our latest development efforts in deposit automation at the upcoming BAI Retail Delivery Conference in mid-November.

Our integrated services business continues to gain traction in the marketplace as our customers look to reduce capital expenditures and gain greater efficiency across their operations. Diebold remains uniquely positioned to provide the infrastructure necessary to manage all aspects of an ATM network: hardware, software, maintenance, transaction processing, cash management, et cetera.

Given the current environment, an uncertainty many in the financial industry are facing, the business case for these services has become even more compelling and we continue to place a strategic emphasis on growing the services component of our business.

In addition, we remain in strong competitive position and key growth regions around the world. In China, we are a market leader in integrating cash recycling technology which represents a significant growth opportunity moving forward.

We have achieved this leadership position despite intense competition from Japanese technology leaders such as Hitachi and Oki, and emerging Chinese competitors such as GRG. We also enjoy a solid competitive position in other emerging growth markets within the Asia-Pacific regions such as Thailand, India, Indonesia and Vietnam.

Looking to EMEA, while overall revenue was down during the quarter, we continue to make significant strides in our profitability within that region. This profitability improvement is a result of prior restructuring in our service operations as well as changing our distribution model in unprofitable operations such as Germany.

In the emerging growth markets in Eastern Europe and Russia, we're in a much stronger competitive position and continue to see solid revenue growth. Despite the progress we've made from a profitability standpoint in EMEA, much work remains to improve our market position in Western Europe where our global competitors control the majority of that market.

In Brazil, we saw significant growth during the quarter as we began seeing revenue from previously announced large orders from Kasha and Banco de Brazil. In Latin America, we saw particularly strong growth during the quarter which was partially driven by new opportunities in Central America.

In North America, we experienced modest growth during the quarter which was driven by the larger financial institutions as they continue to roll out deposit automation technology.

Security revenue during the quarter was down 6.4%. As you know, our security business currently remains U.S.-centric with high exposure to banking. Top line growth was adversely affected by reduced construction of new bank branches.

However, we have a host of innovated security solutions that we will be unveiling at the Retail Delivery Conference next month. And as I mentioned earlier, revenue from a major security contract with the United States Postal Service will begin to be realized in 2009.

So I remain optimistic regarding future growth within this sector. Our cost reduction initiatives and multi-year profit improvement plan have proceeded exceedingly well. Our initial three year $100 million cost reduction plan remains on target. Also, we are progressing on a number of cost reduction opportunities to support our previously announced goal of taking an additional $100 million of cost out of our business, with $70 million of that amount planned by mid year 2010.

Our manufacturing optimization efforts remain on track as well as we have completed the transfer of equipment from the Newark facility into our Lexington, North Carolina plant and have moved non-U.S. centric Optiva production to our facilities in China and Hungary. Closure of the Newark facility remains on schedule to be completed during the first quarter of 2009.

Our product rationalization initiatives are also progressing as we have started manufacturing Optiva units in China and Hungary for transfer to final U.S. distribution sites. We have completed the consolidation of our U.S. product staging and installation footprint as we have eliminated 89 warehouses and are now utilizing the three major distribution centers in Greensboro, North Carolina, Columbus, Ohio, and Phoenix, Arizona.

The success of our cost reduction efforts combined with strong 2008 revenue growth positions us to exceed our operating margin target for 2008. As we continue to successfully execute on our strategic initiative, I have increased confidence in our ability to continue to improve the company's profitability.

In conclusion, I'm proud of the progress we made in the quarter in the midst of a very challenging environment. As we look ahead, while the financial services industry is currently operating in a constant state of change, we remain confident in our ability to continue to execute on our cost reduction initiatives, deliver solutions that help improve our customers' businesses, and create shareholder value.

Now, I'll turn the call over to Kevin.

Kevin Krakora

Thanks Tom and good morning, everyone. Since our last call on August 11, we were successful in bringing all our financial filings current on September 30th. As a result, we now have resumed our normal financial reporting schedule. Let's now turn to a review of our financial results.

In a word, we had an exceptional third quarter, which outpaced our already strong first and second quarters. The third quarter financial results reflected strong order and revenue growth, improved gross profit and operating profit margins, dramatic earnings in EPS improvement, as well as solid improvement in cash flow.

Third quarter orders on a constant currency basis for the financial self service increased over 20% with double digit growth in each of our geographic regions. Security orders, however, decreased in the low double digit range as a result of continued weakness in the U.S. in the areas of new bank branch construction and retail store openings.

Turning to revenues, total third quarter revenue grew by slightly more than 20% with approximately three percentage points of this increase attributable to net positive currency impact.

To help frame up this increase in total revenues, I'll first focus on our largest revenue source, financial self service, which traditionally represents in excess of 70% of our total revenues.

In Q3 2008, financial self service revenues increased by approximately $95 million, or slightly over 18%, compared with Q3 2007 with strong growth in both the product and services revenue lines. In addition, our third quarter 2008 financial self service revenues benefited from a large order in China in which revenue was expected to be recognized during the fourth quarter but occurred during the third quarter due to customer acceptance occurring sooner than expected.

As we have pointed out in our previous earnings calls, financial self service spend in China in 2008 has shifted from the normal heavy fourth quarter spend to heavier spend in Q1 through Q3. As a result, while we expect very low Q4 spend in China, our overall financial self service revenue growth in China for the full year 2008 will be very strong, up slightly more than 20%.

Our second largest revenue source is security, which traditionally represents nearly 25% of our total revenues. Total security revenue dropped approximately $14 million or slightly more than 6% for Q3 compared to Q3 2007. As was the case with security orders, this drop is a result of weakness in both new bank construction and retail store openings.

It's important to note however that our earlier announced significant win of a new multi-year service contract with the United States Postal Service should help bolster future revenue opportunities for our security group.

The remaining revenue increase was primarily a result of fulfilling a large Brazilian based voting order, earning next to total gross margins. Third quarter 2008 gross margins improved dramatically moving from 23.9% in Q3 2007 to 26.2% in Q3 2008. Included in total gross margins were restructuring charges of $10.7 million in the third quarter of 2008 and $1 million in the third quarter 2007.

The third quarter 2008 product gross margins improved by 140 basis points moving from 26.5% in Q3 of 2007 to 27.69% in Q3 2008. Product gross margins included restructuring charges of $8.4 million in Q3 '08 and $800,000 in Q3 2007.

Excluding the impact of restructuring charges from both periods, product gross margins would have improved 290 basis points moving from 26.8% in Q3 of 2007 to 29.7% in Q3 2008. This dramatic improvement in product gross margins was positively affected by the Q3 2008 Brazilian voting business which accounted for slightly more than 60% of the 290 basis points improvement.

The remaining improvement in product gross margins was a result of continued progress and our cost reduction efforts in a higher mix of revenue from China. These positive impacts were partially offset by increased commodity costs, less favorable security product revenue mix and lower overall volume in the security business.

I'm especially pleased with the continued improvement being made with our service gross margins. Service gross margins have continued to improve sequentially and year over year. During the quarter, service gross margins improved by 300 basis points. Service gross margins included restructuring charges of $2.3 million in Q3 2008 and $200,000 in Q3 2007.

Excluding these restructuring charges from both periods, service gross margins would have improved by 340 basis points. These improvements are particularly important given the strong recurring nature of service revenues. In addition, these improvements were experienced in nearly all geographic regions. They are a result of better product quality that benefits from continued investment and training and continued gains in productivity and efficiency.

Moving now to operating expenses, the Q3 2008 operating expense as a percent of revenue were 18.9% compared with 18.4% in the comparable period of 2007. Q3 2008 operating expenses included restructuring charges of $3.8 million and non-routine expenses of $24.7 million, while Q3 2007 included $200,000 in restructuring charges and non-routine expenses of $3.3 million.

These non-routine expenses primarily consisted of legal, audit and consultative fees related to the completion of the internal review of other accounting items, restatement of financial statements, the ongoing government investigations and other advisory fees.

Excluding restructure and non-routine expenses from both periods, operating expense as a percent of revenue would have been 15.7% in Q3 2008 compared with 17.9% in Q3 2007. This significant improvement was a result of ongoing cost reduction efforts as well as benefits from the significant quarter over quarter revenue growth.

As a result of improved profit margins, operating profit margins also improved. Operating profit margins increased from 5.5% in Q3 2007 to 7.4% in Q3 2008. Again excluding restructuring and non-routine expenses from both periods, operating profit margins would have improved from 6.1% in Q3 2007 to 11.8% in Q3 2008.

Net income in Q3 2008 was $46.5 million compared with $28.1 million in Q3 of 2007, an improvement of over 65%. Earnings per share on a fully diluted basis were $0.70 in Q3 2008 compared with $0.42 in Q3 2007.

Excluding restructuring and non-routine expenses from both periods, earnings per share would have been $1.16 in Q3 of 2008 compared with $0.47 in Q3 2007. Again, performance in Q3 2008 benefited from the profitable Brazilian voting business and the higher China revenue quarter-over-quarter.

Aside from these two unique items, we still recognize significant quarter-over-quarter financial improvement as a result of revenue growth, cost savings from ongoing restructuring actions and continued success with our smart business 100/200 cost reduction program.

Turning next to cash flow, year-to-date net cash provided by operating activities improved by 24 million moving from 37.8 million in the nine months ended September 2007 to 61.8 million in the nine months ended September 2008. Year-to-date 2008 free cash flow improved by nearly $26 million moving from 3.5 million in nine months ended September 2007 to 29.2 million in the nine months ended September 2008.

The improvement in year-to-date 2008 net cash from operating activities and free cash flow was driven by very strong improvements realized in the third quarter of 2008. The third quarter of 2008 net cash from operating activities improved by nearly $81 million compared with the third quarter of 2007. Likewise, free cash flow improved by slightly more than 78 million in the third quarter of 2008 compared with the third quarter of 2007.

Looking at working capital metrics, days sales outstanding was 52 days at September 30, 2008 compared with 61 days at September 30, 2007, a nine-day improvement. Inventory turns improved from 3.7 turns at September 30, 2007, to 4.2 turns at September 30, 2008.

Net debt decreased by nearly $12 million from Q3 2007 to Q3 2008. This decrease was realized despite significant restructuring in non-routine expense payments. Our Q3 2008 net debt to capital ratio was 25.3% compared with 26.5% in Q3 of 2007.

Turning to our full year outlook for 2008, as Tom already covered in his opening remarks, the general economy and more specifically the financial service industry has witnessed unprecedented pressure in change particularly over the last two months. The large number of consolidations have already been announced in our strategic banking space and it is reasonable to expect that more consolidation will occur.

We have also seen in the last two months dramatic shifts in the exchange rate of the U.S. dollar to other foreign currencies. As a result of this unparalleled change, forecasting a quarter out or even longer has become more difficult.

Despite these challenges, and given our strong backlog in order growth, we have maintained our total revenue and financial self service growth expectations at 8 to 10% and 9 to 10% respectively. We have reduced our security growth expectations from 1 to 3% to essentially flat based on continued weakness in United States in the bank branch construction and retail store opening space.

Finally, we have slightly raised Election Systems revenue guidance. We now expect our full year 2008 GAAP EPS to be in the range of $1.42 to $1.45. Restructuring charges are expected to be between $0.50 and $0.56 and non-routine expenses are expected to be between $0.53 and $0.55.

Finally, we also incurred a $0.05 impairment charge in the first quarter of 2008. Excluding these items non-GAAP EPS was expected to be in the range of $2.53 to $2.58, a $0.13 increase from our previous guidance.

As you can see, given our current EPS outlook of $2.53 to $2.58, fourth non-GAAP EPS is expected to be in the range of $0.30 to $0.35. Important note included in this earnings range is the potential inventory evaluation adjustment of approximately $0.10 to $0.15 per share related to select equipment within the Premier Election Solutions business. This inventory may require a reduction of value contingent upon order volumes received in the fourth quarter.

Also, as I stated earlier in my comment, as a result of the change of quarterly spend by our Chinese customers, over $0.30 of earnings per share realized in Q4 of 2007 will not occur in fourth quarter of 2008. Important note that the revenue in earnings in China has significantly grown from 2007 to 2008, but these improvements were recognized in Q1 through Q3 of 2008.

We, like many of our customers, must continue to sort with the short and long-term impacts of the current financial crisis. One immediate development of this crisis has been the increased importance of having an ample reserve of cash and/or credit available.

As I already stated, our net debt cap ratio is a relatively conservative 25.3%. In addition, our revolving credit facility which has eleven participating banks provides us with ample capacity and does not mature until April 2010.

Our $300 million private placement has staggered maturity with the first maturity not occurring until 2013. Given the renewed emphasis on companies' liquidities in this recent financial crisis, we do not believe it is prudent in the near term to immediately resume our share repurchase program.

However, we continue to believe that our shares at current prices represent an extraordinary value and we will resume our share repurchase program as soon as the general financial conditions become more stable. Finally, we must continue to be very aggressive in reducing our cost structure to profitably align ourselves with the markets we serve.

As we look to Q4 and beyond, it's hard to know with precision what exact impact the financial crisis will have on our customer demand. We are confident however that our product and services, our strong brand, our commitment to innovation, our improved profitability and our strong cash flow will allow us to outpace our competitors in this period of uncertainty.

Now I’ll turn the call back to John.

John Kristoff

Thank you, Kevin. Allan, at this time we'd like to open the call for our first question, please.

Question-and-Answer Session

Operator

Thank you the question and answer session will be conducted electronically. (Operator Instructions) And we'll take our first question from Kartik Mehta with Ftn Midwest.

Kartik Mehta - FTN Midwest Securities Corp.

Good morning. Tom, you talked a little bit about the impact in consolidation and where market shares stands, at least for the top five institutions. I was wondering if you could talk a little bit about if you believe that there would be any impact to appraising or the fact that you've seen large banks consolidate with each other, or there wouldn't be that much of an impact.

Thomas Swidarski

I think Kartik, from a pricing standpoint, maybe we focus on the U.S. in terms of the consolidation. Most of the major players like the BofA's of the world, the JP Morgan Chase's of the world had very sophisticated sourcing folks in place already.

And so as they take over other institutions or whatever, they were in a very competitive position in terms of using all that leverage today. So I don't think that would have that material of an impact on pricing going forward.

Kartik Mehta - FTN Midwest Securities Corp.

And then just a question on your order growth, now I know it's kind of uncertain right now, the times are uncertain and I was trying to get if you've had any cancellations, in any geographies, from banks because of what's happening or have things been pretty status quo.

Thomas Swidarski

We're scrubbing that daily. I mean I have that same worry constantly and we just had a conference call on that yesterday. To date, we are not seeing anything cancelled. Certainly as things continue to unfold, we're going to be diligent in watching that.

But given the environment that we're in, I was concerned that things would be backing off. We haven't quite witnessed any of that yet. But certainly we have a cautious eye and keep our ears very tuned to that and as a matter of fact we're going through the backlog and we're kind of reviewing and revisiting all that to make sure in fact that we think all of that is solid. But as the work is done, to this point, we're pretty good in terms of the orders and our ability to continue to deliver.

Kartik Mehta - FTN Midwest Securities Corp.

Ken, I wanted to ask you a question on the cash flow. I'm trying to figure out is there a way to look at your cash flow for this year in a normalized, what the normalize would be without some of these one-time expenses.

If you look at what was cashed and not cashed so we could have maybe a base to work off of for 2009. Because I'm assuming 2009 has an opportunity to have significant improvement.

Kevin Krakora

I agree. We tried to do, if you refer to the release is we try to outline in both the restructuring and non-routine expense sections. The actual cash spend to date that we've incurred along with the charges.

So for example, in the third quarter, the non-routine expenses, we spent 8.2 million in Q3 2008 compared to 800,000 Q3 of 2007. We have likewise disclosures about, cash payments regarding third restructuring which were approximately 6 million. So if you back those out of our third quarter spend that can give you an idea what is a more normalized number.

Kartik Mehta - FTN Midwest Securities Corp.

And then, Kevin, just a last question I'm just trying to understand. You talked about in the guidance that there's $0.10 to $0.15 of possible inventory write down that's included in that $2.53 to $2.58 number, or I just want to make sure I understood that right and I heard that correctly.

Kevin Krakora

Right. You understood correctly. We're looking at some inventory that we have and it's dependent on some order volume that may or may not be realized in the fourth quarter.

We're hopeful that it will be realized if there'll not be any kind of valuation of allowance required, but if it isn't, then we will be in a position to need to make a valuation allowance.

So we've tried to pick the conservative approach and indicate the guidance anticipating that outcome but if it isn't likely then we obviously wouldn't need to make those expense adjustments.

Kartik Mehta - FTN Midwest Securities Corp.

Just kind of a follow-up. Just one last question, Kevin. Just tax rate for the rest of the year.

Kevin Krakora

On year-to-date basis, our normal line effective cash rate is somewhere in the low 20% range and that's kind of where we're expecting it to finish by the end of the year. And that's driven mainly by the mix of income that we've experienced this year.

Essentially, while really high picture in the U.S., we are recognizing a lot of net income as a result of all the charges that we're incurring. And consequently or profitably in the U.S. because of these charges is less.

So we're, as you know, the U.S. stands as the second highest tax country in the globe so not have to pay taxes there has reduced that overall tax impact.

Kartik Mehta - FTN Midwest Securities Corp.

Thank you.

Operator

And we'll take our next question from Matt Summerville with Keybanc.

Matt Summerville - Keybanc Capital Markets

This is a follow-up on the tax question, Kevin. If you are to exclude all the noise from the non-routine from the restructuring, what would your tax rate, effective tax rate look like in the fourth quarter?

Kevin Krakora

As we've kind of indicated, I think a more normalized rate is in the high 20% range, that's somewhere around 28 to 30%.

Matt Summerville - Keybanc Capital Markets

Okay. You kind of talked about this in response to one of Kartik's questions, but if you just look at for the full year 2008 the cash restructuring cost, the cash non-routine expenses, what are those anticipated to be for the full year?

Because I'm trying to work into how much of a cash pick-up you will get from the full year '09 from those two discrete items in ’08.

Kevin Krakora

Now, the way that I set that up I guess is I would say most of the expected non-routine expenses will be pretty close to that guidance, save about $14 to $15 million. So it would be just under that by about 14 to 15 million.

On the restructuring phase, when we talk about a total restructuring cash, and let me just pull that up real quick, we talked about it being between 40 to 45 million. That's a little bit more problematic but I would say at least 7 to 10 million of that is likely to occur next year. And that's because of the timing of some other payments and severance payments, et cetera.

Matt Summerville - Keybanc Capital Markets

Okay. If we can talk about your North American business for as second, you mentioned in Q3 you had modest, I think, revenue growth in the ATM business.

Can you give us a little more color on how that would break out in terms of revenue growth between, I'll just call them, big banks versus small banks?

Tom Swidarski

Yeah, what we've seen Matt, this is Tom, what we've seen is the continuation of the, you know, let's call it the big banks sector continue to move aggressively forward and that, percent-wise, has continued through the first three quarters of this year.

The small bank or maybe the regional bank in the credit union sector has been much more cautious. So you would look at that sector being down, the other sector being up significantly and so as such you come up with a kind of more modest number overall.

Matt Summerville - Keybanc Capital Markets

And then with respect to your guidance for the full year, how much FX headwind would be embedded in the fourth quarter on the top line for the total company and then based on current exchange rate today, how much FX headwind we should think about for 2009?

Kevin Krakora

Typically, as we look at our guidance forward on revenue, what we do is we lock our expectation on revenue on the current rates that existed. So we would have looked in saying this is at the rates that we had in early October and would have locked our guidance that way.

As you know in that environment, the dollars has continued to significantly strengthen so there could be some headwind relative to, especially to our Brazilian business with real which last time I looked was trading somewhere around 2.20 to the dollar, where it historically had been under $2 prior to that.

So we have a little exposure that way but again that has been fluctuating so much that we thought the most prudent thing is to lock in the rates that we know today and then extrapolate them forward.

Matt Summerville - Keybanc Capital Markets

So embedded in your guidance then, how much FX headwind is in the fourth quarter?

Kevin Krakora

It might be a couple percentage points.

Matt Summerville - Keybanc Capital Markets

And then similarly for 2009, how should we think about that again today? Or again using today's rate?

Kevin Krakora

Well, we talked about on year-to-date basis. I mean, in the quarter we had about 3 percentage points of net positive impact and we talked on a year-to-date basis and it's slightly more than that.

We have approximately 50% of our revenue being global in nature with a lot that concentrated in Brazil with real. And the reason it's difficult to answer that is it's really hard to gauge where we think that real is going to land relative to the U.S. dollar.

Matt Summerville - Keybanc Capital Markets

That's fair. It certainly had been volatile. I just want to talk about your services gross margins. They've come up essentially to 25%, so pretty dramatic improvement off the bottom which I think was about 20% if you exclude all the various charges.

I guess peak service margins for Diebold back in like 2002 were maybe 27, 28%. I'm just curious as to whether or not this next wave of cost take out, do you have a road map to get back to those previous peak levels? Or has the business, again just look at services, changed materially enough since then that you’re getting closer to the peak now as opposed to what I mentioned a moment ago?

Tom Swidarski

Matt, good question and my perspective on that is I don't know what the exact peak is. The makeup, the reason I feel like we have room to go here, and it's a little more difficult than it was in the past. The service base, you know when you add service and services in together and you look at that number, the services component of that has higher margin opportunity than traditional break fix maintenance kind of service.

So we're making a lot improvement and still the service side of the business is the overwhelming majority of that. We've made a lot of progress there. We have less room to go there than I think we do on the services piece of the total mix so I actually think we'll be hitting, you know, over the next few years, we'll be able to achieve like what we’ve done historically.

The way we'll get there is slightly different by adding in maybe more services to the overall mix there. And those services whether it'd be monitoring or whatever you look at it in that regard are higher margin opportunity. And so as we continue to grow that part of the business, it will make up for the continued pressure you’ll face on the pricing of a traditional maintenance service contract.

Matt Summerville - Keybanc Capital Markets

And then based on how you buy raw materials and how you buy fuel, Tom, at what point do you start to get some benefit from the reductions we've seen whether it'd be steel or whether it'd be gasoline prices.

Tom Swidarski

Kevin, do you have—

Kevin Krakora

Yeah, let me talk to about fuel initially which obviously has fallen dramatically. We kind of set a gauge up, and our exposure is primarily in the U.S. especially with fuel with the large fleet of vans that we have for our technicians. And we've talked about the fact that kind of every $0.10 of fuel price change translates into roughly about $750,000 of profits to us. So as you look and if I were to gauge that—

Matt Summerville - Keybanc Capital Markets

And you have to look at the year-over-year fuel cost. Yeah.

Kevin Krakora

Right. The year-over-year, yeah.

So to give a sense of how that has changed, in 2007 our fuel cost were somewhere around $2.70 per gallon, again, nationwide. If you look at this year, even given the precipitous decline that we've seen recently, I was still expecting it to be somewhere around 3.40 to 3.50.

So we had to absorb, if you will, call it maybe, $5 to $6 million of incremental cost in that environment. So I don't see, again, $0.10 movement can be 750,000 of profit but we're not looking for a dramatic change in that space in the fourth quarter.

Tom Swidarski

Matt, the other thing that I would to that is not only that the year-over-year issue but as prices were going up, we instituted a surcharge. And then recently we've gone out with our service contract and you know our renewal rates are pretty high but we also had a 5% increase that went on there.

And it’s not an automatic increase. It is an increase, somebody can cancel their contract, sometimes it is getting negotiated down. But I think what will happen, or one of the things we are going to face here—because I have already received some of those call—was everybody saying, well now the price at the pump is down a buck less than it was before, I am not paying a 5% increase. So we will be working kind of on that specific issue over the next several months and have a much clearer picture as to the impact for really 2009 which is kind of the important aspect for us to get a handle on.

Matt Summerville - KeyBanc Capital Markets

Alright. And then last question from me. With respect to your backlog, can you give us some color on how much that is up on both a sequential and year-over-year basis for Diebold? Order of magnitude?

Kevin Krakora

We will give you some color, Matt. But you know we don’t report actual backlogs.

Tom Swidarski

I would say that historically our backlog is the largest it has ever been.

Matt Summerville - KeyBanc Capital Markets

Okay. Fair enough, thank you.

Kevin Krakora

Yes, I think in general terms we are comfortable with the backlog. It is significant compared to historic levels.

But again, much like the Cardex question, we are going through that in the order book very closely to make sure that—I think now more than ever we need to be pretty cautious in terms of whether those turn into actual contracts and get revenued.

Matt Summerville - KeyBanc Capital Markets

Thanks a lot.

Tom Swidarski

Thanks, Matt.

Operator

We will go next to Gil Luria with Wedbush.

Gil Luria - Wedbush Morgan Securities

Hi. Thank you for taking my question. First as a clarification, I think you talked about $0.30 in the third quarter that you were not expecting to have there. Is that the extra China business, is that China and Brazil election, and is that revenue that you were just expecting in the fourth quarter and you got in the third quarter? Can you break that down a little bit?

Kevin Krakora

If you are referring to my remarks, the $0.30 I talked about was really the impact of the difference year-over-year for the fourth quarter of China revenue, which as we talked about in 2007 we had a lot that was back end loaded in the year. And this year it was all front end loaded.

So roughly about $0.30 of change between 2007 fourth quarter and 2008 is attributable to this change in spending in China. The large order we talked about relative to the third quarter was essentially somewhere just north of $0.10 of impact as a result of that. Now we would have expected as we were forecasting, expected that to occur in Q4 and it actually occurred in Q3.

Gil Luria - Wedbush Morgan Securities

Great. That is very helpful. In terms of back in August when you initially came out with the financials you started talking about possible goals for operating profits for 2009 and beyond. That was a long time ago and a lot has happened since then.

And I think one of the things that you assumed when you were talking about those targets were at least mid single digit growth to help you with operating leverage. Now that the global banking environment has deteriorated a lot over the last couple of months, that currency is going against you, and considering the fact that you are not going to get the benefit from Brazil elections that seemed to be of pretty decent benefit in this quarter next year, what would your operating profit target be for next year? Let’s say if you were assuming absolutely no top line growth.

Tom Swidarski

Gil, this is Tom. Let me answer that because that is a question we are wrestling with every single day. The way I would view this is this year our operating margin is going to be—I mean we had put a seven number out there and you know it is going to be well north of that.

So the feeling I have here is we are going to improve our operating margin next year. We had originally had a 9% out there with certain assumptions around it, and now clearly with the environment we are in that becomes a very difficult challenge.

So I think what I would be talking about and what we are working toward as we build our 2009 plan, is improvement in the operating margin. We will certainly be feeling good that we can get to improvement. That level of improvement really is going to be dictated by what the volume looks like and where that volume is from.

So it is a combination of those factors and we are still in the throws of trying to put our heads together and make sure we have got a 2009 plan and targets that make sense. But certainly the environment has changed dramatically enough that we are revisiting that issue. I feel good about the procedures and the things we can control to improve the margin despite what could be a very difficult revenue environment.

And we are also looking at how we address plans and action we take if revenue falls even further from that. Because that is the kind of environment we are in. So we are working through all of those contingencies and I do not think at this point I can define it too much tighter than that. Kevin, do you have any comment?

Kevin Krakora

No, I think that hits it right on the mark and you are correct. When we initially set these targets we were assuming what we thought was modest growth of five to 6% which as we finish this year we are going to be well nine to 10.

So that seemed very modest, but again after the last two months it is difficult to assess what that may turn out to be.

Gil Luria - Wedbush Morgan Securities

That is helpful. And then on the buy back, it is clear why you would want to hold off on that right now.

What would be the indication that you would get that you would feel more comfortable resuming that? Is it going to be contingent on stabilization of credit, of liquidity? Is it going to be stabilization from your banks, is it more clarity from your banks? What are you going to be looking for to decide to engage in that buy back again?

Kevin Krakora

Right, that is a great question and I do not think that there is one single indicator that I can point to to look at that. It is a multitude of things that you have just discussed. We clearly want to be sure that the banks are lending to each other and the spread has come down so that there is not any concern about availability of credit and cash.

I was shocked one morning to be driving in and hear one of the regional companies having 150 million of their cash in market security locked up. So we want to be sure of that. Also if you look at our cash position we have over $300 million of cash, but it is important we are a global company and north of 75% of that cash is currently in international locations.

And we have a number of strategies to repatriate that cash back into the US which we are going to execute upon. But that is not going to occur, a large part of that will not occur until the first quarter of 2009. So getting our cash into the right locations will be key, as well as what kind of fourth quarter cash flow we experience.

We had dramatic improvement in September which was very good. Historically the fourth quarter tends to be the quarter that we collect the majority of our cash. So getting visibility of that will be also helpful as we assess that.

But clearly, you know, I sit there and look at our trading range and say I would love to be purchasing today. But as soon as it becomes feasible we are going to do it.

Gil Luria - Wedbush Morgan Securities

Great, thank you very much.

Kevin Krakora

You are welcome.

Operator

We will take our next question from Zahid Siddique with Gabelli and Company.

Zahid Siddique - Gabelli & Company, Inc.

Hi, good morning.

Kevin Krakora

Good morning.

Zahid Siddique - Gabelli & Company, Inc.

You briefly touched on your relationship with Goldman Sachs, and I wanted to see is that relationship still on or is that basically you are done with that?

Kevin Krakora

Goldman Sachs has been our long-term financial advisor who we have had a relationship with them—I know it predates the ‘90s. So we have had a two-decade at least relationship with them.

It obviously became more formalized when we were dealing with the United Technologies bid and as a result of that had entered into a more formal arrangement as they became our principal advisors throughout that process.

But the payment, for example, that we talk about in our release is relative to all the services that were rendered as a result of that this past year with the UTC effort.

Zahid Siddique - Gabelli & Company, Inc.

Okay. So I guess you are not working with them at a formal level at least for now in terms of evaluating strategic options that are available to you? Is that a fair assessment?

Kevin Krakora

They continue to provide us strategic consult, consultative advice, but the related fees relative to that are very modest.

Zahid Siddique - Gabelli & Company, Inc.

Okay. And then my next question is on the financial self service. Would you be able to break down the revenue growth by geographic segments?

Tom Swidarski

Sure, we can do that. In the release—

Kevin Krakora

I will tell you that we have witnessed strong growth in most of our geographic regions.

Tom Swidarski

The way I would look at that is the revenue summary by geographic segment, where you see the Americas, Asia-Pacific, Europe, Middle East, and Africa. I think that is a pretty good indicator relative to financial self service.

I mean so while those, while the numbers percentage-wise may be a few percent swinging either way, I would say that is pretty indicative of what happened for us from a self service standpoint in the regions of the world.

Kevin Krakora

Yes, and keep in mind that there is very little security revenue coming from outside the Americas.

Tom Swidarski

Right. I mean we have a little in Europe, we have a little in Asia, but…

Kevin Krakora

Not enough to move the needle.

Tom Swidarski

Yes.

Zahid Siddique - Gabelli & Company, Inc.

Sure. That is helpful.

And then just a follow up on the share buy back or not initiating the share buy back. Did you also look at the possibility of maybe stopping the dividend or reducing it or maybe exchanging it with the share buy back plan?

Kevin Krakora

Well I would say that we have discussed all of those options with the board. We have another board meeting coming up where, again we will revisit this given the dynamics in the marketplace.

But from the last meeting I think we are very comfortable with kind of current course of speed. Again, we have got to get some of this cash repatriated back, which I think is the biggest driver for us.

Zahid Siddique - Gabelli & Company, Inc.

Okay. Thanks a lot.

Kevin Krakora

You are welcome.

Operator

And our last question comes from Reik Read with Robert Baird and Company.

Reik Read - Robert W. Baird & Co.

Good morning. Could you guys maybe give us some sense of what the cost take out impact might be in the next couple of quarter now that you have completed the warehouse consolidation and the final closure of Newark?

Kevin Krakora

We are in the process of completing that so those—as we talked about when we did that, we have consolidated it, we have begun those closures and we have begun all of the consolidations. Our expectation is by the end of the year to have all of the consolidation done.

But the savings that are going to come from that are going to have to continue as we work through efficiencies that we are going to gain by those consolidating actions. So it is not like we are going to start January with all of the benefit coming in.

I think the best gauge that we have indicated is we are trying to get the 70 million of the next $100 million trench by the first half of 2010. And I would expect that ratably through 2009 and 2010 that is going to occur and it will not be anything like a step function.

Tom Swidarski

Yes, I think that where we are at in that regard is we have got the 70 million goal by 2010. I mean expectation will be 40 million or something along those lines here in 2009. But again, we will be working through that. But it is not going to be all back end loaded in 2010. It is going to be a walk up process.

Reik Read - Robert W. Baird & Co.

Yes, I think part of what I am trying to gauge is, Tom, is that as you were talking before, if you face some incremental weakness, how quickly can some of those costs come out?

And I think you put some language in the release saying you are trying to accelerate some of these programs. So I am just trying to understand how quickly that can happen for you.

Tom Swidarski

Yes, and I do not think I have a good answer that I am comfortable with right now. We have got a team looking at that and what we can control from the acceleration capability, we have got some folks at different parts of the world.

We have got our internal global leadership meeting here coming up in a couple of weeks where we are going to get some reports and some information that will help put better light on that before we comment other than kind of what we said before. That it may be 40-30 if we can accelerate that, we certainly would have to attempt given the environment that we could be facing. But I don’t know I can commit to that right now.

Reik Read - Robert W. Baird & Co.

Okay. Fair enough. And then just last question. You talked a little bit about in your remarks on the integrated service offerings, you commented before about how you want to roll that out more on the geographic basis.

You know it has been very strong in Brazil. Can you give us an update on how that is going and as you roll it out is there any head wind that occurs as part of that process to the service margins that you talked about before?

Tom Swidarski

Yes, let me start with the last part of that. The head wind you face in terms of integrated services that I see that is happening, it is kind of accelerated now a little bit, is the length of time for someone to make a decision. And so what occurs in that regard is because it is complicated you are taking basically to replace of four or five independent suppliers of some combination of suppliers in doing it yourself.

It is a big decision for any institution to make. And so the contract is generally around the neighborhood of five years. So unlike just making a simple hardware or software or maintenance decision that is kind of a one-time decision, this is a little more complicated. So from my standpoint, my approach here is to make sure we continue down this path.

It may elongate some of the sales cycle, but it is worth it at the end of it when you get a contract for five years with someone that includes a refresh of technology kind of across the board. So that aspect of integrated services is probably the one thing that we are witnessing as we have moved into that more aggressively outside of Brazil.

Brazil’s business model was really based on five or six major institutions that all had problems with up time or something specific in a point where they were less sophisticated and you have more risk with that model in that you have got five or six and if any one starts moving away or brings something back in house you have got risk.

In the United States we have begun just on the opposite end of the spectrum. We are dealing with many institutions with 10, 15, 20 or sometimes up to 100 or 200 at this point, ATM fleet of network. And that to me is a much better business model that I like and that we are dealing with a broad range of customers and you are not really at too much risk exposure to any one of those.

As that continues over the next year or so I would expect the size of these deal to continue to improve as our scalability and competencies grow. Likewise I point to other major regions, like we have one in Poland, we have one in India, you have got one in China. India is probably the next developed one where we are probably dealing with ten to 13,000 ATMs that we are currently providing services for.

And most of the other countries outside of those three are at very early stages of this development. And when I talk about the U.S. I am also including Canada in that because Canada is far down that path and that was one of our largest and biggest ones early on.

So we continue to work our way through this but the goal is to spread this business model and this philosophy throughout the entire selling environment that we are in. And it changes the mindset of how we are seen from the customer, it changes the mindset of how we sell, and that is much more of a high level consultative type of environment. But that is the space we want to compete.

Reik Read - Robert W. Baird & Co.

And just one last question. Just in Europe, the revenue is down there.

Tom Swidarski

Yes.

Reik Read - Robert W. Baird & Co.

Is that a function of you guys—you talked about the past, maybe pulling out of certain areas, and is that a function of that or is there something else in there?

Tom Swidarski

No, that would be the heart of it. In essence changing our business model in certain countries. But rather than worrying about the 20 or 30 million in revenue that you are going to get, the most important thing is effecting the profitability.

And so from a profitability standpoint, we want to make sure that we are making sound decisions. We still can have a presence in the country, I just do not need necessarily to have an operation of 100 or 200 or 300 people if in fact we are not going to be profitable.

So that is the tradeoff that we are making and we continue to be diligent relative to the revenue because to me profitability is a priority.

Reik Read - Robert W. Baird & Co.

Thanks very much.

Tom Swidarski

You are welcome.

Operator

And that concludes the question and answer session today. Mr. Kristoff, I would like to turn it back to you for any additional or closing remarks.

John Kristoff

Thanks, Alan. I would like to thank everyone for joining us on the call this morning. And as always, for additional or follow up questions, please contact me directly.

Operator

And ladies and gentlemen that does conclude today’s conference. Thank you for your participation. You may now disconnect.

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