Call Start: 10:00
Call End: 10:50
Diebold, Inc (NYSE:DBD)
Q4 2012 Earnings Call
February 12, 2013 10:00 am ET
John Kristoff – VP, Chief Communications Officer
Henry Wallace – Executive Chairman
George Mayes – EVP, Chief Operating Officer
Brad Richardson – EVP, Chief Financial Officer
Mychal Kempt – VP, North American Operations
Ryan Augustitus – Northcoast Research
Gil Luria – Wedbush Securities
Michael Kim – Imperial Capital
Matt Summerville – KeyBanc
Paul Coster – JP Morgan
Julio Quinteros – Goldman Sachs
Good day, everyone. Welcome to Diebold Incorporated’s Fourth Quarter Financial Results Conference Call. 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
Thank you, Jennifer. Good morning and thank you for joining us for Diebold’s Fourth Quarter Conference Call. Joining me today are Henry Wallace, Executive Chairman; George Mayes, Executive Vice President and Chief Operating Officer; and Brad Richardson, Executive Vice President and Chief Financial Officer. Also with us in the room today and available to answer questions is Mychal Kempt, Vice President, North America Operations.
Just a few notes before we get started. In addition to the earnings release, we’ve provided a supplementary presentation on the Investor page of our website. Henry, George and Brad will be walking through this presentation as part of their opening comments today, and we encourage you to follow along.
Before we discuss our results, as with past calls, it’s important to note that we have restructuring, non-routine expenses and impairment charges in our financials. We believe that excluding these items gives an indication of the company’s baseline operational performance. As a result, many of the remarks this morning will focus on non-GAAP financial information.
For a reconciliation of our GAAP to non-GAAP numbers, please refer to the supplemental material at the end of the presentation. In addition, all results of operations reported today, including prior periods, exclude discontinued operations.
Finally, a replay of this conference call will be available later today from our website.
And as a reminder, some of the comments today may be considered forward-looking statements. Internal and/or external factors could significantly impact financial results. As a precaution, please refer to the more detailed risk factors that have previously been filed with the SEC.
And now with opening remarks, I’ll turn it over to Henry.
Thank you, John, and good morning, everyone. And thanks for joining our call today. I want to express my appreciation to our investors, our customers, and our associates for your patient engagement, and ongoing commitment to Diebold during this time of transition.
To be frank, the 2012 results and the present outlook for 2013 are disappointing, and we need to improve. I’m sure, you’re anxious to understand how we’re going to get this great company back on a more positive trajectory to drive shareholder value. While we are dissatisfied with our recent performance, we have significant opportunities in the marketplace and we have good strategies for growth. Diebold is far from being a broken company, but it is an underperforming company.
Despite the difficult challenges we have faced, we have seen progress on several fronts. We continued to enhance our Financial Self-service offering, with more capable terminals and software that improve efficiency and availability. We’ve expanded our integrated service capabilities and infrastructure, evidenced by our expanded systems implementation by our largest IS customer, Toronto-Dominion, and we intend to leverage that infrastructure to continue to grow the business. And we’ve strengthened the organization and competencies required to grow our Electronic Security business through both organic and acquisitive means.
Whilst these were all positive developments, the operational performance has not met the company’s expectations, nor those of our Board of Directors and our shareholders. While we’ve experienced reasonable revenue growth, our margins have continued to erode. To strengthen our performance, we must drive immediate major organizational change, and structural cost reductions, and accelerate our investment in growth.
Our first task was to realign the organization to more rapidly seize marketplace opportunities and to reduce our cost structure. By establishing a Chief Operating Officer position, we have also created a global model for product development, service, and supply chain management that will enable us to better leverage synergies across regional divisions while attacking our cost structure.
Previously many of these functions operated independently in various degrees on a regional basis. And to that end we’ve named George Mayes to this important new role. George has a track record of delivering. This makes him ideally suited to drive the rapid improvement required to reach our growth and profitability objectives. He has the passion, the skills and the experience to help Diebold achieve these goals. And you’ll hear more from George on this front a little bit later.
As I mentioned earlier, we have good strategies for growth, but we need to improve our execution in order to free up more resources to accelerate our investment in growth and innovation. Regarding our market opportunities, in the Financial Self-service, we have global scale, unparalleled service capabilities and great product offerings. And we are deeply trusted by our customers. As banks around the world face unprecedented cost pressures, they have more need today for our solutions than ever before. We can and we will win in this space.
In our Security business, we have identified electronic security as a very attractive market with fast growth, good margins and strong recurring revenue potential. Over the past year or two, we began changing our business model to focus less on product sales and installation and more on recurring services and monitoring.
And with Diebold’s strong balance sheet, we are well positioned not only to invest in growth opportunities, but to continue our exceptional record of returning cash to shareholders.
Last week, the board authorized Diebold’s 60th consecutive annual dividend increase, the longest standing record among any public company in North America. This is an achievement we are proud of and we believe we have the right strategy to continue increasing our dividend in the future.
And as you are well aware, the board has begun the search process for a new Chief Executive Officer. We have formed a search committee headed by Rick Crandall, a Diebold board member with extensive software and technology experience. The search committee has engaged Korn/Ferry to conduct a global search to help us identify and evaluate the most qualified candidates for the job.
While we feel a sense of urgency in our search and understand the key issues we need to address, there is no set timeframe, but we will focus on finding the right person as soon as possible.
Finally, I’ve been a Director of Diebold for more than a decade and I would just like to say that I truly believe that we have the strategies, the team, and the ability to change our trajectory. We have a strong engaged Board of Directors that is committed to providing the appropriate oversight and to selecting the right leader in a new CEO, so that we can unleash the full potential of Diebold and its outstanding people.
And, again, I’d like to also emphasize that we are committed to delivering shareholder value as an ongoing priority.
I will now turn over to George Mayes. Thanks.
Thank you, Henry. First, let me say that I’m honored to assume the responsibility for operations here at Diebold, and I’m extremely optimistic about our future. As Henry mentioned, there is a critical need to focus on our operational improvements. An increased sense of urgency is imperative in order to extract greater value from our company.
There is opportunity in the markets we serve, especially as we consider the strategies we’ve established in important areas such as integrated services and electronic security. However, we need to improve the execution of our strategies and, critically, the speed with which we execute. The new reporting relationships we have put in place are designed to rapidly drive the changes required to improve our results. We are focusing on execution, performance improvement, and cost reduction.
We will continue to provide the outstanding service our customers expect and we will provide our associates with the essential tools and services necessary to be effective and properly supported in the organization.
In order to improve our financial performance, we must address our cost structure. We will engage the organization and review and evaluate all current activities and costs, based on customer value, best practices and necessity. As we seek to improve our performance, we cannot and will not jeopardize our ability to maintain our core business, grow revenues in new products and markets, pursue new alternative business areas or adhere to governance requirements.
This will require a deliberate approach. We will create a new data-driven business operating model across the Diebold’s entire operation around the globe, with execution, accountability and, most importantly, a culture of discipline, a new culture where delivering on our commitments is the foundation for everything we do.
I firmly believe in our long-term strategies. I believe the fundamentals of Diebold’s businesses are sound. And I am confident in our ability to move quickly and to get the company back on a more positive track.
During our first quarter conference call in April, we will provide more detail around our plans for operational improvement.
Now let’s touch briefly on our performance by region on Slide 11. Starting with North America, total revenue for the quarter was flat. Financial Self-service revenue in the region declined 5%, partially offset by security growth of 8%. Total orders declined in the mid-single digits off tough comparisons from the prior year due to the Financial Self-service business. As previously discussed, we continued to experience a significant mix shift between national and regional accounts, negatively impacting profitability.
Moving to Latin America. Total revenue decreased 6% during the quarter, due to a 50% drop in voting and lottery revenue in Brazil, as well as currency impact. On a constant currency basis, revenue increased 2%. Excluding Brazil, revenue for the quarter increased approximately 16%. We experienced two significant customer delays in Brazil, which had a negative impact on revenue for the quarter.
Total orders in Latin America increased in the low-double digits, but increased more than 20% when excluding the Brazil voting and lottery business. This growth is primarily due to wins in Colombia, Venezuela and Per, as deposit automation continues to gain traction.
In the Asia-Pacific region, total revenue for the quarter decreased 4%, driven mainly by product revenue declines in China and slightly offset by service growth in China and India. However, revenue in the region is up for the year, as we maintained our leading market share in China and Thailand. We experienced strong order growth, in excess of 30% in the region, during the quarter. This growth was primarily due to the previously disclosed government bank outsourcing program in India where we are supplying hardware and services to many of the companies acting as lead deployers for state run banks.
Finally in EMEA, total revenue for the quarter increased 9% or 12% on a constant currency basis. This increase was primarily driven by activity in the Middle East and Western Europe. Despite economic headwinds in the region, we saw order growth in the low-single digit and continue to see momentum from our Flex performance series of ATMs.
And after taking $15 million out of our cost structure in 2011, we achieved mostly modest profitability in the region during the quarter and the full year. We expect to be able to grow our profitability in the region in 2013.
Globally, our full year Financial Self-service revenue increased 8%, despite the major order delays in Brazil. On a constant currency basis, Financial Self-service’s revenue increased more than 12% for the full year.
Some of our competitors have been making claims of market share gains at our expense. However, our growth in Financial Self-service for the year was notably higher than either of our global competitors.
While we have clearly not executed well on the cost side of our business, we are very confident that we have the competitive solutions required to win in the marketplace and maintain our leading position in North America, Brazil, and elsewhere.
I also believe we have the commitment and drive necessary to accomplish our goals. I continue to be impressed by the energy, will, and dedication of Diebold associates throughout our global operations. They have the capacity to meet the challenge of change, to build a high performance culture, achieve sustainable reductions in our cost structure, and deliver the profitability required to drive future growth and value creation.
With that, I’ll turn the call over to Brad.
Thanks, George, and good morning, everyone. Before I get into the details of our fourth quarter and full-year financial results, I’d like to address the more significant challenges we faced during the quarter.
While we hit our revenue targets, we missed our prior full-year earnings guidance by approximately 10% or $0.20 per share. This was primarily due to a $25 million operating profit miss in our North America business during the quarter. In addition, our free cash flow was $86 million, well below our previous expectations.
Again, our lower-than-expected earnings were primarily driven by profit deterioration in North America during the quarter. The deterioration was related to a number of factors, a decline in maintenance revenue, including billed-work services due to a tightening of discretionary spending from regional banks led to a $0.06 decline in EPS from our prior full-year guidance.
Our regional business experienced lower-than-expected volume due to certain installation delays, compounded by a more competitive price environment. This resulted in an additional $0.06 adverse impact.
Finally, the U.S. Service business incurred higher costs, partially due to an unexpected increase in an auto liability insurance reserve and non-recoverable costs related to Hurricane Sandy, which had a negative impact on EPS of $0.05 and $0.03, respectively.
Our free cash flow was also negatively impacted by a number of factors. Net income, adjusted for non-cash items, fell short of our expectations causing an adverse impact of approximately $15 million. In addition, our year-end cash collections were negatively impacted by approximately $60 million due to a shift in business mix from regional banks, which tend to pay early or in some cases prepay, to a stronger concentration of national accounts, which typically have a longer payment cycle.
However, as shown on Slide 15 on a positive note, we were in line with our previous revenue guidance, achieving approximately 6% growth over the prior year or 9% on a constant currency basis. Our core markets, while cyclical, remain soundly intact.
During the fourth quarter, we did experience two large bank customer delays in Brazil, which impacted our revenue performance for the full year.
In addition, the full-year results in 2012 show our restructuring efforts in EMEA contributed positively to our overall performance. As previously guided, we returned to a profitable position in the region for the full year, despite facing economic headwinds.
Despite the underperformance in the quarter, with net debt of approximately $20 million, we have the financial capacity to invest in growth in key areas such as software, services, and electronic security, as well as investing in our core IT infrastructure.
We continue to evaluate and pursue acquisition opportunities in the electronic security and services base to support our key growth strategies. As we think about our capital allocation strategy, we continue to be focused on driving long-term growth of the business and return on capital employed of 15%.
Now to review our financial results. Turning to Slide 16, total revenue for the quarter was $840 million, down approximately 1% from the fourth quarter of 2011, including a negative currency impact of approximately 2%. The fourth quarter revenue was largely affected by a decline in elections revenue in Brazil. This was partially offset by strong performance in security, EMEA, and in Latin America outside of Brazil.
For the quarter, Service revenue increased 5%, while Product revenue declined by 7%. Service represented more than 50% of total revenue during the quarter. Taking a look at the full year 2012, total revenue increased approximately 6% including a negative currency impact of 3%. We were up in all regions on a constant currency basis.
Looking at our Financial Self-service business on Slide 17, fourth quarter revenue was $631 million, a decline of 2%, but flat on a constant currency basis. This was due to a fall off in regional business activity in North America, as well as the slight decline in Asia-Pacific against tough comparisons with the prior year. This was offset by growth in EMEA and Latin America.
The Security business on Slide 18 increased approximately 11%, enabling us to achieve our full-year guidance of 3% revenue growth. In addition, our electronic security business saw strong growth in the quarter, giving further credence to our electronic security growth strategy.
We remain committed to focusing on growing recurring services in electronic security with less emphasis on one-off enterprise implementation projects.
Turning now to Slide 19, the total gross margin for the fourth quarter declined 4.1 percentage points from 2011,with near equivalent declines in both Product and Service. We experienced pressure on Product gross margin during the quarter, due primarily to the tough comparison we had within the high margin Brazil election business in 2011. Product gross margins were also impacted by an unfavorable customer mix in North America, as regionals comprised a lower percent of the revenue in Q4 2012.
Turning to the Service gross margin. There was lower volume related to a number of operational and unusual items such as Hurricane Sandy and the insurance reserve I mentioned earlier. Aside from these factors, the underlying Service margin was approximately 27%.
Moving on to non-GAAP operating expense. As highlighted on Slide 20, in the fourth quarter, operating expense decreased $4 million or 30 basis points as a percent of revenue. We drove underlying improvement of $7 million in our discretionary cost structure in order to free-up monies to cover an incremental $3 million investment in R&D to support future offerings.
For the full year, our operating expense performance as a percentage of revenue was down 80 basis points, as we leveraged our operating expense structure over greater volume in 2012, while continuing to invest in next-generation hardware and software platforms.
Now to Slide 21, non-GAAP operating margins in the fourth quarter decreased to 5.1 percentage points from 8.9% in 2011. Our full-year operating margin declined to 6.1 percentage points from 7% in 2011. While we have driven marked improvements in EMEA, Brazil has been highly dilutive to our margins this year, due to the cyclical nature of the business there, combined with a negative mix shift in North America.
Turning to the EPS reconciliation table on Slide 22. Non-GAAP EPS moved from $1.40 per share in the fourth quarter of 2011 to $0.45 per share in the current quarter. As a reminder, fourth quarter 2011 included a non-recurring discrete item of $0.43 a share related to a Brazil tax valuation allowance reserve adjustment.
Turning to the fourth quarter of 2012. As previously disclosed, we accrued approximately $18 million for the eventual resolution of the FCPA related investigation, equating to $0.20 per share in EPS. Also we incurred pension expense of about $22 million related to our early buyout program during the quarter. This equates to $0.24 per share impact on EPS. Our full year non-GAAP tax rate was 27.8% in line with our prior expectations. And, finally, our full year non-GAAP EPS was $2.07 per share.
Turning to Slide 23. Free cash flow decreased $103 million in the fourth quarter, while the full year free cash flow decreased by $75 million. Working capital and deferred revenue, or what we often called prepayments, negatively impacted cash flow for the full year by about $30 million and $65 million, respectively.
The driving factors behind these two items was a shift mix – shift in business mix from regional banks, which tend to pay early, to a stronger concentration of national accounts, which typically have a longer payment cycle.
Net income, adjusted for non-cash items, fell short of our expectations, causing an adverse impact of approximately $25 million. Approximately half of the $45 million benefit shown within the Other category is comprised of lease sales in support of our growing IS business.
Moving next to liquidity and net debt on Slide 24. We finished the year in a net debt position of approximately $22 million, an increase of $14 million from the net debt position at the end of 2011. As Henry mentioned, our strong balance sheet puts us in a position to continue returning cash to shareholders.
Last week, the board authorized Diebold’s 60th consecutive year of dividend increases, the longest standing performance among any public company in North America. In addition, during the last several years, we have returned a solid 3% to 4% dividend yield, reflecting the financial strength of our company and our steadfast commitment to our shareholders.
During the quarter, we did not repurchase any shares. While we have roughly 2.4 million shares remaining on a repurchase authorization, our investment priorities are our dividend, acquisition activity and reinvestment in the business.
In regards to our outlook for 2013, we expect relatively flat revenue overall, with growth in Asia and Latin America, offset by declines in North America, due to the difficult comparison to the U.S. regional banks’ ADA, PCI upgrade cycle in 2012.
While we are encouraged by the strong fourth quarter order growth in Asia-Pacific, U.S. national accounts and Latin America, outside of Brazil, we expect the U.S. regional bank space to be down substantially, particularly in the first half of the year.
As we’ve previously disclosed, we expect EPS to be flat to down moderately. We are not providing a specific EPS range at this time due to the wide range of possible outcomes on two fronts, Brazil and the U.S. regional bank space.
In Brazil, there are several large tenders that are outstanding, specifically, two of these tenders pushed out from 2012 to 2013. The first deal is with Banco do Brasil. In the fourth quarter of 2012, the bank conducted a public bid to upgrade 45 ATMs, which we won. Subsequently, the bank cancelled the award as they decided to replace, rather than upgrade the units.
The second tender was with Caixa Econômica for replacement of 6,500 ATMs occurring during the fourth quarter, we won that bid. Subsequently, one of our competitors protested on technical grounds and the bid was cancelled. The bank is re-bidding this business in 2013.
These two government bank tenders, coupled with other large orders, represent a total opportunity to replace 18,000 ATMs in Brazil in 2013. Additionally, in the U.S. regional space demand has been consistently weaker than our expectations. Though we believe order activity stabilized during the fourth quarter, we’ll have a clearer view of this market once we fully progress through the first quarter.
So, in addition to the typical range of outcomes found in our business, this activity in Brazil and the U.S. regional bank space adds about $30 million of potential operating profit variation for 2013. Given the timing of the two Brazil orders and the relatively weak order activity with the U.S. regional banks during the second half of 2012, we expect the first quarter earnings to be well below historical norms.
As a result, we anticipate 20% to 25% of 2013 EPS to be delivered in the first half of the year. We will have better clarity after the first quarter orders come in and we see a return to more normal discretionary spending around billed-work. We will update our outlook as we get more visibility on these factors throughout the year.
Moving on to free cash flow on Slide 26. Our expectations for 2013 are based on the following assumptions, flat to moderately down earnings; relatively stable core working capital elements; and prepay activity versus a negative cash impact of $70 million in 2012; and a slight increase in capital expenditures to approximately $60 million.
Taking these factors into consideration and excluding the impact of any potential FCPA related settlements, we believe the business is capable of generating free cash flow of at least $100 million in 2013. This is more than enough to sustain our dividend and continued investments in our growth initiatives.
In closing, we faced a challenging fourth quarter. However, as Henry indicated, the fundamentals of our business remain sound and our four growth strategies remain intact, branch transformation and deposit automation, integrated services, electronic security, and emerging markets. These strategies, along with the operational improvement initiative that George is driving, are designed to offset underlying margin pressure we have in the core business.
And, finally, our solid balance sheet positions us to capitalize on growth opportunities and deliver sustained shareholder value.
With that, I’ll turn it back to John.
Thank you, Brad. Before we head to questions, in the interest of giving everyone on the call an opportunity to ask a question, I would ask you to respectfully limit yourself to one question and one follow-up and then get back in queue and we’ll take as many questions as time allows.
So with that Jennifer, can we open it up to the first question?
Yes. Thank you, sir. (Operator Instructions) Our first question will come from Ryan Augustitus with Northcoast Research.
Ryan Augustitus – Northcoast Research
Hi. Good morning. Have there been any retention programs put in place to keep key management personnel?
Ryan, this is Henry Wallace. I’ll answer that. The answer is no. Our view is on retention that the best way to retain our people is to get the business moving forward and upwards and that’s what we’re focused on as a team. That doesn’t mean to say we might not lose one or two people, that’s always a risk, but paying people to stay when their mindset is to go because they’re unhappy with the company isn’t a good strategy. So, our aim is clearly to get this business moving upwards and onwards, a place where people get up in the morning and want to come and work because it’s a company that’s going places and that’s our real focus here.
Ryan Augustitus – Northcoast Research
Okay. And then one more question, what is the current environment like for acquiring electronic security businesses?
Ryan, it’s Brad here. Certainly, as you are aware, I mean, we’ve looked at several opportunities. We’ve gotten very far along in those opportunities. In one particular, we ran in to a valuation issue. So, I think the point being is there are lots of opportunities out there. We are focused clearly on looking in the electronic security space to acquire a beachhead. Again, there are multiple opportunities and these are tucked away in private equity portfolios or their family-owned and we see good opportunity to acquire a beachhead, and then have several bolt-ons thereafter.
So, again, there’s lots of opportunities out there. And I would just also make the point that, again, as Henry mentioned, as I mentioned, I mean, we have strong balance sheet capacity. This is a core strategy that’s been reviewed with the board. And so this is something that we’ll move forward with ahead of a CEO coming onboard, as the opportunities come to fruition.
Thank you. And next we’ll move to a question from Gil Luria with Wedbush Securities.
Gil Luria – Wedbush Securities
Thanks for taking my question. So I think you went through the fact that last year, you actually gained share on a global basis. Going forward, especially as you think of the emerging markets, Middle East, Africa, Asia-Pacific, do you have an opportunity to gain share? You went through some issues a couple of years ago around FCPA and divesting and strategically realigning the European business. Going forward, into the next couple of years, do you now have an opportunity to possibly gain some shares as your big U.S.-based competitor’s going through the same issues?
Yes, this is George. I think when you look at our ability to gain share, we’re very excited about our new next-generation ATM. We believe that we will be able to differentiate ourselves in the market based on total cost of ownership, reliability, and some of our advanced security features, as well as if you look at the success that we’re having with our Flex ATM units around the globe, we think there’s additional runway there as well as emerging markets move towards deposit automation.
Gil Luria – Wedbush Securities
Got it. And then in terms of electronic security giving you more of a recurring revenue, of your service component within Security, what portion of that is recurring maintenance/monitoring type revenue versus the one-time oriented installation professional services type revenue?
Yeah Gil. It’s Brad. I mean, the electronic security business profile that we have is very similar to the total company, with about half of the revenues of the total security business being services locked up under typical type maintenance type agreements and monitoring agreements.
Okay. Next we’ll take a question from Michael Kim with Imperial Capital.
Michael Kim – Imperial Capital
Hi, good morning, guys. Yeah, just again on electronic security, with the pending leadership change, does that change the timing of any potential activity to grow that business strategically at least until you have a permanent CEO?
No, I don’t think it’s going to change it at all. Essentially, we set up our new organization in security over the last couple of years. We’re building our muscle there and we intend to go grow the business. And so, as and when we get the opportunity to acquire the right companies, we’ll do that. It’ll depend obviously on are they bringing the right capabilities to us and can we make the right investments that will pay off and grow the business going forward. But it isn’t dependent upon a CEO being here or not. The board has endorsed this strategy and we’re committed to investing in that space.
Michael Kim – Imperial Capital
Okay. Great. And then just on the electronic security business itself, one of your larger competitors in this sector recently talked about expanding their focus on the financial and banking vertical. They had made a fairly acquisition and expanded in North America. Are you seeing any increasing competition for new projects and more generally on the environment?
Yeah. Michael, it’s Brad. I mean, again, as we pointed out in the fourth quarter, our total security business grew by about 11% and certainly the growth in the electronic security business was even stronger. Our targeted market, as you know, is focused on the financial institutions. And we’ve seen very good success in that marketplace.
And we’ll now hear from Matt Summerville with KeyBanc.
Matt Summerville – KeyBanc
Good morning. George, I’m curious to hear what your thoughts are behind Diebold’s sort of general inability to forecast revenue profit and cash flow over the last few quarters? And how quickly that can be remedied? And how you’re attacking that?
Well, clearly, I think that there’s room for improvement in terms of our forecasting. There is significant unpredictability in our business, given our concentrated nature of our end markets in the U.S. and Brazil specifically. And I think if you look at the opportunities in Brazil and the opportunities we have with the public tenders as we go forward in 2013, timing and the outcome of those tenders will really give us ability to improve our forecasting as we go forward.
Matt Summerville – KeyBanc
And then just, one follow-up. Henry, maybe you can comment. Early on in your prepared remarks, you mentioned that how displeased the board has been with the level of execution in this company. I guess what gives you the confidence to move forward with this M&A strategy and potentially do what I would imagine would be the biggest acquisition Diebold’s done in its history?
Well, I don’t know what you mean by the biggest acquisition that Diebold has done in its history. But let me take it one step at a time. Our issue is we’re concerned about the short-term performance of the company. And I think we’ve got strategies in place to rebuild that and to refocus our energies, and basically harvest the capabilities of our global organization so that we can generate more cash in the business, which is more cash for investing into growth areas.
In terms of what we buy, we’re still looking at those. I haven’t seen anything that that makes me feel as though it’s the biggest investment that we’ve ever seen. But we will be obviously looking in electronic security to find a platform that we can really build the business around. And then I would imagine it would be a series of small acquisitions to bolt onto that, because this is a very fragmented business throughout the U.S. And, therefore, this – once we’ve got the platform established and what we need to do, it will then be how quickly we want to invest and ratchet up those smaller acquisition capabilities.
Thank you. (Operator Instructions) And now, we’ll hear from Paul Coster with JP Morgan.
Paul Coster – JP Morgan
Thank you for taking the question. Obviously, the regional bank business, the comps have gotten pretty tough and it sounds out of your control, but it sounds like it disappointed nonetheless. What do you attribute the disappointment to? Is it products? Is it sales? Is it the assessment of the pipeline? And what do you think you can do about it?
Yeah. This is George. I think from my view, as in the U.S. market, as in all of our markets, we continue to face some pretty significant competitive pressures, along with pricing pressures. And, clearly, the mix change between the national and regional space had a lot to do with our performance as well in 2012. I’d like to ask, Mychal to add some color there.
Thanks, George. As Brad stated previously, we have seen in our regional bank segment a reset to more – to a more normalized rate coming off of this big 88 PCI upgrade cycle in 2011 and 2012. We do still see, though, deposit automation is driving incremental improvements to our normal core business run rate, but it’s just at a much slower adoption rate than we had previously expected in the segment.
Paul Coster – JP Morgan
Okay. So, the implication is that – it’s just the customers faded away, it wasn’t that your pipeline was sort of overstated or that the – the sales team was so overly optimistic?
That’s correct. We just – we’re really seeing a reset in the business back to kind of our core run rate, that would set up for pre-ADA PCI levels.
Yeah, Paul, just, again, just to support Mychal’s point, again, I mean, we’ve got – as we forecast what happened in the fourth quarter, we had very good kind of visibility to what was going to be scheduled and delivered. But we did see in the fourth quarter some customer delays where they pushed installation into 2013. So, we are seeing, again, that’s driven by the overall softness in the marketplace.
And, now we’ll take a follow-up question from Matt Summerville with KeyBanc.
Matt Summerville – KeyBanc
Just two follow-ups, maybe to help illustrate some of the margin pressure you’ve seen, Brad, can you give any detail around what your mix was in North American Product revenue in the first quarter of 2012 versus where you see it right now?
Yeah. Let me just, I won’t answer your question exactly, but I think it’s helpful to look at kind of the mix between regionals and nationals in total and, again, there’s Product and Service component to that. But as it relates to kind of the Product side, I mean, in the first quarter 80% of our revenues were into that regional space. When we concluded 2012, the fourth quarter, we were at 60%, so we saw a very significant mix shift as we’ve talked about on this call from the regionals back to the national throughout the year.
Matt Summerville – KeyBanc
And then, George, as you’ve done a lot of work in tackling sort of the product related cost of goods sold, I guess what’s sort of left in the gas tank there as you’ve kind of realigned manufacturing? You’ve done a lot with supply chain and yet the product margins are still under pressure and I get the whole mix thing, but at the end of the day margins need to move up not down. And then what’s your sort of initial impression on the cost structure of the Service business and what you can bring to the table there?
Well, I think the most important part of our restructuring here, our reorganization is that by creating the global functional organization, it allows us to have a single focus, a single owner, a clear sight of ownership and responsibility, accountability to drive results. And so, in the past I think we’ve made significant improvements, but those improvements often stopped at – between the functional boundaries of the organizations. And so, with the new organizational structure in place, I’m very excited about our opportunities to drive additional cost savings throughout the company, especially in the Services area.
And we will hear from Julio Quinteros with Goldman Sachs.
Julio Quinteros – Goldman Sachs
Great. Hey, guys. Good morning. Maybe one quick one with a quick follow-up. On the – the visibility that you guys have into the capital expenditure budgets or the IT budgets of your bank customers in the U.S., do you guys have a good sense right now on what that’s trending like? Are budgets up, flat or any color that you guys can provide there in terms of the expectations would be helpful?
Yeah, thank you. This is Mychal Kempt. I would say right now there’s been a bit of a pause coming off of this ADA PCI run and that as we look out into 2013, right now, it’s a little bit soft in terms of the feedback we’re getting from our customers. So, as they’re starting to look out, there is a tremendous amount of work to be done. And they don’t have great clarity on their capital budgets, but it’s – see a fairly soft start and each month as we move forward, I gain a little bit better clarity as to how the year’s going to shape up.
Julio Quinteros – Goldman Sachs
Okay. And then, secondly, on Brazil, I think we’re two or three quarters now into this order that keeps getting delayed. At what point do you guys just sort of write it off and say, it’s just not going to happen? Or is there something that essentially guarantees that eventually that work turns to revenue for you guys?
No, I mean, we feel like ultimately, I mean, these units need to be replaced. They need to be upgraded. So we do believe that those ultimately will come to fruition. Again, the two orders that we spoke to we won those outright. They got cancelled for various reasons. And we do expect those orders to come back for public tender here in the first half of the year, with assuming that we win – which, again, we’ve had a very, very good track record -but assuming we win then those would be delivered in the second half of this year.
But, again, pointing out that there are many variables here. And this is why we talked about the variation in the earnings. One is, as you point out, Julio, the auction has to take place. It has to take place in a timely manner, such that then we have the opportunity to win it, and then execute on it in the second half. So, again there’s a lot of variables here that we’re watching very, very closely.
Thank you. And at this time, I would like to turn the call back over to Mr. John Kristoff for any additional or closing remarks.
Thank you, Jennifer. And I’d just like to thank everyone for joining us on the call this morning. And as always, if you have any follow-up questions, please feel free to contact me directly or Nick Codispoti. Thank you very much.
Thank you, sir. That does conclude today’s conference call. We do thank you all for your participation.
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